Question
What you do mean by transaction exposure? Describe various techniques available to manage transaction exposure both in the short term as well as the long term.
Answer :
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Skip in 10
Transaction exposure in international business finance refers to the risk that a company faces due to fluctuations in exchange rates between the time a transaction is initiated and the time it is settled. This type of exposure arises because firms engaged in cross-border trade or investment often deal with receivables or payables denominated in foreign currencies. When the value of these currencies changes relative to the firm’s domestic currency, it can directly impact the cash flows and profitability of the company. Transaction exposure is distinct from economic exposure, which affects a firm's market value over the long term, and translation exposure, which affects the reporting of financial statements in consolidated accounts. Transaction exposure is immediate and measurable, as it pertains to specific outstanding obligations or expected cash flows in foreign currency. For example, if an Indian exporter agrees to receive payment in US dollars three months from now, a depreciation of the US dollar against the Indian rupee during this period will reduce the amount the exporter ultimately receives in rupees. Conversely, if the exporter has to make payment in foreign currency, appreciation of that currency will increase the cost in domestic currency terms. Therefore, companies need effective strategies to manage transaction exposure to protect against unexpected losses and ensure predictable cash flows. There are several techniques available to manage transaction exposure, which can be broadly classified into short-term and long-term strategies. Short-term techniques primarily focus on hedging specific transactions to reduce the impact of exchange rate fluctuations in the near term, whereas long-term techniques aim at creating an overall risk management framework that stabilizes cash flows and operations over an extended period. In the short term, one of the most common techniques is forward contracts. A forward contract is an agreement between a firm and a financial institution to buy or sell a specific amount of foreign currency at a predetermined rate
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