Questions and answers about Foreign Exchange Exposure

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2008/05/05 22:14 | by mlzy ]

Just for remembering these answers so that I typed them out.

1. Give a general definition of "foreign exchange exposure" as it relates to the operations of a multinational enterprise.

In its general sense, foreign exposure is the possibilities of either beneficial or harmful effects on companies caused by the change in foreign exchange rates. The effect on the company may be on its cash flows, its profits, or its market value.

2. Explain the differences among the transaction, operation and translating exposure.

Transaction exposure is the potential gain or loss in contracted-for near term cash flows caused by a foreign exchange rate induced change in the value of amounts due to MNE or amount MNE owes to other parties. As such, it is a change in the home currency value of cash flows that are already contracted for.

Operating exposure is the potential for a change in the value of MNE, usually viewed as the present value of all cashinflows, caused by unexpected exchange rate changes. As such, it is a change in expected long-term cash flows; i.e., future cash flow expected in the cause of normal business but not yet contracted for.

Translation exposure is the possibility of change in the entity section(common stock, retained earnings, and equity reserves) of MNE's consolidated balance sheet, caused by a change (expected or not expected) in foreign exchange rates. As such, it is not a cash flow change but a result in consolidating into one parent company's financial statement the individual financial statements of related subsidiaries and affiliates.

3. What is risk tolerance? can it be measured?

Risk tolerance is the psychological or philosophical willingness of a firm, or of its managers, to bear risk. As such, it can not be quantified or measured, although observations and comparisons of management decisions over times can provide a rough inkling of such management's risk tolerance.

Variations in risk tolerance reflect the fact that different individuals have different opinions about whether or not a risk is worth bearing, or, conversely, whether or not a risk should be left open ended or hedged.