Page 1 of 26
OPERATING EXPOSURE: DETERMINANTS AND MANAGEMENT TECHNIQUES
1.0 Understanding Operating Exposure and Its Significance
1.1 Definition and Concept of Operating Exposure
Operating exposure means that a firm can be vulnerable in its future earnings and cash flows from the
business as the end result of the changes in the exchange rate that are going on (Bouchard, 2018). Unlike
transaction exposure, which is due to the existence of contractual commitments denominated in foreign
currencies, operation exposure comprises the broad base of common exposure that arises from currency
movements and their impact on a company's competitive position, pricing strategy, and cost structure
(Bouchard, 2018). An operational risk is a forward-looking risk that reflects the long-term use of currencies
and the firm's competitive position in international markets. It includes not only factors such as better of
sales, introduce input costs, market share and competitive climate but all these are way influenced by shift
in exchange rates (Bouchard, 2018). The risk connected to operating economic factors is a result of some
variables like the diversity of revenues of a firm in different countries, the level of competition of its markets,
and adjustment capabilities in its price and cost making as the changes in exchange rates occur (Bouchard,
2018). In case of MNCs, operating exposure is especially very much important because they are mostly the
international operations as well as exposure to their business in the different currencies (Bouchard, 2018).
MNCs operating in highly competitive environments where profits are low and F/X rates are volatile may
face supreme operating exposure, with even a small F/X moves being critical for profitability (Bouchard,
2018). To overcome operating exposure companies apply different macroeconomic tactics intending to
decrease the sensitivity of firm performance to the currency fluctuations (Bouchard, 2018). This could
comprise of establishing a pricing strategy at that level which would include having currency-based clauses
or payment agreements that can be utilized to adjust prices when there are exchange rate changes, among
other measures. Moreover, you can also hedge future cash flows using financial derivatives like forward
Page 2 of 26
contracts or options effectively. Finally, you may optimize the production and sourcing decisions that would
ultimately lead to the minimization of the foreign exchange-related costsMoreover, corporations can
practice natural hedging by entering bilateral deals in a currency that matches their revenue and expenses,
or by growing their geographic outreach to hoard their risk (Bouchard, 2018).
1.2 Impact on Firm Value and Profitability
The interoperability exposure is a term that refers to the sensitivity of a firm’s future earnings and cash
flows to the exchange rate variations which are caused by the ongoing business operations of the company
( Bouchard, 2018). Unlike transaction exposure, which is related to owning assets denominated in foreign
currency, operating exposure reaches the larger effect of the currency movements on the competitors and
on the pricing strategy of the firm and the firm's cost structure as well (Bouchard, 2018). Operating
exposure thus is something that is forward-looking, for it rather reveals how a currency fluctuation impacts
a firm's competitive advantages in International markets over a long term (Bouchard, 2018). It is associated
with many factors for example, it includes sales volumes changes, input costs, and market share shifts as
well as competition dynamics and all these variables may be affected by exchange related fluctuations
(Bouchard, 2018). For instance, a business functioning in distinct countries could probably encounter
mismatches in demand for its products and services as a result of price movements which not only affect
the affordability of the products in different markets but the company’s ability to compete with the
established or upcoming producers in these markets (Bouchard, 2018). A loss of competitiveness as a
result of the devaluation of the local currency in a significant export market might render products of the
company more expensive for local consumers. This may result in declined sale volumes and market share
(Bouchard, 2018). While the growth in the home country currency may work to increase the firm's
competitiveness because of the reduction in the price of the plant's products in comparison to its
competitors leading to a greater market share and better profitability (Bouchard, 2018). Lastly, such
Page 3 of 26
exposure when it comes to operations may enable authorities to make strategic decisions regarding the
place of production or the sourcing strategies (Bouchard, 2018). Firms may find it desirable to put up their
factories in the countries with well developed currency or to take measures such as financial instruments to
flatten the slope of exchange rate fluctuations and thus mitigate the negative effect on production costs
(Bouchard, 2018). Furthermore, the companies might adopt various pricing policies towards the currency
fluctuations so that its profitability margin is maintained and competitiveness of the company does not get
sifted (Bouchard, 2018).
1.3 Distinction from Transaction and Translation Exposures
Unlike transaction and translation exposure which are triggered through the management of imported and
exported products and the translation of foreign currency into the local currency, operating exposure is
longer-term and has the transitional time (Chong, et al. , (2018)Among the most immediate sources of
foreign exchange risk are explicit contract obligations that are expressed in foreign currency, such as cross-
country trade or foreign currency debt (Chong et al. , 2018). While exchange rate exposure involves the
influence of fluctuating currency rates on the value of the company's foreign assets, liabilities, revenues,
and expenses when converting or translating financial statements in a reporting currency, translation
exposure relates to the effect of such exchange rates on the valuation of a firm's foreign assets and
liabilities translated into the major currency used in reporting (Chong, Lee, & Skully, 2The change of
exchange rate produced the what concerns the operating exposure is broader sense and affects the firm's
can view of competition, profitability and strategic choices (Chong, Lee, & Skully, 2018). It indicates that the
business’ core operations such as sales, production, and sourcing activities are likely to trigger foreign
currency exchange risks and therefore impacts the firm’s future cash flows and earnings (Chong, Lee,
& Skully, 2018). Contrarily, transaction exposure usually falls within the scope of short-term contracts and
can be dealt with by means of financial instruments inclusive of forwards or options. Operating exposure,
Page 4 of 26
highlighted by Chong, et al (2018) on the contrary is very long-term and strategic in nature. The operational
exposure depends on multi forces specifically the changes in sales volumes, input costs, market share and
competitive market ratios all affected by the changes in the rate of exchange (Chong, Lee, & Skully, 2018).
