Question

Why Is operating exposure to currency risk hard to manage? In light of this fact, should firms perhaps abstain from it and concentrate on managing their transaction exposures instead? Why, or why not?

Answer 1

Operating exposure to currency risk ,also known as economic exposure or exchange rate risk,it occurs as a result of the effects the unexpected currency fluctuations have on a firm's cash flow, and market value.The operating exposure is long term in nature and is harder to manage.Operating exposure can affect the competitive position of the firm.They are harder to manage since they are a result of unexpected currency fluctuations.Another factor that which makes managing operating exposure hard is the fact that t cannot be as accurately predicted or quantified as translation or transaction exposure.

Despite the fact that operating exposure to currency risk, managements often abstain from the management of operating exposure to currency risk ,since most tools that are used for risk management in the case of transaction exposures like options ,swaps etc are purely speculative.The fact that economic exposure cannot be precisely measured is another reason.Also the presence of certain equilibrium conditions like Purchase power parity(relationship between prices of goods in different markets) and the relationship between interest rates and exchange rates (International fisher effect) make the economic exposure management less relevant.All of the aforementioned facts leads to the conclusion that management cannot always hedge against currency risk.

Managements however can focus on which currency risk they want to manage and can choose to focus on the impact it has cash flow rather than the overall earnings .The management can choose to prioritize the currency risk that might cause financial distress over the other currency risks.