Transaction exposure
This defines the foreign exchange rate risk in terms of the impact of exchange rate movement on the
firm’s future cash flows. This type of exposure arises from an obligation to either accept or deliver
foreign currency at a future date. The most important transactions leading to transaction exposure are
accounts receivable and accounts payables denominated in foreign currency.
Translation Exposure
Translation exposure defines exchange rate risk in terms of the impact of exchange rate movement on the
financial statement of the firm. When a business is organized as several separate corporations, then
financial statements must be filed on a consolidated basis so as to give shareholders concise and complete
information as to the financial position and the operating performance of the firm as a whole. When
subsidiary operate in a foreign country then major complications occur in consolidation process. This
problem arises from the fact that financial statements of the foreign subsidiary are usually in a currency
which is different form that of the parent company. The foreign currency must be converted into the
home currency before accounts can be consolidated. Translation exposure therefore is the extent to which
multinational firms consolidated financial statements are affected by the need to convert its foreign
subsidiary accounts to the home currency. As the value of the exchange rate fluctuates, so would be the
value of the foreign subsidiary.
Economic Exposure
Economic exposure defines exchange rate risk as the total impact on all the cash flow of the firm (both
contractual and non-contractual) It is broader than the other types of exposure and may be considered to
be the overall impact of the foreign exchange fluctuations on the shareholders wealth. It affects both the
companies that enter into foreign currency transactions and those that do not.
Kavungya answered the question on April 15, 2021 at 07:05
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Date posted: April 14, 2021. Answers (1)