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Managing Transaction Exposure

This document discusses transaction exposure, which is the risk faced by international businesses from currency exchange rate fluctuations after financial obligations have been agreed upon. Transaction exposure can be hedged using techniques like futures contracts, forward contracts, money market hedges, and currency options to lock in exchange rates and limit losses from shifting rates. Alternative techniques like leading and lagging payments, cross-hedging using correlated currencies, and diversifying business across currencies can also help reduce transaction exposure risk.

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Varun Kumar
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298 views14 pages

Managing Transaction Exposure

This document discusses transaction exposure, which is the risk faced by international businesses from currency exchange rate fluctuations after financial obligations have been agreed upon. Transaction exposure can be hedged using techniques like futures contracts, forward contracts, money market hedges, and currency options to lock in exchange rates and limit losses from shifting rates. Alternative techniques like leading and lagging payments, cross-hedging using correlated currencies, and diversifying business across currencies can also help reduce transaction exposure risk.

Uploaded by

Varun Kumar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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MANAGING

TRANSACTION
EXPOSURE

BY VARUN KUMAR
MEANING

– Transaction exposure is the level of uncertainty businesses


involved in international trade face. Specifically, it is the risk that
currency exchange rates will fluctuate after a firm has already
undertaken a financial obligation. A high level of vulnerability to
shifting exchange rates can lead to major capital losses for these
international businesses.
– Transaction exposure is also known as translation exposure or
translation risk.
UNDERSTANDING TRANSACTION
EXPOSURE

– The danger of transaction exposure is typically one-sided. Only the


business that completes a transaction in a foreign currency may
feel the vulnerability. The entity that is receiving or paying a bill
using its home currency is not subjected to the same risk.
– Usually, the buyer agrees to buy the product using foreign money.
If this is the case, the hazard comes if that foreign currency
should appreciate , as this would result in the buyer needing to
spend more than they had budgeted for the goods.
EXAMPLE OF TRANSACTION
EXPOSURE
– Suppose that a United States-based company is looking to purchase a product
from a company in Germany. The American company agrees to negotiate the
deal and pay for the goods using the German company's currency, the euro.
Assume that when the U.S. firm begins the process of negotiation, the value
of the euro/dollar exchange is a 1-to-1.5 ratio. This rate of exchange equates
to one euro being equivalent to 1.50 U.S. dollars (USD).
– Once the agreement is complete, the sale might not take place immediately.
Meanwhile, the exchange rate may change before the sale is final. This risk of
change is transaction exposure.
MANAGING TRANSACTION
EXPOSURE
– One way that firms can limit their exposure to changes in
the exchange rate is to implement a hedging strategy.
– Once the degree of transactions exposure has been
determined (by currency) with relative certainty, the next
step is to figure out:
– Whether all transactions exposure should be hedged
– Whether transactions exposure should be hedged selectively,
– None of the transactions exposure should be hedged at all.
Techniques to Eliminate Transaction
Exposure
– Hedging techniques include:
 Futures Hedge
 Forward Hedge
 Money market Hedge
 Currency Hedge
– MNCs will normally compare the cash flows that would be expected
from each hedging technique before determining which technique to
apply.
FUTURES AND FORWARD
HEDGES
– A futures hedge uses currency futures, while a forward hedge uses
forward contracts, to lock in the future exchange rate.
– Forward contracts are commonly negotiated for large transactions,
while the standardized futures contracts tend to be used for
smaller amounts.
– To hedge future payables a firm may purchase currency futures, or
negotiate a forward contract to purchase the currency forward.
MONEY MARKET HEDGE

– A money market hedge involves taking a money market position to cover a


future payables or receivables position.
– A money market hedge is a technique used to lock in the value of a foreign currency
transaction in a company’s domestic currency. 
– It is called a money market hedge because the process involves depositing funds into a
money market, which is the financial market of highly liquid and short-term instruments
like Treasury bills, bankers’ acceptances, and commercial paper.
CURRENCY OPTION HEDGE

– A currency option hedge uses currency call or put options to hedge


transaction exposure.
– Since options need not be exercised, they can protect a firm from
adverse exchange rate movements, and yet allow the firm to
benefit from favorable movements.
ALTERNATIVE HEDGING
TECHNIQUES
– Sometimes, a perfect hedge is not available to eliminate
transaction exposure.
– To reduce exposure under such conditions, the firm can
consider:
 leading and lagging,
 cross-hedging,
 currency diversification.
LEADING AND LAGGING

– Leading and lagging strategies involve adjusting the timing of a


payment request or disbursement to reflect expectations about
future currency movements.
– Expediting a payment is referred to as leading, while deferring a
payment is termed lagging.
CROSS-HEDGING

– When a currency cannot be hedged, another currency that can be


hedged and is highly correlated may be hedged instead.
– The stronger the positive correlation between the two currencies,
the more effective the cross hedging strategy will be.
CURRENCY DIVERSIFICATION

– An MNC may reduce its exposure to exchange rate movements


when it diversifies its business among numerous countries.
– Currency diversification is more effective when the currencies are
not highly positively correlated.

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