Economic Exposure
Economic exposure refers to the risk a company faces from fluctuations in exchange rates, which can impact its future cash flows, profits, and competitive position. It reflects the potential impact of currency movements on a company's international operations and financial performance. Managing economic exposure involves strategies such as hedging and diversification to mitigate the potential adverse effects of currency fluctuations.
6 Key excerpts on "Economic Exposure"
eBook - ePub- J. Falzon(Author)
- 2013(Publication Date)
- Palgrave Macmillan(Publisher)
...In principle, a transaction exposure is usually related to the flows of funds that starts at the moment of pricing or, more precisely, at the moment an order is placed, and ends at the moment the payment is converted into the headquarters currency and placed on its current accounts. The Economic Exposure is described as the long-term measure on how the value of a company will change relative to long-term changes in exchange rates. This measure extends the transaction exposure to cash flows that are not yet realized but may influence future sales volumes, prices and also input costs (Dhanani and Groves, 2001; Moffett and Karlsen, 1994). Economic Exposure is a result of a misalignment between firms’ future operative costs and future operative earnings. Consequently, other definitions are operational exposure or business exposure. Because of its long-term nature, and due to the fact that companies face competition from foreign companies, this exposure is argued to be best managed through natural hedges, and should be part of the overall strategy of the company (Chow et al., 1997; Pringle and Connolly, 1993). A common definition of translation exposure is ‘the net balance position of foreign currency translated at the currency exchange rate’ (for example Oxelheim and Wihlborg, 2005, p. 62). It is not only a translation of financial (income) statements from affiliated firms into the parent firm, but also a translation of assets and liabilities denoted in foreign currencies into that of the parent. Theoretically, it is argued that this type of exposure is irrelevant to hedging, as it only relates to past performance and does not affect future cash flow...
eBook - ePub- Alastair Graham, Alastair Graham(Authors)
- 2014(Publication Date)
- Routledge(Publisher)
...These exposures can be either short term or long term. Direct Economic Exposures are a company's expected future receipts and payments in foreign currency, where specific transactions have not yet been made. For example, a Norwegian oil company, selling its North Sea output in dollars, will know that it can expect future dollar income from its oil sales. It has continuing Economic Exposures because of its dollar income, and is at risk from a decline in the dollar's value. Indirect Economic Exposures are the long-term risks to a business from adverse economic developments in the country in which it is based, resulting in exchange rate movements that benefit foreign competitors. Example 1 A Spanish company competes with a US company and a Brazilian company, for markets in the European Union and the US. The costs per unit are €10 to the Spanish company, $11 to the US company and BRR22 to the Brazilian company. The selling price per unit of product is €15 in Europe and $16.50 in the US. Exchange rates are €1 = $1.10, €1 = BRR2.20 and $1 = BRR2 Analysis At these costs, exchange rates and selling prices, all three companies are equally competitive in the European and US markets. Suppose, however, that exchange rates changed as follows €1 = $1.50 €1 = BRR3.00 $1 = BRR2.00 The euro has strengthened against both the dollar and the Brazilian real, but the relative value of the Brazilian real and the dollar against each other is unchanged. The consequences for the Spanish company would be devastating. In the US market, where the product is sold for $16.50, the Spanish company would now earn revenue of just €11 per unit, and because the cost of sale is €10, sales to the US would be barely profitable. In the European market, the Spanish company will come under threat from low-cost producers in the US and Brazil...
- Gary Shoup(Author)
- 2013(Publication Date)
- Routledge(Publisher)
...Knowledge that the pound moves less than four cents 95% of the time is irrelevant when the UK pulls out of the European Monetary System, and the pound goes down 18¢ overnight. So a measurement of historical risk is only a guess of future risk. Figure 8-1: Volatility of British Pound Assuming Random Price Movement: Hypothetical Example The second step in developing a currency management program is to review company's objectives and priorities, and then determine how each might be exposed to a particular change in a currency exchange rate. Under various “what-if’ scenarios, exactly how much damage can the exposure really do? Are only 6% of projected revenues exposed to a shift in exchange rates, or is the company's entire sales program at risk? The real risk of exposure goes unnoticed much of the time. A specific change in exchange rates can have a positive effect on one corporate objective, a neutral influence on a second, and, simultaneously, a negative effect on a third. The company may only be aware of the positive effect. A business enterprise seeking to reduce currency risk may actually increase risk by focusing on exposure from the wrong angle. Lack of a common language to describe risk exposure hampers those who try to manage it. Foreign currency management is still developing, and the terminology is unsettled. One hears of accounting exposure, Economic Exposure, operation exposure, anticipatory asset and liability exposure, contingency exposure, net income exposure, and so on. Very often, the definition of the term depends upon the speaker and the context in which it is used. This book uses the terminology and the hierarchy of definitions developed by Christine R. Hekman. 1 She categorizes exposures by duration, the business functions that are affected, and the performance measurements that will be protected by their management...
