For WizardKim-DP2

Week 6 Discussion 1st Response:

Instructions: Respond to the post below from your fellow classmate. Any opinions, or anything you would like to add to discuss about their post. Must be three substantial paragraphs, and three references.

In my past courses, I didn’t have a problem reading and understanding the information. In this course I have found the textbook to be very dense, often causing me to become confused. In order to help myself retain even the slightest of information in this week’s reading, I was forced to read the chapter twice and ask my boss for assistance. After allowing my boss to look over what we are reading, I was relieved to find out this course covers what many consider to be the hardest part of the CPA exam. Furthermore, this week’s reading is known as one of the most complex parts of the hardest part of the exam. This news made worry a little less that I was the only one absolutely lost.

            All this being said, foreign exchange exposure is the risk a company takes when they make business transactions in foreign currencies. Currencies can experience fluctuation in price, which can undesirably affect the company’s profit margins. However, if there are certain strategies in place, the company can protect their cash flow from currency fluctuations. The three most common foreign exchange exposures are translation, transaction, and economic exposure.

            Transaction Risk is the exposure to uncertainty factors, not limited to foreign exchange risk, commodity, and time risk (Transaction Risk - Definition, Examples and Diagram, 2019). Essentially, it incorporates all negative events that could stop a deal from occuring. A deal that has a high transaction risk will usually require a higher return. Therefore, it is important to consider such risk when evaluating a prospective investment. Companies engage in hedging arrangements to reduce the level of potential risk that comes from the price movement. Hedging provides companies with protection against unfavorable changes to asset prices that can negatively affect investment (Transaction Risk - Definition, Examples and Diagram, 2019).

            Economic exposure is the measure of the change in the net present value of a company as a result of changes in cash flow caused by changes in foreign exchange rates (Economic Exposure - Definition, Examples, Impact of FX, 2019). Economic exposure is not easily mitigated because it is related to the unpredictable volatility of currency exchange rates. As the business environment continues increasing globalization causing more economic relations between countries, more economic exposure continues to affect more companies. Since unexpected rate changes affect a company’s cash flows, economic exposure can result in serious negative consequences for the company’s operations and profitability (Economic Exposure - Definition, Examples, Impact of FX, 2019). In fact, this is one of the many reasons why many large companies have moved manufacturing to less developed countries.

            Spot transfers are the most basic form of exchange exposure risk management tool (How to protect your business against foreign exchange exposure, 2020). These transfer types indicate the terms of the exchange of two currencies between an end user and a financial institution. Forward Exchange Contracts allow companies to use today’s currency rate for a future transfer. Another popular form of managing market risk is a Limit Order (How to protect your business against foreign exchange exposure, 2020). A Limit Order is where a company sets a target rate, and then experts monitor the market for you. This way, if the rate hits that target, the company is informed to make your transfer.

References

Corporate Finance Institute. (2019, December 5). Economic Exposure - Definition, Examples, Impact of FX. Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/knowledge/economics/economic-exposure/.

Corporate Finance Institute. (2019, October 11). Transaction Risk - Definition, Examples and Diagram. Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/knowledge/deals/transaction-risk/.

OFX. (2020). How to protect your business against foreign exchange exposure. International Currency. https://www.ofx.com/en-us/blog/foreign-exchange-exposure/.