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Foreign Exchange Exposure- Economic, Transaction

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Please be as detailed as possible:

A) Define foreign exchange exposure for a firm. Is a purely domestic firm subject to some foreign exchange exposure? If yes, why?

B) What are the key differences among economic exposure, transaction exposure, and translation exposure?

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A) Foreign exchange exposure: Fluctuations in exchange rate exposes the firm's revenues, costs, operating cash flows and hence their market value to substantial fluctuations. This is known as foreign exchange exposure. Firms which have transactions in multiple countries - exports and imports of goods and services, foreign borrowing and lending, foreign portfolio and direct investment etc are all directly exposed to this fluctuation. Even purely domestic firms which have absolutely no cross border transactions are also exposed because their customers, suppliers and competitors are exposed.

Suppose a purely US firm is manufacturing cars for the domestic market. But it has a supplier of parts which in turn imports components from Japan. The supplier will price the parts depending on the $/Yen exchange rate and therefore the firm will be exposed to the foreign exchange fluctuations.

Economic exposure: This is much broader than Transaction exposure( see below for ...

Solution Summary

The solution describes economic, transaction and translation exposures and answers whether a purely domestic firm is exposed to foreign exchange exposure.

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6. How does hedging help limit an organization's transactional exposure?
7. How does a currency swap help in limiting transactional exposure?

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