foreign currency exposures

Examples of foreign currency exposures in the following topics:

• Types of Exchange Exposure: Short-Run, Long-Run, and Translation

  • Foreign currency exposures are categorized as transaction/ short-run exposure, economic/ long-run exposure, and translation exposure.
  • Foreign currency exposures are generally categorized into the following three distinct types: transaction (short-run) exposure, economic (long-run) exposure, and translation exposure.
  • A firm has transaction exposure/ short-term exposure whenever it has contractual cash flows (receivables and payables) whose values are subject to unanticipated changes in exchange rates due to a contract being denominated in a foreign currency.
  • To realize the domestic value of its foreign-denominated cash flows, the firm must exchange foreign currency for domestic currency.
  • As all firms generally must prepare consolidated financial statements for reporting purposes, the consolidation process for multinationals entails translating foreign assets and liabilities or the financial statements of foreign subsidiaries from foreign to domestic currency.

• Global finance: initial considerations

  • The price of one country's currency in units of another country's currency is known as a foreign currency exchange rate.
  • One way, known as a direct quote, is to state the number of domestic units of currency per one unit of foreign currency.
  • The foreign exchange (Forex) market is the mechanism, which facilitates the purchase and the sale of foreign currencies.
  • Currency risk is the potential consequence from an adverse movement in foreign exchange rates (Coyle, 2000).
  • Hedging is the term used to describe the actions that reduce or eliminate an exposure to risk (Coyle, 2000).

• Exposure Types

  • As a business invests or operates in a foreign country, a changing exchange rate causes gains or losses on international business activities.
  • Firms are subjected to currency risk, called exposure.
  • Transaction exposure comes from the risk of transactions denominated in different currencies.
  • Economic exposure is how a firm's expected cash flows are affected by unexpected changes in currency exchange rates.
  • Translation exposure, referred to as accounting exposure, is fluctuations in currency exchange rates affect a firm's consolidated statements.

• Answers to Chapter 19 Questions

  • Transaction exposure is the impact on current transactions, such as accounts receivable and accounts payable in a foreign country when the exchange rate changes.
  • Economic exposure is fluctuating exchange rates affect expected cash flows over time.
  • Translation exposure is the change in a company's consolidated financial statements because accountants use different exchange rates to convert accounts into the domestic currency.
  • Thus, the transaction exposure is your costs rise while your revenues fall.
  • Second, company can shift its production to low-cost countries, especially in countries that weaken its currency.

• Measuring and Protecting against Economic Exposure

  • A firm must accurately forecast cash flows and exchange rates because the transaction exposure alters future cash flows as the currency exchange rates fluctuate.
  • If a subsidiary sees positive cash flows after correcting for the currency exchange rates, then its net transaction exposure is low.
  • Analysts can estimate economic exposure accurately if currency exchange rates display a trend, and they know future cash flows with certainty.
  • Using a simple example, our home country is the United States while Europe is the foreign country.
  • Thus, the price, P, is the foreign asset's price in U.S. dollars while S indicates the spot exchange rate, defined as U.S. dollars per euro.

• International Exchange of Money

  • The foreign exchange market is a form of exchange for international currencies that determines the relative values of different currencies.
  • In a typical foreign exchange transaction, a party purchases a quantity of one currency by paying a quantity of another currency.
  • The foreign exchange market (forex, FX, or currency market) is a form of exchange for the global decentralized trading of international currencies.
  • The foreign exchange market determines the relative values of different currencies.
  • The foreign exchange market assists international trade and investment by enabling currency conversion.

• Introducing Exchange Rates

  • In finance, an exchange rate (also known as a foreign-exchange rate, forex rate, or rate) between two currencies is the rate at which one currency will be exchanged for another.
  • It is also regarded as the value of one country's currency in terms of another currency .
  • Exchange rates are determined in the foreign exchange market, which is open to a wide range of buyers and sellers where currency trading is continuous.
  • The buying rate is the rate at which money dealers will buy foreign currency, and the selling rate is the rate at which they will sell the currency.
  • Explain the concept of a foreign exchange market and an exchange rate

• Exchange Rates

  • The price of one country's currency in units of another country's currency is known as a foreign currency exchange rate.
  • A foreign currency exchange rate between two currencies is the rate at which one currency will be exchanged for another.
  • Exchange rates can be quoted in two ways: (1) A direct quote, is to state the number of domestic units of currency per one unit of foreign currency; (2) If an exchange rate is an indirect quote, the exchange rate is stated as the number of foreign units per one unit of domestic currency.
  • For example, people intending to travel to another country may buy foreign currency in a bank in their home country, where they may buy foreign currency cash, traveler's checks, or a travel-card.
  • A currency pair is the quotation of the relative value of a currency unit against the unit of another currency in the foreign exchange market.

• Overview of Exchange Rates

  • In finance, an exchange rate (also known as the foreign-exchange rate, forex rate, or FX rate) between two currencies is the rate at which one currency will be exchanged for another.
  • Conversely, if the foreign currency is strengthening, the exchange rate number increases and the home currency is depreciating.
  • This is presented by a higher exchange rate if the exchange rate is quoted as home currency / 1 foreign currency.
  • The balance of payment model holds that a foreign exchange rate must be at its equilibrium level, which is the rate which produces a stable current account balance.
  • A nation with a trade deficit will experience a reduction in its foreign exchange rate reserves, which ultimately lowers (depreciates) the value of its currency.

• Exchange Rate Systems

  • An exchange rate regime is how a nation manages its currency in the foreign exchange market.
  • A floating exchange rate, or fluctuating exchange rate, is a type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market.
  • These regimes enable a country to dampen the impact of shocks and foreign business cycles, and to preempt the possibility of having a balance of payments crisis.
  • To ensure that a currency will maintain its "pegged" value, the country's central bank maintain reserves of foreign currencies and gold.
  • They can sell these reserves in order to intervene in the foreign exchange market to make up excess demand or take up excess supply of the country's currency.