05_Transaction+Exposure - Management of Transaction Exposure 1 Introduction There are three basic kinds of exposure to changes in foreign exchange rates

05_Transaction+Exposure - Management of Transaction...

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Management of Transaction Exposure 1
Introduction There are three basic kinds of exposure to changes in foreign exchange rates: Transaction exposure Economic (Competitive) exposure Translation (Accounting) exposure A classic example of transaction exposure is a firm that has signed a contract to ship goods overseas at a fixed foreign currency price. 2
Introduction 3 t 1 t 4 t 2 t 3 Life Span of Transaction Exposure Seller quotes a price to buyer (verbal or in written form) Buyer places firm order with seller at price offered at time t 1 Seller ships product and bills buyer Buyer settles A/R with cash in amount of currency quoted at time t 1
Forward Market Hedge: Imports If you expect to oweforeign currency in the future, you can hedge by agreeing today to buythe foreign currency in the future at a set price by entering into a long position in a forward contract. Forward Contract Counterparty Importer Foreign Supplier 4
Forward Market Hedge: Exports If you are going to receiveforeign currency in the future, agree to sellthe foreign currency in the future at a set price by entering into short position in a forward contract. 5

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