Exposure Analysis
Foreign Exchange Exposure Analysis
- These three components (profits, cash flow and market value) are the key financial elements of how we view the relative success or failure of a firm
- While finance theories tell us that cash flows matter and accounting does not, we know that currency-related gains and losses can have destructive impacts on reported earnings – which are fundamental to the markets opinion of that company
The foreign exchange rate exposure of a firm is a measure of the sensitivity of its cash flows to changes in exchange rates. Since cash flows are difficult to measure, most researchers have examined exposure by studying how the firm’s market value, the present value of its expected cash flows, responds to changes in exchange rates
FX Gain (Loss) = [ St+n - St ] [ Exposure ]
Exposure is expressed in units of the underlying host currency, the exchange rate is the price of the host currency in units of home currency (i.e. $/FC), and hence the exchange rate gain/loss is in home currency units.
| Variable / Cash Flows | Transaction Type |
| Contracted Foreign Currency Cash Flows
Foreign Interest Rates, whether Floating or Fixed Cash Flows from Hedge Transactions Projected/ Contingent Cash Flows |
Both Capital and Revenue in nature
All Interest Payments/ Receipts All Open hedge transactions Both Capital and Revenue in nature |
Analysis These exposures will be analysed and the following aspects will be studied:
- Foreign Currency Cash Flows/ Schedules
- Variability of Cashflows – how certain are value dates?
- Inflow-Outflow Mismatches / Gaps Time Mismatches / Gaps
- Currency Portfolio Mix
- Floating / Fixed Interest Rate ratio
Market Forecast » « Introduction to Foreign Exchange Risk Management