Compare and contrast transaction exposure and economic exposure. Why would an MNC consider examining only its...

Compare and contrast transaction exposure and economic exposure. Why would an MNC consider examining only its “net” cash flows in each currency when assessing its transaction exposure?

Expert Solution

Transaction exposure vs economic exposure

	Transaction exposure	Economic exposure
Definition	Transaction exposure is due to international transactions by the firm.	Economic exposure includes any form of activity which will affect cash flows.
Hedging	These are more frequently hedged	These are seldom apply hedging
Nature of risk	Risk is limited to the contract or transaction under discussion. This is more technical and tactical	Risk affects the core value of business. This is strategy based
Mitigation of exposure	Firms can limit their transaction exposure to changes in the exchange rate is to implement a hedging.	Economic exposure can be mitigated either through operational strategies or currency risk mitigation strategies.
Source of uncertainty	Future exchange rate	Future exchange rates and its effect on sales, price and cost

Transaction exposure considers the actual cash outflow whereas economic exposure considers potential flows.
Most MNCs use operational hedging techniques such as diversity in marketing, financing research and development, and technology.
Economic exposure is the overall impact of exchange rate changes on the value of the firm.
Transaction exposure only considers international transactions by a firm, economic exposure considers all factors affecting cash flows.

Some of the inflows and outflows offset each other, net cash flow is a better measure for transaction exposure that's why MNC consider examining only its net cash flows in each currency when assessing its transaction exposure.

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