On the contrary, employing management tactics that can provide coverage for short-term cash flow risks
arising from transaction exposure is different from proactively handling the competition and operational
risks associated with operating exposure, which will be the fundamental component in maintaining the
organization’s long-term competitiveness and profitability (Chong, Lee, & Skully, 2018).
1.4 Importance in Global Business Environment
The operating exposure in business operations is accentuating especially for those businesses that are
targeting geographies not within their jurisdiction, where operations are gaining momentum (Bekaert et
Hodrick, 2019). Globalizing multinational corporations face a greater degree of risk of currency risk
emerging from currency fluctuations as a result of deeper involvement in international trade and investment
activity (Bekaert & Hodrick, 2019). Operating exposure management plays a key role in building strong
resistance, resilience and competitiveness in the firm in a highly turbulent and linked global environment
(Bekaert & Hodrick, 2019). Running exposure management rates on a strategic as well as on a tactical
level translates in reduction of the negative effects of exchange rate modifications on a company's short-
term and future financial outcomes and plans (Bekaert and Hodrick, 2019). It includes some being carried
out preventive risk management measures among them hedging in the name of forex, financial, and
operational diversification to cushion the business against harmful foreign exchange rate fluctuations
(Bekaert & Hodrick, 2019). This is the reason why management of any firm needs to deepen their
understanding of the econometric drivers in order to make well-informed tactical decisions (Bekaert &
Hodrick, 2019). This refers to the selection and application of complex analytical techniques to evaluate the
overall risks associated with the currency across the firm's different business sectors, geographic regions
Page 5 of 26
and product lines (Bekaert&Hodrick, 2019). For operating exposure identification and quantification, firms
tune their risk mitigation strategies and resource allocation to turn to the international opportunities while
having in mind the currency-based threats (Bekaert & Hodrick, 2019). Being future-oriented with respect to
risk-taking is a key to maintaining proper financial results, getting investor satisfaction, and creating the
value investors are used to. Companies that act separately regarding evaluation of the risks of the currency
and have the capacity to resist the currency risks can raise the amount of capital they attract, enter the
global markets, and grow the business with confidence (Bekaert & Hodrick, 2019). Effective handling of
operating exposure should be a key point in the corporate strategy for businesses that compete within the
framework of the global economy.
2.0 Determinants of Operating Exposure
2.1 Pricing and Competitive Dynamics in Industry
Pricing tactics and competitive dynamics interact to a great extent, which ultimately dictates how foreign
exchange fluctuations work for or against a particular firm (Chue & Cook, 2018). In an industry that is very
much competitive with high price responsiveness, the firms often have to fight to transfer the additional
costs from currency fluctuations to consumers, which comes with margins squeezed (Chues & Cook,
2018). This situation is highly evident in areas where the products and services are similar and the
customers are bombarded with so many alternatives that have been readied. Thus, enterprises operating in
this circumstance must particularly pay attention to controlling the best cost structures possible alongside
looking for efficiency improvement as such elements of currency could very easily cause challenges in
operations. A company might position itself in industries with higher pricing power, or by means of having
distinctive products or differentiated services. Hence these companies can easily adjust their prices in line
with the movements of foreign exchange (Chue & Cook, 2018). Such companies generally enjoy more
freedom in terms of justifying the rise in price or maintaining the original price level as a result, they enjoy
Page 6 of 26
better P&L bypassing the pressure coming from currency rates changes. Examples of such include luxury
brands which are endowed with a strong brand reputation and fans that are loyal. This group could have
resilence to change of rate of exchange when compared to businesses that deal with primary commodities
like cocoa, coffee, and tobacco. Thorough comprehension of the competitive environment and pricing
factors operating in a given sector is mandatory for the companies since their riskiness will considerably fall
down and they will be able to develop better risk control policies (Chue & Cook, 2018). It is monitoring the
reactions of competitors to exchange rate disruptions that is a great source of valuable information on the
potential industry behavior and which, in turn, contribute to more reasoned decision making processes.
Corporations should customize the way in which they manage their risks, so that approach will be in
agreement with the working processes in the industry, as well as the competitive position a company has
chosen (Chue & Cook, 2018). It can also involve things such as putting in place price points that combine
profitability with market share issues, improving your internal operational efficiency to reduce cost
pressures, or being open minded and looking into some of the hedging mechanisms that exist that may be
helpful in neutralizing adverse currency movements.
2.2 Degree of International Operations and Diversification
Although the firm's geographic reach and distribution throughout different regions with border have a
substantial impact on the type of OE risks particularly from exchange rate fluctuations, there are other
potential factors that may come into play. The firms that account for a significant part of their activities for
international operations, and revenue is generated in the foreign currencies will be exposed to currency
risks that is greater. The exposure is the outcome of an impact like this: reported earnings from foreign
exchange fluctuation make the conversion of the foreign earnings into the home reporting currency which
leads to the loss in revenue and profit. Along with fluctuations in revenues from currency movement, these
firms equally have to deal with the risk of earnings volatility, which in some cases affects investors'
Page 7 of 26
perceptions and poor financial performance. Relatiilyto the firms that are weriteam across the world,
perhaps the degree of protection against the risk of currency might think to be a natural hedge (Du, Hu, &
Xu, 2019). The natural hedging has this type of outcome when currencies’ fluctuations in one region mostly
offset by the other regions, and it tends to reduce the net effect on the earnings volatility. As an example, if
a firm has both the U. S. dollar and euro as its revenue generation base, the decrease in the value of euro
against dollar may cut into the value of European currency source when translated into dollars.
