A comparison of the three exposures

The management of foreign-exchange risk based on translation exposure is basically static and historically oriented. By definition, translation exposure does not look to the future impact of an exchange rate change that has occurred or may occur. In addition, it does not involve actual cash flows. In contrast, both transaction and economic exposures look to the future impact of an exchange rate change that has occurred or may occur. These exposures also involve actual or potential cash flow changes.

Transaction risk and economic risk are the same in kind, but they differ in degree. For example, economic risk is essentially subjective, because it depends on estimated future cash flows for an arbitrary time horizon. Transaction risk, on the other hand, is essentially objective, because it depends on outstanding obligations that existed before changes in exchange rates but were settled after changes in exchange rates. Table 9.1 illustrates the major differences among these three exposures.

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