Exposure (to fx risk): firm is affected by a change in the exchange rate


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Exposure (to FX risk): firm is affected by a change in the exchange rate

  • Exposure (to FX risk): firm is affected by a change in the exchange rate

  • Transactions Exposure: firm’s cash flow

  • Operating Exposure: firm’s cash flow

  • Accounting Exposure: firm’s financial statements

  • Translation Exposure: firm’s financial statements


Contractual: contract exists that specifies a certain amount of FX will be received/paid e.g. export/import, debt denominated in FX.

  • Contractual: contract exists that specifies a certain amount of FX will be received/paid e.g. export/import, debt denominated in FX.

  • Change in the FX rate results in gain/loss.

  • FX receipt worry: FX depreciation

  • FX payment worry: FX appreciation

  • Transactions exposure is reflected in the firm’s financial statements, i.e. firm with transactions also has accounting exposure.



Worry: FX depreciation

  • Worry: FX depreciation

  • Sell the FX forward: sign contract now with bank committing to sell the FX at the future date at a rate set now

  • Will receive Y10 million at year end

  • Hedge by selling Y10 million one-year forward at one-year forward rate

  • The C$-value of the Y10 million is now set, i.e. now know the C$-value



Worry: FX appreciation

  • Worry: FX appreciation

  • Buy the FX forward: sign contract now with bank committing to buy the FX at the future date at a rate set now

  • E.g. will pay Y10 million at year end

  • Hedge by buying Y10 million one-year forward at one-year forward rate.

  • The C$-value of the Y10 million is now set, i.e. now know the C$-value of the FX payment



Non-contractual: no contract exists, yet firm is exposed

  • Non-contractual: no contract exists, yet firm is exposed

  • Change in the exchange rate results in gain or loss of competitive advantage

  • Explored in 3 vignettes document

  • Effects of operating exposure do not appear on the firm’s financial statements

  • Explored in Canuck Ltd.’s accounting exposure



1. Aspen Skiing (US firm): Revenues exhibited positive operating exposure to French franc, C$, Italian lira, etc.

  • 1. Aspen Skiing (US firm): Revenues exhibited positive operating exposure to French franc, C$, Italian lira, etc.

  • 2. Laker Airways (UK firm): Ditto, but negative operating exposure to U$.

  • 3. Canuck Ltd. (Canadian firm): Positive operating exposure to UK pound sterling.



Colorado resort: all balance sheet items and cash flows in greenbacks.

  • Colorado resort: all balance sheet items and cash flows in greenbacks.

  • Yet exposed to C$, FFr, etc.

  • In 1983, U$ appreciated, I.e. C$, FFr depreciated.

  • Domestic and foreign clientele shifted holidays to Banff, Chamonix, Chicopee.



Y-axis: Cash flows in U$; X-axis: S(U$/C$)

          • Y-axis: Cash flows in U$; X-axis: S(U$/C$)


Although you operate exclusively domestically, if your clientele has the option of purchasing in a foreign market, you exhibit positive exposure to that foreign market’s currency. A U.S. firm with Aspen Skiing as client likewise possesses the same type of exposure.

  • Although you operate exclusively domestically, if your clientele has the option of purchasing in a foreign market, you exhibit positive exposure to that foreign market’s currency. A U.S. firm with Aspen Skiing as client likewise possesses the same type of exposure.



Hedge positive operating exposure of cash flows to C$, FFr, etc.

  • Hedge positive operating exposure of cash flows to C$, FFr, etc.

  • Denominate some debt in C$, FFr, etc. Result: negative transactions exposure of debt offsets positive operating exposure of revenues.

  • Buy resorts in Canada, France, etc. Result: some revenue streams rise, other fall with rise in C$, FFr, etc.



Early exploiter of air transport deregulation in late 70’s. Target market: Price conscious Brit tourists vacationing in Florida.

  • Early exploiter of air transport deregulation in late 70’s. Target market: Price conscious Brit tourists vacationing in Florida.