eBook - ePubBusiness
The Ultimate Resource
- Bloomsbury Publishing(Author)
- 2011(Publication Date)
...Due to changes in rates, operating costs will rise and make a product uncompetitive in the world market, thus eroding profitability. There’s little that can be done about economic risk; it’s simply a routine business risk that every enterprise must endure. • Translation exposure. The impact of currency exchange rates will reduce a company’s earnings and weaken its balance sheet. In turn, the denominations of assets and liabilities are important, although many experts contend that currency fluctuations have no significant impact on real assets. • Transaction exposure. There will be an unfavorable move in a specific currency between the time when a contract is agreed and the time it is completed, or between the time when a lending or borrowing is initiated and the time the funds are repaid. This is the most common problem that confronts most companies. Requiring payment in advance is rarely practical, and impossible, of course, for borrowing and lending. “Debt is an evil conscience.” Thomas Fuller To reduce translation exposure, experienced corporate fund managers use a variety of techniques known as currency hedging, which amounts to diversifying currency holdings, monitoring exchange rates, and acting accordingly, depending upon specific conditions. Its advocates contend that taking appropriate action can greatly reduce translation risks, if not avoid them altogether. Currency hedging, however, is also technical and sophisticated. Transaction exposure can be eased by a process known as factoring. Major exporters, in particular, transfer title to their foreign accounts receivable to a third-party factoring house that assumes responsibility for collections, administrative services, and any other services requested. The fee for this service is a percentage of the value of the receivables, anywhere from 5 percent to 10 percent or higher, depending on the currencies involved...
eBook - ePubForeign Exchange
A Practical Guide to the FX Markets
- Tim Weithers(Author)
- 2011(Publication Date)
- Wiley(Publisher)
...cents on every Pound that is sold forward. On the other hand, if the forward is quoted at a discount, say F = 1.7600, this looks unattractive—almost as if they are giving away four U.S. cents per Pound. 2 Nevertheless, if the company specializes in food products and does not have an opinion (or “ax”) on FX rates, perhaps this is the prudent approach to transactional FX risk management. Corporates are also sensitive to the hedging activities of their industry rivals, which could, therefore, impact their relative competitiveness. For this reason, they sometimes “layer” in their hedges as their business activities develop throughout the year, that is, as their foreign exchange needs become more certain. Also, corporates often budget for a certain FX rate (a “hurdle” rate) which they may attempt, more or less actively, to better. An entirely different type of foreign exchange risk for a multinational firm is translational exposure. What this highlights is the fact that large international businesses may own subsidiaries, factories, plants, and inventories outside their home country. Since most publicly-traded companies must file quarterly and annual reports, and since these firms must convert all assets into their reporting currency, movements in exchange rates will affect the value of their institution—if only through their corporate financial statements; it is our understanding that most firms do not actively hedge this exposure. There is a third, different type of FX risk that businesses have: Economic Exposure. This is most easily explained by an example. Imagine that you are the CEO of RunCo, a U.S. company that produces a new portable CD player—the Runaround. Further, assume that you only make these in the United States, that you only use parts manufactured in the United States, that you employ only U.S. workers, that you pay for the inputs and wages exclusively in USD, and that you refuse to sell your product outside the United States...
eBook - ePub- Peter S Morrell(Author)
- 2018(Publication Date)
- Routledge(Publisher)
...7 Foreign Currency and Fuel Price Exposure 7.1 Exchange rate volatility International airlines sell tickets in many different countries and currencies, even in places where they do not have their own operations. They also incur operating expenses in the currencies of the countries they serve, and buy capital equipment from the major aerospace exporting countries such as the US, Canada, UK, France, Brazil and Germany. It would be impossible for there to be a perfect match in both amounts and timing of foreign currency receipts and expenses. An airline may achieve some sort of balance over the year as a whole in receipts and expenses in a certain currency, but there will be weeks and months of surpluses followed by periods of shortfall. This can be managed by borrowing and lending in this one currency, and thus not involving conversion into another currency or any exchange risk. But net surpluses in a foreign currency would have to be exchanged into the local currency, which is the currency in which most costs are incurred and ultimately any profits would be retained or distributed. Here, there will be a time lag between income and expenditure which involves a risk of a movement in the exchange rate, and therefore a foreign exchange loss or gain. An airline’s treasury has the task of managing revenues, expenditures, assets and liabilities in both local and foreign currencies, and thus minimising the risks of exposure to large currency movements. Since the late 1960s, exchange rates of currencies have floated with respect to other major currencies, subject to central bank intervention, in pursuit of economic and monetary goals. Some currencies are pegged to major currencies, such as the US dollar, or a basket of the currencies of their major trading partners...
