CandleFocus Glossary Editor
Economic exposure, also known as translation exposure, is a risk associated with fluctuations in exchange rates that can heavily influence a company's global profits and cash flows. This exposure can impact even businesses that do not purchase or sell goods and services in international markets, as these companies may still be exposed to currency changes. Given the volatility and uncertainty of exchange rates, even the most sophisticated financial and operational strategies may not adequately reduce or fully protect against economic exposure.
The primary source of economic exposure is changes in the exchange rate between two currencies. The impact of exchange rate volatility on business, especially multinationals, can be substantial and long lasting. With increasing economic globalization, even domestic companies are now being exposed to foreign currency values.
One simple way to assess economic exposure is to look at the net current asset value in a foreign currency. This figure is often referred to as ‘net open position’ and it reflects the value of a company’s foreign assets and liabilities. A net open position of more than zero indicates that the company has more assets than liabilities in that currency and a positive exposure to that currency's exchange rate volatility.
For multinationals, currency volatility can also impact their profits when foreign exchange losses and gains are recognized in their financial results. Likewise, cash flows can be adversely affected when foreign exchange losses and gains arise from receivables and payables of foreign subsidiaries.
However, there are a variety of methods multinationals can use to minimize their economic exposure. Some of these include:
1. Structuring existing assets and liabilities to offset each other in different currencies;
2. Setting up hedging strategies to protect against unexpected currency rate movements;
3. Exploring financial engineering and new financing strategies, such as currency swaps and other derivative instruments;
4. Disciplined cash management, such as ensuring foreign cash balances are partially invested in liquid assets;
5. Using buying or selling parallel currency markets to achieve additional gains when exchange rate movements are not in line with expectations.
The evolving nature of global markets has forced companies to adopt new strategies and technologies to protect themselves from the risks posed by economic exposure. By understanding their potential exposure, companies can better prepare for the risks posed by currency volatility and take the necessary steps to effectively manage their financial and operational risk profile.
The primary source of economic exposure is changes in the exchange rate between two currencies. The impact of exchange rate volatility on business, especially multinationals, can be substantial and long lasting. With increasing economic globalization, even domestic companies are now being exposed to foreign currency values.
One simple way to assess economic exposure is to look at the net current asset value in a foreign currency. This figure is often referred to as ‘net open position’ and it reflects the value of a company’s foreign assets and liabilities. A net open position of more than zero indicates that the company has more assets than liabilities in that currency and a positive exposure to that currency's exchange rate volatility.
For multinationals, currency volatility can also impact their profits when foreign exchange losses and gains are recognized in their financial results. Likewise, cash flows can be adversely affected when foreign exchange losses and gains arise from receivables and payables of foreign subsidiaries.
However, there are a variety of methods multinationals can use to minimize their economic exposure. Some of these include:
1. Structuring existing assets and liabilities to offset each other in different currencies;
2. Setting up hedging strategies to protect against unexpected currency rate movements;
3. Exploring financial engineering and new financing strategies, such as currency swaps and other derivative instruments;
4. Disciplined cash management, such as ensuring foreign cash balances are partially invested in liquid assets;
5. Using buying or selling parallel currency markets to achieve additional gains when exchange rate movements are not in line with expectations.
The evolving nature of global markets has forced companies to adopt new strategies and technologies to protect themselves from the risks posed by economic exposure. By understanding their potential exposure, companies can better prepare for the risks posed by currency volatility and take the necessary steps to effectively manage their financial and operational risk profile.