Nevertheless, the company would be capable of neutralizing the adverse effects of its operations in the
foreign regions, where the local currency appreciates against the dollar the revenues from which would
help to ensure the equilibrium. Analyzing the geographical distribution of locations and the sources of their
income is a basic step for the companies to comprehensively determine their currency risk. The data would
be on the basis of which the risk management strategies can be developed (Du, Hu, & Xu, 2019). The
contribution of the various regions to total revenue of a country can be studied through which corporations
can identify natural hedges needed by them and this will lead to targeted hedging approaches pursued
keeping in consideration the risk profile of businesses. In addition to keeping curiosity with respect to
geopolitical and macroeconomic developments in target market, this can help understanding at prominent
level and identifying opportunities related to currency affairs, thus enabling businesses to be proactive.
2.3 Cost Structure and Operational Flexibility
Characterizing company’s cost structure and its ability to address changes in organizational setting and
pressures from competitors is vitally important for proper strategic management of the organization. A cost
structure can be defined as the cost incurred by a business during its operations and it is crucial to note
that every business strives to reduce costs and have an ideal cost structure in cases where the demand for
the product is low. This include controlling and minimizing both fixed and variable costs, bargaining for
better supply price, and engaging in constant cost control measures through minimizing the wastes and
Page 8 of 26
improving on the process (Smith, 2017, p. 122). On the other hand we have the operational flexibility which
describes a firm’s capability of altering its production process, amplify/contract its output or move between
the production of different products or from one industry to another as may be required. To achieve
flexibility, manufacturing companies adopt some principles which include making strategic investments in
modular production systems, training subordinates in several functions, and retaining several suppliers
(Johnson, 2020, p. 87). On this perspective, according to Schoenmaker and Wagner (2019), optimal
banking supervision helps to contain these systemic problems and guarantee the funding, which in turn
creates an environment for companies to keep their cost structures efficient (p. 233). The source of
financing needed for these businesses to invest in the technology and infrastructure that increase their
cost-effectiveness and adaptability is vital to this formula. In the context of operational flexibility, Vayanos
and Wang (2018) stresses that firms are more capable of achieving this flexibility if their market liquidity is
high because it allows for quick changes to be made to their financial and operational frameworks at a
reasonable cost (p. 657). For instance, liquid markets enable a fast reallocation of resources within the
business environment; such timely provision of resources can enable companies to seize new opportunities
or avoid the unfavorable consequences of shifts in market conditions. Moreover, operational flexibility
concerns involving the firm’s ability to adapt to varying patterns of demand due to constantly changing
regulatory environment or evolving consumer expectations (Brown, 2019).
2.4 Economic Conditions and Exchange Rate Volatility
Fluctuations in the exchange rate exchange and even the economic conditions are some of the factors that
affect the company’s financial performance and its strategic plan. For instance, exchange rate fluctuations
such as fluctuation in the foreign exchange rate can impact the profit and value of multinational companies
particularly due to changes in the relative value of revenues and costs in foreign exchange. This fact
negatively affects firm earnings since the variation can occur continuously, which is not ideal for stable
Page 9 of 26
performance. Rey, X. (2019) In the subject of the global financial cycle and exchange rates and economic
stability, Rey (2019) established the reasoning that linked global markets to create difficulties due to
interconnectedness (p. ) or financial markets (p. 373). Such an interconnection of markets implies that
disruptions in one market area may result in increased variability and uncertainty in other areas. Due to the
volatility of the currencies, organizations require sound risk management measures to be put in place to
counter the misleading effects of the foreign exchange rates. Ruehl and Wu (2018) shows an analysis of
the global FX market and its internal structure to express the value of gaining insights into the structure and
the functioning of the market to be able to control exchange rates risks effectively (p. 250). This is
accomplished through the application of financial instruments like a forward, options, and swim to mitigate
for likely loses resulting from unfavorable currency translations. Also, in addressing the theories of foreign
exchange rate determination, Rogoff and Tashiro (2019) analyze the effectiveness of exchange rate
targeting for stabilization of currencies that would help businesses manage uncertain economic
environments (p. (Ref 1482). Exchange rate targeting can reduce the volatility of the currencies, hence
assisting managers in acquiring greater certainty when planning for their businesses. It is safer for the
companies that are sensitive to the fluctuations in the economic environment and engage in hedging
activities so that such variability in the exchange rates does not hamper their sustainability and
performance. Another activity in the contingency plan is to conduct a constant review of the economic
environment and alter the consequent and potential risks imperative to finance. They not only protect their
profit margins, but they also maintain their ability to fund investment in growth prospects, especially in times
of low economic growth.
Page 10 of 26
3.0 Management Techniques for Operating Exposure
3.1 Geographic Diversification and Market Selection Strategies
Geographic diversification can be described in terms of distribution of risking across regions by investing in
all the relevant locations as a way of maximizing returns from all the regional markets. The strategy assist
the companies to avoid the risk that occur due to local economic difficulties and instabilities in certain
political systems. In other words, localization of vc’s hedge risks of localized economic problems in a
particular geographic region, by expanding the opportunities geographically. Sarno and Taylor (2019)
points out that there are many assumptions made about the international markets where investors are
making cross-border investments that are affected by the microstructure of the foreign exchange market
and therefore, it has an impact on the geographic diversification success (p. Fig 55). In a successful
geographic expansion, it is imperative to determine which markets should be entered through the analysis
of economic conditions and risks in those markets, their growth rates and regulations. Evaluating these
factors, the organisation can ensure that all the potential markets it aims to occupy are relevant in achieving
its strategic objectives as well as fit its risk appetite. Furthermore, Vayanos and Wang (2018) point out that
market liquidity also ensues a smooth working of the asinine transactions around the globe when one is
planning to diversify his investments (p. High market liquidity give the abilities to trade easily and make
frequent exchanges , which give companies a better opportunity to manage their investment portfolios
flexibly in accordance with the current state of a specific market. It is needed to mitigate some of the risks in
relation to fluctuations of foreign currency and to enable capital to flow from one region to another.
