This chapter has discussed two foreign-exchange exposures and their management. Every single company faces an exposure to gain or loss from changes in exchange rates, because globalization is totally reshaping the way we live and do business. Transaction exposure refers to possible gains or losses that may result from the settlement of transactions whose payment terms are stated in a foreign currency. Economic exposure measures the total impact of exchange rate changes on a firm's profitability.
In essence, a hedge or a cover is a type of insurance that provides security against the risk of loss from a change in exchange rates. When devaluation seems likely, the MNC must determine whether it has any unwanted net exposure to foreign-exchange risk. When the company finds that it has an unwanted net exposure to exchange risk, it can use a variety of operational techniques and financial instruments to reduce this net exposure. These include the forward market hedge, the money market hedge, the options market hedge, swaps, and others. These financial instruments are primarily used to minimize transaction exposures. Economic exposure can be managed by balancing the sensitivity of revenues and expenses of changes to exchange rates through diversification and strategic planning.
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