Question

6. Identify whether the following create substantial transaction, operating, and/or translation exposure (or no exposure at all) for a U.S. company, and how the company will be affected if the foreign currency depreciates. The examples will typically create more than one type of exposure.

a) Budweiser sells 50 mln euro worth of beer in Germany; payment will be made in euro next October.

Answer 1

Transaction exposure occurs when a Company has receivable or payable funds in foreign currency, the domestic currency equivalent of which is unknown. There might be differences in the exchange rate prevailing at the time of entering the transactions and the rate prevailing at the time of payment.

Translation Exposure occurs when a Company has subsidiaries, associates etc in foreign countries and it prepares the year end Consolidated Financial Statements of the group, including the Financial statements of its foreign counterparts. There might be differences in the exchange rate prevailing at the time of entering the transactions and the rate at which the Financial statement assertions must be converted in the Consolidated Statements. This might lead to a potential overstatement/ understatement of assest and liabilities.

Operating Exposure refers to how a Firm;s future cash flows and thereby the overall Firm value will be affected due to a change in foreign exchange rates. It also affects the entire industry or market as a whole and the economy is exposed to forex risk. It also related to unseen challenges from competitors, entry exit barriers etc.

As per the Question, Budweiser sells 50 mln euro worth of beer in Germany; payment will be made in euro next October. Also, German currency depreciates in October meaning that German currency becomes less valuable as compared to ruppee. Example, Euro depreciates from $ 1.5 per euro to $1.3 per euro in Oct, and Budweiser has euro receivable, so this will lead to a loss for Budweiser to the extent of : 50 mn (1.5-1.3)= $ 10 million .

Thus two types of exposures involved: 1. Transaction exposure due to the change in rates and potential loss.

2. Operating exposure as this exchange rate change affects similar companies/competitors in the US and therefore the economy as a whole. This eposure will prove to be a deterrant for Budweiser's future transactions in Germany and for other market players as well.

beer industry of US