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Unit 6: Economic Fundamentals and Foreign Exchange Risk Exposure

Third, Translate using current method recording gains/losses in the balance sheet and as Notes
realized.

Finally, consolidate into parent company financial statements.
Transaction Exposure

This exposure refers to the extent to which the future value of firm’s domestic cash flow is
affected by exchange rate fluctuations. It arises from the possibility of incurring foreign exchange
gains or losses on transaction already entered into and denominated in a foreign currency.

The degree of transaction exposure depends on the extent to which a firm’s transactions are in
foreign currency.

Example: The transaction in exposure will be more if the firm has more transactions in
foreign currency.
According to FASB 52 all transaction gains and losses should be accounted for and included in
the equity’s net income for the reporting period. Unlike translation gains and loses which
require only a bookkeeping adjustment, transaction gains and losses are realised as soon as
exchange rate changes.
The exposure could be interpreted either from the standpoint of the affiliate or the parent
company. An entity cannot have an exposure in the currency in which its transactions are
measured.

Caselet Transaction Exposure – NHS Computers

The Exposure Problem
An Indian company, NHS Computers is involved in manufacturing of computer machines
and spare parts. It imports raw materials from USA and exports the machinery to USA and
receives the income in dollars. Machinery has to be imported on regular basis. As per the
definition of exposure, NHS Computers is exposed to currency risk. In this case, the
company is importing raw materials for which it is paying the money in dollars and while
exporting it is receiving the money in dollars. It is exposed to currency risk in the form of
transaction exposure, i.e. Dollar/Rupee exchange rate risk is prevalent only between the
period when it needs to pay for its imports and when it realizes the dollars for its exports
and the difference between the two amounts.

Thus, a company is exposed to currency risk when exchange rate movements directly
affect its cash flows. It is equally important for the company to know the types of risk it is
exposed to and the origins of risk.

The Environment
In the Indian context, let us assume that all the restrictions related to imports and exports
have been removed by the Government of India. Suppose a company is involved in the
manufacturing of electronic goods with indigenous technology and is selling the products
in India. It has no dealing whatsoever with any other countries. It is getting threatened by
an American firm, which is selling the same goods with a lesser price and superior
technological features. The company in this case is again exposed to the Dollar/Rupee
exchange rate inspite of not having any exposure whatsoever in foreign currencies.
Contd...

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