12.18 Transaction exposure
The firm is exposed to transaction risks which arise because the exchange rate between the buying and selling currency might change between the time of the sale and that of the payment. The risk can be minimised through a hedge in the futures or forward market. Other measures to reduce this risk include financing transactions repayable in the buyers' home currency or other hard currencies, discounting foreign notes and bills, and currency swaps.
In addition to the tactics noted above, firms can also use leads and lags.
A lag strategy involves delaying payments or delaying receipts in a foreign currency, usually in the expectation that the foreign currency will become stronger.
A lead strategy is the opposite of a lag strategy: it involves paying foreign currency debts early and collecting foreign currency receipts early, on the assumption that the foreign currency will become weaker.
The main problems in exercising leads and lags are firstly that firms are often faced with moving small amounts of money frequently which makes the system difficult to manage and, secondly, leads and lags are often subject to government control because of the impact on the balance of payments of a country.
Translation exposure is the impact of currency exchange rates on reported consolidated results and balance sheets of a company. Translation is concerned with the present measurement (balance sheet date) of past events (any time during the accounting period). The gains or losses on the balance sheet are paper gains and losses: that is, the gains or losses are unrealised. The problem with unrealised gains or losses is that they may give financial markets a distorted view of the firm's true financial position and also lead to an increase in the firm's cost of borrowing in capital markets.
Measures used to reduce translation exposure are the same as those discussed for transaction exposure.
Economic exposure is the extent to which a firm's future profitability is affected by changes in exchange rates. The rapid rise in the value of the $US in the early 1980s made US imports expensive and uncompetitive on world markets. In the late 1980s and early 1990s the $US has fallen in relation to other currencies and US exports are now thriving. In the last decade the increasing value of the yen has forced Japanese motor vehicle manufacturers to reduce their economic exposure by moving production offshore to lower cost countries, including the US .
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