Foreign Exchange Exposure – Meaning & Classification

If the Dollar rises by ₹5, does it hurt you?

• If you are a student in India: No. (Zero Exposure).
• If you are a student planning to study in USA: Yes. (High Exposure).

Exposure is the measure of sensitivity of the firm's value to changes in exchange rates.

1. Risk vs Exposure

• Forex Risk: The probability that the exchange rate will change. (e.g., Variance of USD/INR).
• Forex Exposure: The amount of money at risk due to that change.
  • Equation: Exposure = Amount of Foreign Currency Assets - Amount of Foreign Currency Liabilities.

2. Classification of Exposure (The Big 3)

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3. Comparison of Types

4. Exam Notes: Writing the Answer

Question: "Classify Foreign Exchange Exposure." (10 Marks)

Answering Strategy:

1. Define: "Extent to which value of firm is affected...".
2. Tree Diagram: Draw the 3 types clearly.
3. Explain:
   • Transaction: "Committed cash flows".
   • Translation: "Consolidation of accounts".
   • Operating: "Future competitiveness".

Summary

• Transaction: Past decisions, current payment.
• Operating: Future decisions, future payment.
• Translation: No cash movement, only book entry.

Quiz Time! 🎯

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