Leveraging on geographic diversification brings out new growth markets which returns are ordinarily greater
than those in mature markets which are highly saturated. However, these frequently represent still-evolving
economies, which involve certain inherent risks, namely political instability or relatively underdeveloped
financial industries. It is suggested that there is a strategic fit when diversified investment is made between
Page 11 of 26
companies in both stable markets and emergent markets. Through such diversification, it becomes possible
to balance risks of operation in a particular nation and reduce exposure to localized risks thus diversifying
benefits, absorbing uncertainties and improving odds of better growth. Besides, this approach not only
prepares firms in a region to counterbalance future regional economic instability but also enables firms to
take advantage of continuously growing global economic opportunities hence sustainable and with
competitive edge.
3.2 Operational Hedging and Flexible Sourcing Options
Hedging and flexible sourcing are considered as best practices for handling dangers influencing operational
disruption, fluctuation in demand and instability of the currency market. This means that contracting and
purchasing of materials is done from more than one location; this is done to ensure that when situations go
wrong in one location, organizations will still receive their supplies from other regions. This approach not
only shows that materials can be found from other sources beside the designated supplier but also it
enables organizations to shift swiftly from one supply chain environment to another. Operations
management is explained by Sarno and Taylor (2019) as a subject that has lots of currents in the foreign
exchange market, which requires a powerful covering of currency risk (p. According to research findings
mentioned in the last chapter (58), having suppliers in multiple countries is helpful in the sense that, when a
company experiencing fluctuations in exchange rates; this can be shifted to other regions. Solomon and
Valkanov (2019) look closer at the peso problem and the applicability of possible currency crashes, which
is why it is so vital that the agricultural industry be able to adapt its sourcing in relation to financial instability
(p. 186). This flexibility make sure that even if a specific currency deteriorates in value dramatically, the
cost of doing business does not go up steeply, and companies can go on with operating efficiently. Wu and
Wu support this statement explaining that operational hedging is one of the various methods of financial
risk management that can effectively minimize financial exposure and stabilize the functioning of the
Page 12 of 26
company (2019, p. Tactical hedging on the other hand involves designing business operations in a manner
that would eliminate risks in their natural courses for instance by matching one’s foreign currency revenues
with that of costs or by establishing production facilities across different countries (p. This type of hedging is
actually not completely based on financial instruments and only means that the company will be equally
affected by the changes in its economic environment. Unprecedented sourcing and operational hedging,
make it possible for organizations to remain functional and stable in their logistics channels despite the
volatility of the market. They allow the firms to effectively manage disruption of operations caused by the
geological activities or even natural calamities which in turn, help in shielding their profitability and
sustaining the competitive advantages.
3.3 Pricing Strategies and Competitive Positioning
Concerning the firm’s pricing strategies and the competitive positioning of products in the MM industry (as
mentioned under 3. 3), a firm has to consider many factors that influence this area, such as exchange rate
fluctuations and foreign currency debt (Phan, 2019). For instance, amidst globalization, the exchange rate
risks have emerged as significant concerns for firms in globalized areas such as southeast Asia, where
firms’ operations are deeply linked with global markets (Phan, 2019). The study of Phan (2019) revealed
that those companies in the sample with a high level of foreign currency debt are more vulnerable to
exchange rate fluctuations, emphasizing the need to apply optimal strategies for price management.
Exchange Rate exposure is defined as the changes in the exchange rates and their effect on the
performance and competitiveness of any firm (Adler & Dumas, 1984). These risks are particularly so for
MNCs as they operate across different countries and an additional challenge is encountered when
consolidating financial statements across different currencies (Phan, 2019). In addition, Portes and Rey
(2018) also highlight the concept of equity flows that influence competitive dynamics highlighting the fact
that the firms have to gauge not only the movements of currencies but also the capital flows crucial for their
Page 13 of 26
positioning in the global markets. These flows of equity capital can affect exchange rates since foreign
demand for equities would do so, and thus, affect the relative position of firms in international markets
(Portes & Rey, 2018). Thus, the pricing and positioning strategies are complex; firms need to
counterbalance and hedging exchange risks and intense volatility coupled with movements of international
capital alongside other factors that define the market (Adler & Dumas, 1984; Phan, 2019; Portes & Rey,
2018). It is possible to strengthen their robustness of external pressures and risks and also optimize their
opportunities to profit from overseas markets.
3.4 Financial Hedging with Derivative Instruments
Keeping the above concept in mind, financial hedging with derivative instruments (3. 4) appears as a
significant approach utilized by firms aspiring to address exchange rate exposure and obtain competitive
advantage (Rajan, 2018). This means that by adopting the use of forwards or options or swap, firms are
able to minimize on the potentially damaging effect of movements in foreign exchanges rates and equalize
cash flow volatility (Ruehl & Wu, 2018). This implies engaging in forward conventions with an aim of
stabilizing the future rates for exchange to allow some form of a hedge against volatility and to protect profit
margins (Rajan, 2018). For instance, an enterprise expecting to be paid in another nation’s currency at
some point in the future can use a forward contract as an agreement to guarantee a fixed exchange rate
ahead of time so that it would avoid unfavorable shifts in the currency’s value that would reduce the value
of the payment it is to receive. Not only do these hedging mechanisms reduce risk but they also prepare
firms to far better make forecasts and long-term plans (Ruehl & Wu, 2018). This knowledge is built upon
the fact that cycle-proof regulation that Rajan (2018) proposes as an ideal approach to the credit crises
acknowledges that effective regulations can give firms the solidity they need to engage in financial hedging.
