11 Pages Posted: 5 Apr 2010
This note describes the economic exposure that arises from changes in currency exchange rates. After illustrating the economic impact of exchange rate changes, including a discussion of real exchange rate changes, the note provides a summary of methods used to manage exposure. The use of forward rates and money markets is explored in detail.
Rev. Nov. 12, 2009
The term exposure refers to the extent to which a firm is affected by exchange rate changes. Exposure determines the potential magnitude of the risks that accompany currency fluctuations. A distinction is commonly drawn between accounting exposure, which refers to the changes in financial statements that occur due to currency changes, and economic exposure, which refers to real economic changes. Accounting exposure may or may not have economic consequences. Economic exposure, in turn, is commonly divided into two categories:
Operating exposure is the economic exposure created when the operations of a firm generate foreign-currency-denominated cash flows.
Transaction exposure is the economic exposure created when contractual obligations are denominated in foreign currencies.
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Keywords: currency exchange rate change hedge hedging exposure operating transaction
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