Translation and Transaction exposure

Question 1

What are the different types of exposure?

Answer 1

1. Translation or accounting exposure
2. Transaction exposure (????)
3. Operating exposure (arises because exchange rate changes alter the value of future revenues and costs )

Economic exposure = transaction exposure + operating exposure

Operating (future, operating cash flow), translation (past), transaction (both past and future)

Question 2

What are the different conversion rates that can be used?

Answer 2

1. historical rate
2. average of conversion rate in the period
3. current rate

Question 3

What are the four types of translation method?

Answer 3

1. current/non-current (current on current account/ average on income statement)
2. Monetary/non-monetary (monetary accounts - current, non-monetary - historical, income statement - average)
3. Temporal method (inventory uses current)
4. Current method (all statements use current rate)

Question 4

What are ways to hedge against translation exposure?

Answer 4

1. adjust fund flows (reduce the firm’s local currency accounting exposure )
2. Forward contracts (creating an offsetting asset or liability in the foreign currency)
3. Exposure netting

Question 5

What are ways to hedge against transaction exposure?

Answer 5

A. Risk shifting (you being smart, shifting the risk to your partner)
B. Currency risk sharing (agreement zone, outside the zone, sharing the risks)
C. Currency collars (contract bought outside of the neutral zone- range forward)
D. Cross-hedging (hedge with other currencies, highly correlated)
E. Exposure netting
F. Forward market hedge
G. Foreign currency options

Question 6

Transaction exposure

Answer 6

Transaction exposure results from the possibility of incurring a gain or loss related to a sale or purchase already entered into and denominated in another currency.

You have sold it for 10 pounds, but the currency might fluctuate