Managing Transaction Exposure

Merchants have no country. The mere spot they stand on does not constitute so strong an attachment as that from which they draw their gains.

Thomas Jefferson

In the early phases of internationalization, firms are primarily exposed to foreign exchange (FX or forex) risks of a transaction nature. Firms that are actively involved in exporting will find it necessary, for competitive reasons, to invoice accounts receivable in the currency of the foreign buyer. Similarly, firms actively sourcing components or finished products and services from foreign companies may have to accept being invoiced in the currency of their foreign supplier. In other words, their accounts payable would be in a foreign currency. Either way, whether a firm buys or sells goods in a foreign currency, sizable exchange losses may be incurred from unforeseen and abrupt exchange rate movements. These currency fluctuations can wipe out profits on export sales or eliminate cost savings on foreign procurements (see International Corporate Finance in Practice 16.1).

After showing how to measure and consolidate transaction exposure, this chapter introduces and compares various hedging techniques for the elimination or reduction of such transaction exposures. Whether they are short-term or long-term, known with certainty or contingent upon other events, different transaction exposures require different hedging mechanisms. A firm must assess its particular type of exposure, as ...

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