Page 99 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes The Solution
In the above example, if it were a British firm, the extent of Indian firm’s exposure is
dependent on Dollar/Pound exchange rate and Dollar/Rupee exchange rate. The company
should first establish direct linkages between direct movements and cash flow
destabilization before it attempts to control currency risks. In this case, the Indian firm has
exposure because of its structural nature. It will be exposed to this risk as long as it is in the
manufacturing of the products which it is presently involved in. If it changes the existing
product mix it can eliminate the risk arising out of the Dollar/Rupee and Dollar/Pound
exchange rates on its cash flows. Structural risk is a recurring one and is long term in
nature. A long-term risk can be broken into slices and can be controlled temporarily but
it will not give a permanent solution.
Source: International Financial Management, Madhu Vij, Excel Books.

Economic Exposure

Economic exposure refers to the degree to which a firm’s present value of future cash flows can
be influenced by exchange rate fluctuations. Economic exposure is a more managerial concept
than an accounting concept. A company can have an economic exposure to say Pound/Rupee
rates even if it does not have any transaction or translation exposure in the British currency. This
situation would arise when the company’s competitors are using British imports. If the Pound
weakens, the company loses its competitiveness (or vice versa if the Pound becomes strong).
Thus, economic exposure to an exchange rate is the risk that a variation in the rate will affect the
company’s competitive position in the market and hence its profits. Further, economic exposure
affects the profitability of the company over a longer time span than transaction or translation
exposure.

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Caution Under the Indian exchange control, economic exposure cannot be hedged while
both transaction and translation exposure can be hedged.

Self Assessment

State whether the following statements are true or false:

11. The degree of translation exposure depends on the extent to which a firm’s transactions
are in foreign currency.
12. Economic exposure refers to the degree to which a firm’s present value of future cash
flows can be influenced by exchange rate fluctuations.

Task Conduct a survey of CEOs of MNCs based in India to assess if they have an
understanding of the difference between transaction, translation and economic exposure.
The questionnaire should be framed to assess the following:

1. What is their perception of the kinds of exposure?
2. Extent to which firms covered themselves against the three kinds of exposures.
3. Do they give the same importance to the three kinds of exposure?

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