Transaction Exposure:
Nature: Short-term and specific.
Focus: Relates to the impact of exchange rate movements on individual transactions, typically
involving the purchase or sale of goods or services.
Example: A company that exports products and invoices in a foreign currency is exposed to
transaction exposure.
Translation Exposure (Accounting Exposure):
Nature: Medium to long-term and holistic.
Focus: Concerns the translation of financial statements from one currency to another for
consolidation purposes, impacting the overall financial position of a multinational company.
Example: A multinational corporation consolidating financial statements from subsidiaries located
in different countries faces translation exposure.
Economic Exposure (Operating Exposure):
Nature: Long-term and strategic.
Focus: Involves the impact of exchange rate movements on a company's future cash flows, market
value, and overall competitiveness in the global market.
Example: A company with significant international operations that is sensitive to changes in
exchange rates impacting its competitiveness and profitability faces economic exposure.
Hedging is a risk management strategy aimed at minimizing potential losses from adverse price
movements in assets, commodities, or currencies. It involves using financial instruments like
derivatives (futures, options) to offset risks. For example, a company may hedge against currency
fluctuations when trading internationally.
Example of Hedging:
Scenario: A farmer is concerned about the future price of corn, which might decline by the time of
the harvest, leading to reduced revenue.
Hedging Strategy: The farmer enters into a futures contract to sell a specified amount of corn at a
predetermined price. This hedges against the risk of falling corn prices, ensuring a fixed selling
price regardless of market fluctuations.