Currency can be affected from the fluctuations in forward market.

Exposure refers to the degree to which company is affected by exchange rate change. EXCHANGE EXPOSURE : Extent to which transaction, asset & liabilities of an enterprise are denominated in currencies other than currency of parent company of the enterprise. Exposure arises because enterprise operates in foreign market. Exposure is measured by

the value of the asset and liabilities.

EXCHANGE RISK : It is defined as net potential gains or losses which can arise from exchange rate

changes to the foreign exchange exposure of an enterprise.

Exposure relates to absolute value of an asset involved. Risk relates to changes in the value.

CLASSIFICATION OF FOREIGN EXCHANGE EXPOSURE:

Translation Exposure/ Accounting Exposure

Transaction Exposure
Economic/ operating Exposure

TRANSLATION EXPOSURE : Financial statements including information of all subsidiaries has to restate the local currency transactions into home currency and corresponding profit & losses arise due to translation from local currency to home currency. It is translation or accounting exposure.

TRANSLATION EXPOSURE
FOREIGN CURRENCY APPRECIATION

GAIN

T R A N S L A T I O N

E X P O S U R E

EXPOSED ASSET > EXPOSED LIABILITIES

POSITIVE/ LONG POSITION

FOREIGN CURRENCY DEPRECIATION

LOSS

EXPOSED ASSET < EXPOSED LIABILITIES

FOREIGN CURRENCY APPRECIATION NEGATIVE /SHORT POSITION FOREIGN CURRENCY DEPRECIATION

LOSS

GAIN

ACCOUNTING EXPOSURE :Accounting exposure arises from the need for purposes of reporting to convert the financial statements of foreign operations from the local currency involved to the home currency.

Measurement
Current Non current method Monetary- Non monetary method

Temporal method
Current Rate method

CURRENT NON CURRENT METHOD: The basis of this method is maturity of Asset and Liability. Under this method a foreign subsidiaries Current assets

and current liabilities are translated at current exchange

rate to home currency. Non current assets and liabilities are translated at historical exchange rate, i.e. the rate prevailing at the time of creating current assets and liabilities.

Monetary-Non Monetary Method : This method differentiates between monetary

assets and liabilities and non monetary assets

and liabilities.

Monetary assets and liabilities are converted

into home currency at current exchange rate and

Non

monetary

items

are

converted

into

historical exchange rate.

Temporal Method:
In temporal method inventory can be

translated at current exchange rate if it is

shown in the balance sheet at market value.

Otherwise like non monetary and monetary

method it will be translated into historical

exchange rate.

CURRENT RATE METHOD: Translate all balance sheet and income items at the current exchange rate. Mostly used by British Companies and various MNCs of USA.

TRANSACTION EXPOSURE :
It occurs because of foreign currency denominating transaction. If it remains unhedged than underlying transaction remains exposed to transactional risk. It is real risk and will effect the value of firm and it will result in variable future cash inflows.

Managing Transaction Exposure

It is based on the concept of hedging. Hedging a particular currency exposure means establishing an offsetting currency position such as

whatever is lost or gained on original currency exposure is exactly

offset by corresponding foreign exchange gains or losses on currency hedge.

FORWARD MARKET HEDGE

A Company that is long a foreign currency will sell the foreign currency forward where as A Company that is short a foreign currency will buy the currency forward.
In this way the company can fix the dollar value of future foreign currency cash flow.

MONEY MARKET HEDGE

Process of simultaneously borrowing or

lending in two different currencies to lock

into the value of dollar cash flow.

RISK SHIFTING Attempt to invoice exports in strong currencies and imports in weak currencies

RISK SHARING
Currency risk sharing can be used by formulating a customized hedging contract where by a base price is adjusted to reflect certain exchange rate changes. The parties to contract would share the currency risk beyond

neutral zone. This neutral zone represents the currency

range in which risk is not shared.

EXPOSURE NETTING :It involves the process of exposure in one currency is offset by exposure in another or same currency where exchange rate are expected to move in such a way that profit / losses on one currency position offset profit and losses in another currency.

Three possibilities are considered under exposure netting : Offsetting long position in one currency with short position in same currency. If exchange rate movements of two currencies are positively correlated then firm can offset a long position in one currency with short position in another. If exchange rate movements of two currencies are negatively correlated then short position can be used to offset each other.

ECONOMIC EXPOSURE It may be defined as the extent to which or degree to which the value of firm changes. Measured by present value of future cash flows as a result of exchange rate changes. Economic risk decisions are taken as strategic decision relating to strategic are. Decision reflects on future date the value of firm. Measurement of Economic Exposure Mathematically the economic exposure is expressed PV over e is change in exchange rate. PV change in present value of cash flow when the exchange rate changes by e Operating exposure arises because exchange rate fluctuations can alter the futures operating cash flows. Measuring operating exposure requires a long term view of firm as a going concern. In case of operating exposure it is real and not nominal exchange rate which plays the vital role.

Managing economic exposure includes:

Marketing Strategy
Production Strategy Financial Strategy

MARKETING STRATEGY Market Selection: The major consideration for exporter is to sell the product in a appropriate market by carefully selecting a market. In USA when dollar grew stronger it became stronger as compared to other countries. The domestic exporter faced the problem of costlier exports and eventually they had to pull out from US market to other markets,. On other hand strong dollar gave incentive to Japanese & European to increase their market share in USA. In India when rupee was quiet stronger between 1995 to June 1997. When it stayed around Rs. 36/- to a dollar than Indian exporter suffered and entered into Asian market as a strategy of market segmentation.

Thus market selection and market segmentation provides a marketing mix to a

company which can hedge against exchange rate variation by existing costlier market and entering cheaper market.

PRODUCTION STRATEGY :When the home currency rise is so strong that marketing strategy

alone fails to manage exchange rate risk. Choice for firm of US

following a very strong US $ either to cut the cost of production or drop the uncompetitive product.

Following production strategies may be used:

Shifting Production among plants Plant location Raising Productivity

PRICING STRATEGY :
It involves deciding about striking a balance between market share and profit margins.

PROMOTION STRATEGY :
while allocating promotional budget currency fluctuations should be taken care of. PRODUCT STRATEGY: Product strategy includes:
New product Introduction Product line decision Product Innovation

FINANCIAL STRATEGY Since marketing and production strategy takes too much time to implement and still more time to get results

therefore financial strategy is designed to support the

successful implementation of marketing and production strategy. Financial strategy deals with generating liabilities in same currency in which assets have been created. In order to service the liabilities the amount generated from assets in same currency is used.