Foreign Exchange Exposure

Definition: Foreign Exchange Exposure refers to the risk associated with the foreign exchange rates that change frequently and can have an adverse effect on the financial transactions denominated in some foreign currency rather than the domestic currency of the company.

In other words, the firm’s risk that its future cash flows get affected by the change in the value of the foreign currency, in which it has maintained its books of accounts (balance sheet), due to the volatility of the foreign exchange rates is termed as foreign exchange exposure.

It is not only those firms who directly make the financial transactions in the foreign currency denominations faces the risk of foreign exposure, but also, the other firms who are indirectly related to the foreign currency is exposed to foreign currency risk.

For example, if Indian company is competing against the products imported from China and if the Chinese yuan per Indian rupee falls, then the importers enjoy decreased cost advantage over the Indian company. This shows, that the companies not having any direct link to the forex do get affected by the change in the foreign currency.

Types of Foreign Exchange Exposure

 

Foreign Exchange Exposure

  1. Transaction Exposure
  2. Operating Exposure
  3. Translation Exposure

Out of these three risks, the first two risks, i.e. transaction risk and the operating risk are called “cash flow exposure” or “economic exposure”, while the translation risk is called the “accounting exposure”.

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