Question

Please explain economic exposure through an example. How can it be managed?

Answer 1

Economic exposure is the measure of change in total value of the company as a result of fluctuation in cash flows caused by changes in foreign currency exchange rate.

There are two ways through which economic exposure can be managed -

1 it can be through operational strategy which is aiming to adjust the company's operation to mitigate the risk associated with foreign currency fluctuations.

This could be done by diversification of production facilities and Markets of products and acquisition of key inputs from different regions which will help in sourcing the flexibility. It can also be done through diversifying the financial need from capital markets in different regions..

2. Economic risk can also be mitigated through currency risk mitigation strategies which involves minimising the economic exposure through hedging.hedging of economic exposure can be done through matching the currency flows in which the company matches foreign currency outflows with foreign currency inflows.

it can also be done through currency swaps in which a company can use currency swaps to obtain the required cash flows in foreign currency at the fixed exchange rate and swap it with the same in another currency at fixed date until the maturity of swap.

A lot of company also uses currency risk sharing agreement in which the risk is shared between both the parties.