  • Cost structure: jet fuel U$-denominated.

  • Financed jets with cheap U$-debt provided by US Ex-Im Bank.

  • Steep U$ appreciated in early 80’s spelled doom for Laker Airways.



Jet fuel: both transactions and operating exposure to U$.

  • Jet fuel: both transactions and operating exposure to U$.

  • Debt: transactions exposure to U$.

  • Revenues: negative operating exposure to U$. When U$ appreciated target clientele shifted holidays from Florida to Palma de Mallorca, Islas Canarias, Marbella, etc.



If your business involves assisting a domestic clientele purchase goods/services in a foreign country, you have negative operating exposure to that foreign country’s currency.

  • If your business involves assisting a domestic clientele purchase goods/services in a foreign country, you have negative operating exposure to that foreign country’s currency.

  • Dollar denomination of debt aggravated the firm’s negative exposure to the greenback.



Error: Denominated debt in U$’s.

  • Error: Denominated debt in U$’s.

  • Appreciation of U$ resulted in: Sterling value of costs and debt service increasing; Sterling value of revenues decreasing.

  • Sir Freddie got squeezed!

  • Hedges: debt denominated in Sterling; cater to Yank clientele vacationing in UK.



Canadian firm operating exclusively in Canada with no FX denominated assets/contracts.

  • Canadian firm operating exclusively in Canada with no FX denominated assets/contracts.

  • Major competitor in Canada sources product in the UK.

  • Canuck Ltd. has positive exposure to the Pound Sterling, PS. If PS appreciates, Canuck gains competitive advantage.

  • Hedge with PS denominated debt.



Effects of FX rate changes that are reflected in the firm’s financial statements.

  • Effects of FX rate changes that are reflected in the firm’s financial statements.

  • Transactions exposure is reflected.

  • Translation exposure is reflected.

  • Operating exposure is not reflected.

  • Accounting Exp. comprised of Transactions Exp. & Translation Exp



Parent company has a foreign subsidiary

  • Parent company has a foreign subsidiary

  • Foreign subsidiary’s financial statements must be consolidated (combined) with those of parent

  • E.g. Canadian parent (C$) vs. Chinese subsidiary (RMB) currency

  • Subsidiary’s statements are FX denominated

  • If FX (RMB) rate changes, consolidated statements are impacted: translation exposure!



Primary currency of the subsidiary’s activities, i.e. in which cash flows are generated

  • Primary currency of the subsidiary’s activities, i.e. in which cash flows are generated

  • 2 possibilities: parent’s currency (C$) versus subsidiary’s currency (RMB)

  • Distinction: subsidiary’s currency versus subsidiary’s functional currency



Most foreign subsidiary’s sales in the foreign country. It is a freestanding entity with self-contained operations

  • Most foreign subsidiary’s sales in the foreign country. It is a freestanding entity with self-contained operations

  • Functional currency is foreign (RMB)

  • Translation via current rate method

  • All assets / liabilities translated at the rate prevailing on the balance sheet date



Most foreign subsidiary’s sales in the parent country; a mere extension of parent, i.e. not freestanding

  • Most foreign subsidiary’s sales in the parent country; a mere extension of parent, i.e. not freestanding

  • Subsidiary’s functional currency is parent’s currency (C$)

  • Translation via temporal method

  • Only monetary assets / liabilities translated at the rate that prevails on the balance sheet date.



Assets: cash, marketable securities, accounts receivable

  • Assets: cash, marketable securities, accounts receivable

  • Liabilities: current liabilities, all debt (short term and long term)

  • Monetary means promises a fixed amount of currency

  • Nonmonetary: inventory, fixed assets, equity



Net Translation Exposure (NTE) in FX

  • Net Translation Exposure (NTE) in FX

  • Sell the amount of NTE forward: write contract now with bank committing to sell the amount of NTE at year-end

  • E.g. NTE=Y10 million; Hedge by selling Y10 million one-year forward

  • If NTE=-Y4 million, buy Y4 million forward; selling a negative quantity means buying



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