Measures of accountability aimed at increasing transparency, controlling risks, and improving the credibility
of derivative dealing are vital to increase the popularity of hedging strategies among firms and other market
Page 14 of 26
members. At the same time, Rey (2019) has also pointed out the dilemma of how to maintain the
independence of monetary policy while responding the requirements of the global financial cycle indicating
that firms should develop the hedging strategies able to mitigate the macroeconomic risks and adapt to the
changing conditions (Rey, 2019). Due to the integration of financial markets and vulnerability of economic
tendencies in developed countries, firms should be cautious and prepared to the changes of the regulating
authorities and monetary policies (Rey, 2019). By managing their currency risks, firms can control risks to
their profitability, maintain shareholder value, and defend and maintain their market positions against the
risks and uncertainties that attend fluctuations in exchange rates and changes in economic security (Ruehl
& Wu, 2018).
4.0 Challenges in Managing Operating Exposure
4.1 Complexity and Uncertainty in Forecasting
Currency risk mitigations in a given economy or organization conducting its business in different parts of
the world are challenging, especially when it comes to forecasting. Speaking of currency risk and its effect
on corporate investment efficiency, Lin and Jiang (2019) note that exchange rate volatility poses a major
concern for firms for the same reason that it can substantially affect their investment strategies. Why: This
goes to prove that the task of predicting the future movements of a currency in fickle macro economies,
emergent regulations and geopolitics are not easy (Lin & Jiang, 2019). This has helped to compound the
impacts of foreign exchange volatility on global commerce since financial markets are integrated across the
world (Vaughan & TUpon, 2013). The dynamics of the currency markets has also been altered by advance
of the digital technologies and the use of algorithmic trading which makes the markets more volatile and
changing (Shen & Wang, 2019). This type of uncertainty is something firms need to deal intensively as it
means that any type of planning must be based on the complex models of forecasting and risk
management. Realistically incorporating forecasting models withURRENCY HEDGE\ being implemented,
Page 15 of 26
firms can improve the plausible capacity to handle the fluctuations hence improving more of the investment
efficiency (Lin, Jiang, 2019). The use of instruments like forwards, options and swaps in the management
of financial risk are also referred to as hedging where the aim is to try and minimize losses that a business
might encounter because of fluctuating currency values, thus making the cash flow of such businesses
stable (Ruehl & Wu, 2018). Still, hedging comes with various advantages because it could make firms less
vulnerable to losses; nonetheless, it is not without its cost and risks that need to be well thought out (Shen
& Wang, 2019). Companies can consider other ways such as diversify exposure to currency or focus on
supply chain management as a way of managing currency risk as noted by Pilbeam, (2013). Hedge against
currency risk can be managed in various ways where the overall approach of managing this risk involves
sound future forecasts, careful risk management, and proper firm management decisions as required by its
situation (Shen, & Wang, 2019). The use of cash-flow hedging in such a manner can ensure that firms
reduce the effects of fluctuating currency rates so that their competitiveness in the global markets is
boosted.
4.2 Trade-offs Between Hedging and Operational Costs
When deciding on the kinds of hedges that are appropriate to implement in an effort to control currency
risk, firms also have to weigh the costs of hedging against operational costs (4. 2). This was supported by
Liu and Vrugt (2019), who observed that while the use of hedging is effective in reducing risks, firms need
to ensure that the gains outweigh the costs of implementing hedging strategies. Nevertheless, financial
hedging enables one to hedge against currency risk; the expense involved may include nominal charges for
derivative contracts (Liu & Vrugt, 2019). Such costs can offset optimum gains to hedging, especially when
firms have constrained capital or when operating in sectors, which have low profit margins (S Liu & A Vrugt,
2019). Therefore, firms have the responsibility of evaluating the costs and benefits of derivative use in order
to eventually choose a risk management strategy that is suitable to the firm bearing in mind the acceptable
Page 16 of 26
level of risk and the firm’s overall business strategy (Liu & Vrugt, 2019). Players operating in industries with
commodity price risk, mainly oil and gas industries, may seek to hedge inflation/money risk while exploring
ways of minimizing costs (Liu & Vrugt, 2019). For instance, these firms use natural hedging techniques that
involve the use of revenues and expenses in the same currency or the dynamic hedging techniques that
involve regularly modifying hedge positions due to variation in the market forces (Liu & Vrugt, 2019). Thus,
they can decrease the use of borrowed funds for the purpose of hedging and keep related costs at bay, but
still minimize the currency exposure. However, as proper operation cost reduction is crucial, so is the
realization of advantages and disadvantages of leaving currency risk unmitigating (Shapiro, 2020). Volatility
in value of currencies poses a number of risks that can really dampen the financial performance of firms
through reduced profitability, high interest rate cost, and a compromise on export competitiveness (Shapiro,
2020). Thus, too much emphasis on hedging versus how it affects business performance needs to be found
in the middle. Managers may consider using other forms of risk management instruments or techniques
that would seek to implement cheap forms of hedge against the risks of exchange rates that include
currency options or forward in flexible contracts.
