Question

1. List and describe the three types of exchange rate exposure that firms engaged in international business face.

Answer 1

Three types of exchange rate exposure are as follows -

1. Transaction exposure- This type of exposure reflects the sensitivity of domestic currency value of foreign currency denominated transactions arising from credit purchases and credit sales.The future cash flows in domestic currency is dependent of exchange rate on the future date on which payment & receipt happens.Any adverse movement in exchange rates can increase payable and reduce receivable by a significant margin.

2. Translation exposure- This type of exposure is the sensitivity of changes in the domestic currency value of the overseas. When the domestic currency of the parent company weakens in comparison with foreign currency if it's subsidiary , the value of assets and profits of foreign subsidiary grows resulting into favourable translation exposure and vice versa.

3. Operating exposure- This type of exposure reflects sensitivity to the change in exchange rate of domestic currency value of future payment stream of foreign currency.This deals with the business operations of the firm in coming months . It is a risk that firms revenue will be significantly impacted due to substantial change in exchange rate and inflation rate .