Economic exposure is based on extent to which currency changes affect a. value of firm's balance...

Economic exposure is based on extent to which currency changes affect

	a.	value of firm's balance sheet assets & liabilities
	b.	market value of the firm
	c.	netting of cash flows across subsidiaries of companies
	d.	a firm’s financial statements

Expert Solution

The correct answer is b. Market Value of the firm

Economic exposure is an indirect exposure which is faced by all firms. Thus even though a firm may not have foreign currency receivable or payable it will be affected by the change in exchange rate. The impact of economic exposure is on the market value of the firm. Where due to change or fluctuations in the exchange rate the value of the firm gets affected. Unlike transaction exposure, the economic exposure is difficult to hedge.

Example - Suppose an Indian firm is exporting goods to USA and drawing an invoice of Rs.500, 000. Prima facie it would seem that the Indian firm is not affected by the change in Rupee / US Dollar rate. However if US Dollar rate depreciates from 50 to 40 the dollar equivalent price for the US customer would rise from (500,000 / 50) = $10,000 to (500,000 / 40) = $12,500. This will result in 25% increase in price for the US customer. If price elasticity of demand is 2 then demand for the product will fall by (25*2) = 50%. This will adversely affect the Indian firm.

jeff jeffy answered 1 year ago

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