Foreign Exchange Exposure and Risk.

World is changing faster than human Endeavor

Referred International Financial Management by P.G. Apte, fifth edition

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Currency Exposure

Short Terma. Accounting ( Translation)

b. Cash FlowI. Contractual( Transactions)

II. Anticipated

Long Term a. Operating

b. Strategic

Referred International Financial Management by P.G. Apte, fifth edition

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Exposure and Risk

Though exposure and risk are used interchangeably But Exposure is the measure of the sensitivity of

the value of the financial item( asset liabilities or cash flow) to change in relevant risk factor

while Risk is a measure of variability of the value of the item attributable to the risk factor.

Example: Firm export import having significant exposure to Foreign exchange rate. But may not perceive significant risk as the dollar –rupee exchange rate is stable for last so many months

Referred International Financial Management by P.G. Apte, fifth edition

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( Accounting) Translation Exposure Translation Exposure is also known as the

Accounting Exposure A firm may have assets and liabilities denominated

in foreign currency. Accounting standard which governs the reporting

and disclosure practices, the firm must translate the values of these currency –denominated items into home currency and report these in the balance sheet.

Referred International Financial Management by P.G. Apte, fifth edition

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Translation Exposure

Translation exposure typically arise when a parent multinational company required to consolidate a foreign subsidiary's financial statement

Example At the beginning of the financial year the subsidiary has real estate, inventories and cash valued at $100000, $200000, and $150000 respectively the spot rate is 1$= 46 Rs, by the close of financial year the values are changed as dollar depreciated to Rs at 1$ = 42Rs here the Indian concern with USA subsidiaries will make huge loss of $450000*(Rs 46 – Rs 42).

Referred International Financial Management by P.G. Apte, fifth edition

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Translation Loss or gain

The loss suffered by converting the assets and liabilities from foreign currency to domestic currency is known as transaction loss.

Similarly for the gain.

Referred International Financial Management by P.G. Apte, fifth edition

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( Contractual) Transactions Exposures It measures the sensitivity arises when the assets or

liabilities are liquidated due to change in the exchange rate.

Examples: A currency has to be converted in order to make or receive payment for goods and services- import payable or export receivables denominated in a foreign currency

A currency has to be converted to make a dividend payment, royalty, payment and receivable to repay foreign loan and interest.

Referred International Financial Management by P.G. Apte, fifth edition

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Transaction Risk

An unanticipated change in the exchange rate has an impact favorable or adverse on its cash flows.

Transaction risk can be defined as a measure of variability of assets and liabilities when they are liquidated. May lead to exchange gain or loss.

The key difference between transaction exposure and translation is that former has impact on cash flows while latter has no direct effect on cash flows. ( This is true if there is no tax effects arising out of translational gains or loss. )

Referred International Financial Management by P.G. Apte, fifth edition

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Anticipated

Sometimes transaction is being negotiated, all terms more and less finalized but a contractual agreement yet to be entered into.

Referred International Financial Management by P.G. Apte, fifth edition

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Strategic exposure

The focus impact of cash flows of firm in years to come

Horizon are long nothing is contractually fixed and the impact of exchange rate fluctuations can have substantial, sustained implication

In long run exchange rate effect can undermine a firm's competitive advantage by raising by raising it’s cost above the competitors cost.

Referred International Financial Management by P.G. Apte, fifth edition

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Unanticipated exchange rate change on firm’s revenue, operating cost and operating net cash flow over a medium term horizon

Change in exchange rate can affect on sales volume, input cost of imported materials, labour costs, interest costs, inflation, income distribution

Referred International Financial Management by P.G. Apte, fifth edition

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Operating Exchange Exposure Of two kind of long term exposure operating

and strategic . Operating exposures capture the impact of

unanticipated exchange rate changes on the firm’s revenue, operating costs and operating net cash flows over a medium term say up to three years.

Referred International Financial Management by P.G. Apte, fifth edition

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Thank You

Exposure can be Covered , Risk can be Neutralized completely it needs self confidence, patience and courage to be Creative. Not stress , tension and frustration to feel desperate..