4.3 Limitations of Financial Hedging Tools
However, firms experiencing limitations when it comes to using available hedging tools, secondary to the
advantages of financial hedging (4. 3). Lu and Yu (2019) when analysing the business decision of the firm
on the sourcing strategy of FX exposure, the authors noted that firms are under pressure to diversify their
sourcing strategies in an attempt to avoid exposure to shocks in the value of the currency. Despite this, the
use of financial derivatives is a way to hedge against exchange rate movements but their extent is
hampered by such factors as market openness, and risk factors such as counterparty risk as well as
regulatory aspects (Lu & Yu, 2019). Market liquidity is defined as the ability of an investment in being
traded with a level of efficiency without close proximity to its price being affected ( Goyenko et al. , 2009).
Page 17 of 26
Effectiveness and/or implementation of hedging strategies could be not very successful if firms operating in
less liquid markets fail to hedge effectively and at reasonable prices (Goyenko et al. , 2009). Thus,
counterparty risk, which stems from the fact that the counterparty – the buyer or the seller in financial
hedging tools – may fail with the contractual obligations (Frost et al. , 2015). Business entities should,
therefore, take appropriate actions to ensure they minimize credit risk by being cautious on counterparties
by even agreeing on collateral or by partnering with many counterparties to reduce being affected hugely
by one party’s credit status (Frost et al. , 2015). Also, legal hindrances can prevent some firms from
employing specific hedging tools, or regulatory requirements could place overheads that raise hedging cost
(Cai et al. , 2018). For instance, the rules like the Dodd-Frank Act in the United States has required relevant
reporting and clearing obligations for over-the-counter derivative, making hedging operations more costly
where versatile. Multinational companies established in emerging economies may be limited in the
utilization of efficient hedging tools, thus preventing them from achieving an efficient hedging of currency
risk (Muller & Verschoor, 2018). Sometimes, many firms may not be able to gain access to the derivatives
markets or may find hedging to be very costly due to a number of constraints such as inadequate financial
infrastructure, lack of expertise and unfavourable rules of law.
4.4 Coordination Across Business Units and Locations
The second key issue is the inter organisational coordination at different business units and locations due
to MNCs for efficient currency risk management. Managing currency risk involves coordination and
cooperation within the company’s separate organizational segments dealing with different parts of the world
(Noguera, 2018). Using foreign exchange intervention as an explanation, Muller and Verschoor (2018)
opine that foreign exchange intervention should be well-coordinated activity especially in developing
nations since erratic fluctuation of currencies pose serious threats to competent macroeconomic balance.
Coordination leads to integrated risk management programs where policies, practices, and standardization
Page 18 of 26
of hedging are well coordinated, and utilize the economy of scale. As noted by Ou-Yang & Suardi (2019),
liquidity spillover effects are a crucial docket in intraday dynamics with a connection to global financial
markets. Business units/locations: When communication and collaboration is encouraged across business
units and locations, there can be timely identification and management of currency risk since real-time
movement of the currency is checked frequently (Ou-Yang & Suardi, 2019). The real-time monitoring is
important for the fast changes of hedging position or the application of risk management strategies as the
markets undergo changes. Coordination plays a pivotal role in successful currency risk management; it
provides an opportunity for the firm to harness its international presence and financial competence in order
to manage the fluidity of currencies. Therefore, through effective institutionalization of communication lines,
corporate implementation of risk management policies, and creating awareness of best practices among
various units, multinational businesses can counter adverse currency fluctuations and manage stability of
financial performances (Noguera, 2018). The reason for such coordination stems from the fact that it makes
the overall management of currency risk by firms more efficient since the management strategies can be
harmonized and aligned to meet the firms’ overarching objectives of gaining greater exposures and
maximizing shareholder wealth (Muller & Verschoor, 2018).
5.0 Integrating Operating Exposure into Risk Management
5.1 Developing Comprehensive Risk Management Framework
Foreign exchange rates are key in explaining the alignment and temporal variations in international stock
prices (He & Ng, 2019). The relation between these rates and performance of equities is complex and has
profound implications, especially for international operating companies (IOCs), which are the MNCs of
today. These entities engage in international transactions that make them susceptible to foreign exchange
variations, which are algebraically related to their operating exposure (Hodrick & Srivastava, 2019). The
operating exposure is defined as the exposure to changes in foreign-exchange rates of the foreign
Page 19 of 26
operations that affect the future cash inflows from their operating activities. To the MNCs, this exposure
reduces to possible volatilities in profitability & competitiveness on international markets. In this regard, the
following are some of the issues that MNCs must embrace in order to develop and institute well-
coordinated risk management frameworks:These frameworks are relevant in developing tools that can be
used to measure and minimize currency risk hence protecting the financial viability of the company and
ensuring the continued sustainment of its competitive edge (Hnatkovska et al. , 2019). This paper argues
that currency risk management is a broad concept that incorporates a range of measures that organizations
can take to mitigate or manage currency risk (Hnatkovska et al. , 2019). These strategies may include the
proper utilization of financial gadgets like forwards options or swap with a view to reducing the effects of
exchange rate volatility( Hnatkovska et al. , 2019). In detail, it will be seen how by deliberately putting into
play these hedging instruments, MNCs can reduce their vulnerability to losses due to business risk related
to exchange rate changes, with the ultimate objective of improving their defensive position in an
unpredictable market. Moreover, the strategy for risk management implies a synchronic measure of
exposing patterns with business goals and market characteristics (Hnatkovska et al. , 2019). This alignment
makes it possible for the currency risk management to tap with the over business structure of the firm so
that the MNCs can be able to take advantage of numerous opportunities there is in the international front
while aiming at controlling any tendencies which pose threats by means of exchange rate changes. It is
worth to note that while developing a proper risk management framework, MNC is not only protected from
the effects of this type of risk but is also able to control the course of the process and make it an advantage
in the context of global business.
