BY- MONIKA SOOD JITENDRA SINGH

INTRODUCTION Foreign exchange risk is the possibility of a gain or loss to a firm that occurs due to unanticipated changes in exchange rate.

 EXCHANGE RISK IS DIVERSIFIABLE.

TYPES
TYPES OF EXPOSURE

TRANSLATION

TRANSACTIO N

ECONOMIC

TRANSLATION EXPOSURE
It is the degree to which a firm`s currency denominated financial statements are affected by exchange rate changes. It is also called accounting exposure.

TYPES
Current rate method Current/non-current method Monetary/non-monetary method Temporal method

Current rate method All items of balance sheet and income statement are translated at current rate or post change rate.

 Merit of this method is that the relative proportion of individual balance sheet accounts remains the same and the process does not distort various balance sheet ratios. Demerit is that the fixed assets are also translated at current rate that goes against the principles of accounting.

Current/ non current method

Only current assets and current liabilities are translated at current rate or post change rate but the fixed assets and long term liabilities are translated at historical rate.

 Demerit of this method is that the long term debts which is also exposed to exchange rate change is ignored by this method.

Monetary/ non-monetary method

Items that represent a claim to receive come under monetary group whereas physical assets and liabilities come under nonmonetary group. Monetary assets and liabilities are translated at current rate while non-monetary assets and liabilities are translated at historical rate.

Temporal method
Historical cost items are translated at historical rate while items that are related to replacement cost ,market value are translated at current rate. This method resembles the monetary/nonmonetary method only the difference is that in temporal method inventory is translated at current rate if it is shown at market value but in former the inventory is always translated at historical rates.

ECONOMIC EXPOSURE
It refers to the degree to which a firm`s present value future cash flows can be influenced by exchange rate fluctuations. Hence, this exposure affects the profitability of the company over a longer time span than translation or transaction exposure.

 Economic exposure cannot be hedged while both transaction and translation exposure can be hedged.

TRANSACTION EXPOSURE
It refers to the extent to which the future value of firm`s domestic cash flow is affected by exchange rate fluctuations.