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Economic and Transaction Exposure

How is economic exposure different from transaction exposure? Please give an example of each.

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Economic Exposure (also called operating exposure, competitive exposure, or revenue exposure) measures the impact of an exchange rate change on the net present value of expected future cash flows from a foreign investment project. It measures the degree to which a company's expected cash flows are affected by unexpected changes in exchange rates. This exposure cannot be hedged. Thus if the home currency appreciates unexpectedly, exports would be hit. Or if the home currency depreciates unexpectedly, imports would be hit.

Economic exposure is the extent to which the economic value of a company can decline because of exchange rate changes. The decline can be due to a decline in the level of expected cash flows or an increase in the risk of these cash flows. An example of economic exposure is the devaluation of the currency of a country in which a company's products are sold. The devaluation makes its products relatively more expensive and it would be less competitive in the foreign country (as well as domestically), resulting in lower sales and lower profits.

Example: Dollar ...

Solution Summary

The solution explains how the economic exposure is different from transaction exposure.

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