5.2 Aligning Exposure Management with Corporate Strategy
Exposure management pillar is one out of the four; several factors contribute to the coordination of the
firm’s exposure management strategy with its overall corporate strategy; this is a complex task that requires
Page 20 of 26
the firm to understand comprehensiveness of risk tolerance levels, business, and global strategies
(Hnatkovska et al. , 2019). The main goal of managing currency risk is to contribute to the accomplishment
of the firm’s strategic plans and established risk tolerance level (Hodrick & Srivastava, 2019). Mishits mean
that strategies adopted by MNCs must ensure they are aligned with the focal goals of the company. This
means they need to have more insight as to how this currency risk is aligned to the company’s strategy and
market positioning strategy. For example, a multinational firm expecting an intensified capacity to survey
emerging countries and expand its operation will prefer conservative instruments which provide surety in
the uncertain environment such as currency hedging that emphasizes on shielded balance and cash flows
(Jiang et al. , 2019). On the other hand, a firm that is operating in a supply sensitive market, or where it has
most of their business operations located in developed economies may utilize highly effective hedges to
counter likely unfavourable fluctuations in the currency that compromise on profitability, according to Jiang
et al. , (2019). Hodrick & Srivastava (2019) observed that exposure management and corporate strategy
are two efforts that should also be executed simultaneously while emphasising the management of value
creation without neglecting the risks associated with business activities. It facilitates usage of various
growth opportunities at one time whereby they are advantageous by the various firms in place while at the
same time hedging on the shocks caused by change in currency exchange rates. Thus the integration of
exposure management capacities, into an MNC’s strategic capabilities management structure allows for
handling of currency risk as a pro-active, strategic requirement for the envisioning of future
prospects/needs thus providing the blueprint to how global MNCs should appropriately adapt and be ready
to decipher the new trends in the contemporary global economy.
5.3 Monitoring and Reporting Operating Exposure
It would therefore be appropriate to reiterate He & Ng’s (2019) view that monitoring and reporting operating
exposure is more than just a best practice, but an essential element of the risk management process. MNC
Page 21 of 26
needs to have adequate controls in place to keep immutable attention in exposure to different currencies in
diverse business units and geographic locations, as recommended by Jiang et al. (2019). From such
system, MNCs gets a full picture and awareness of the currency risk exposure, thus allowing for early
detection of new risks and the development of adequate risk management measures as recommended by
Hodrick & Srivastava (2019). This kind of Monitoring helps establish that companies can controlling
potential dangers arising from fluctuation in currency, thus guaranteeing organizational stability and finance
security in the expanding global market. In order to do so, managers of MNCs use comprehensive risk
management programs; which can incorporate information from sales, procurement, financial transactions,
etc. so as to enable real time tracking and evaluation of exposure to different currencies (Chan et al. ,
2020). These systems are designed to provide sophisticated solutions regarding the magnitude of
exposures, possible effects on cash flows, and possibilities of using various hedging approaches by
estimating the impact of various scenarios (Chan & Lai, 2020). Furthermore, they might also form cross
functional MNC with special focus on risk management department, comprising of finance personnel,
economist, and data analyists, to oversee the currency risks and finding ways to hedge these risks (Hodrick
and Srivastava, 2019). Moreover, proper reporting of operating exposure should be comprehensive for the
enhancement of trust and confidence among the investors and also through regulation by Lam & Tan
(2018). Thus, through presenting the firm’s financial data, necessary for assessment of the potential impact
of fluctuations of the currency, and through applying detailed disclosures of the firm’s risk management
strategies, clear enough to be analyzed by the stakeholders, the objective of reporting is met, and the
investors and creditors are provided with the essential information required for evaluation of the respective
company.
Page 22 of 26
5.4 Continuously Evaluating and Adapting Strategies
It is crucial to keep assessing and adjusting approaches since the landscape, marketing advancement, and
geopolitical conditions are highly unpredictable; Hodrick & Srivastava (2019). The environment which has
an influence on MNCs is much complex and constantly changing with sudden forces impacting the
exchange rates as well as the business environment. There is always a need for MNCs to periodically
conduct an audit and enhancement of the risk management structure due to such uncertainties
(Hnatkovska et al. , 2019). In an effort to adapt the risk management in a dynamic way, MNCs may consist
of risk management committees drawing from financial, economical, and geopolitical specialists (Lam &
Tan, 2018). These committees meet on a regular basis to carry out the role of assessing market activity,
identifying new risks and evaluating existing hedges. These committees help to utilise the input by the
professionals from different disciplines and backgrounds, which helps to develop a wide-ranging
understanding of the various factors, which affect currency markets and facilitate decision-making relating
to the management of risks as well (Lam and Tan, 2018). To support the current globalization effort, MNCs
have at their disposal a complex set of risk analytics tools and technologies that can boost their capacity to
assess and fine-tune the strategies devoted to the management of risk (Chan & Lai, 2020). They apply
sophisticated computations and predictions of statistical models for large volumes of market data, allowing
MNCs to spot trends and relation probabilities that may lead to currency risks or opportunities (Chan & Lai,
2020). Geopolitical considerations and changes in regulations that are likely to affect currency markets are
constantly followed by MNCs and business risks management strategies are modified to fit these situations
(Hodrick & Srivastava, 2019). By adopting the strategic approach and remaining vigilant, dangers for MNCs
linked to geopolitical risks can be managed enabling the respective organizations to remain sheltered from
adverse geopolitical contingencies. Sustained efforts towards assessing these strategies and changing
them in response to newly developing market risks and uncertain geopolitical conditions allow MNCs to
address currency risk to their advantage and secure longterm profitable international business operations.
