Class notes Chapter 10 Class notes Chapter 10 Measuring Exposure to Exchange Rate Fluctuations FX risk in general terms. Risk is uncertainty, particularly uncertainty about future cash flows. FX risk is the uncertainty about future cash flows that arises because of uncertain future changes in FX rates. Exposure and risk are related but different concepts. A firm has FX exposure when its profits, net cash flows, or market value can change because of changes in FX rates.
Exposure is defined as the degree to which a company is affected by exchange rate changes.
Three general categories of exposure to FX risk Transaction Exposure measures changes in the value of outstanding financial obligations as a result on changes in FX rates. If our transaction exposure is evenly spread over currencies that tend not to move together, the FX risk is lower in general. The change in value depends on the effect of the exchange rate change on future sales volume, prices, and costs. Accounting Exposure accounting changes in owner's equity from translation of foreign subsidiary accounting records from foreign currencies into the domestic currency not a cash loss, but does represent a decrease in value of foreign assets arises because financial statements of foreign affiliates must be restated in the parent's reporting currency to prepare consolidated financial statements. If PPP holds, FX risk does not exist since we have offsetting changes in price levels and FX rates.