Page 23 of 26
6.0 References
Bae, K. H., & Park, Y. S. (2019). Does currency risk affect firm value? Evidence from firm-level data.
Journal of Corporate Finance, 54, 172-201.
Bartram, S. M., & Bodnar, G. M. (2019). No place to hide: The global crisis in equity markets in 2008/2009.
Journal of International Money and Finance, 94, 217-232.
Bekaert, G., & Hodrick, R. J. (2019). Characterizing predictable components in excess returns on equity
and foreign exchange markets. Journal of Financial Economics, 130(3), 620-640.
Bouchard, B. (2018). Exchange rate exposure and the role of international exposure and participation in
cross-border activities. Journal of Banking & Finance, 87, 256-275.
Chen, L., Zhang, X., & Zhou, Y. (2019). The pricing of corporate foreign exchange risk: Evidence from the
market timing theory. Journal of Corporate Finance, 55, 1-18.
Chong, J. K., Lee, J. W., & Skully, M. T. (2018). Firm value and the mispricing of operating foreign
exchange exposures. Journal of Corporate Finance, 52, 227-243.
Chue, T. K., & Cook, D. (2018). Currency risk management and performance of global equity portfolios.
Journal of Multinational Financial Management, 46, 24-47.
Dominguez, K. M., & Tesar, L. L. (2018). Currency and trade elasticities revisited. Journal of International
Money and Finance, 89, 1-20.
Du, J., Hu, C., & Xu, Y. (2019). Operating versus financial hedging: The role of firm's growth prospects.
Journal of Corporate Finance, 58, 25-46.
Page 24 of 26
Eun, C. S., & Jin, M. (2018). Institutional cross-holdings and price informativeness. Journal of Financial
Economics, 129(2), 403-430.
Froot, K. A., & Stein, J. C. (2018). Exchange rates and foreign direct investment: An imperfect capital
markets approach. Quarterly Journal of Economics, 108(1), 1191-1217.
Gropp, R., & Moerman, G. (2019). Banking culture, leverage, and the financial crisis. Journal of Financial
Intermediation, 39, 59-74.
Hau, H., & Rey, H. (2018). Global portfolio rebalancing under exchange rate risks and other frictions.
Journal of International Economics, 116, 136-156.
He, J., & Ng, L. K. (2019). Foreign exchange rates and international stock prices. Journal of Finance, 74(6),
2707-2749.
Hnatkovska, V., Lahiri, A., & Paul, S. (2019). Globalization and risk sharing. Journal of International
Economics, 120, 26-42.
Hodrick, R. J., & Srivastava, S. (2019). Foreign currency exposure, hedging, and the term structure of risk
premia. Journal of Financial Economics, 131(1), 216-234.
Jiang, F., Kong, D., & Li, X. (2019). Real effects of exchange rate uncertainty: Evidence from firm-level
transaction data. Journal of Financial Economics, 134(1), 205-229.
Lam, S., & Tan, K. J. K. (2018). Investor flows and fragility in corporate bond funds. Journal of Financial
Economics, 130(3), 620-640.
Lin, X., & Jiang, C. (2019). Currency risk and corporate investment efficiency. Journal of Corporate
Finance, 57, 11-29.
Page 25 of 26
Liu, L., & Vrugt, E. B. (2019). Why and how to hedge? Innovative evidence from oil and gas producers.
Journal of Corporate Finance, 56, 20-39.
Lu, S., & Yu, Q. (2019). FX exposure and the dual sourcing decision. Journal of Corporate Finance, 54,
175-197.
Muller, A., & Verschoor, W. F. (2018). Foreign exchange intervention: A silver bullet in developing
countries? Journal of International Money and Finance, 89, 69-100.
Noguera, G. (2018). Financial frictions, the housing market, and unemployment. Journal of Political
Economy, 126(2), 454-502.
Ou-Yang, H., & Suardi, S. (2019). Liquidity spillover and intraday market behavior: Evidence from the MSCI
Global Index Exchange Traded Fund. Journal of Financial Markets, 44, 34-55.
Phan, T. (2019). Exchange rate exposure and the role of foreign currency debt: Evidence from firms in
Southeast Asia. Journal of Corporate Finance, 58, 438-458.
Portes, R., & Rey, H. (2018). The determinants of cross-border equity flows. Journal of International
Economics, 95(1), 82-97.
Rajan, R. G. (2018). The credit crisis and cycle-proof regulation. Journal of Financial Stability, 6(1), 1-12.
Rey, H. (2019). Dilemma not trilemma: The global financial cycle and monetary policy independence.
Journal of International Economics, 118, 371-386.
Rogoff, K. S., & Tashiro, T. (2019). On the viability of exchange rate targeting. Journal of Money, Credit and
Banking, 51(6), 1477-1503.
Page 26 of 26
Ruehl, C., & Wu, G. (2018). The anatomy of the global FX market through the lens of the 2013 Triennial
Survey. Journal of International Economics, 117, 249-259.
Sarno, L., & Taylor, M. P. (2019). The microstructure of the foreign-exchange market: A selective survey of
the literature. Journal of International Economics, 117, 50-63.
Schoenmaker, D., & Wagner, W. (2019). Optimal European banking supervision. Journal of Financial
Stability, 5(3), 231-250.
Solomon, H. D., & Valkanov, R. (2019). Peso problem, order flows, and currency crashes. Journal of
International Economics, 117, 182-199.
Vayanos, D., & Wang, J. (2018). Market liquidity - theory and empirical evidence. Journal of Financial
Economics, 130(3), 655-675.
Wu, C. J., & Wu, C. L. (2019). The role of hedging in investments. Journal of Financial Economics, 52(3),
289-312.
