Currency instability

       

Three major risks due to currency instability

There are three basic types of risks that companies face due to currency instability:

Transaction exposure:

Transaction exposure arises when the rise and fall of exchange rates affect the obligations of the company in order to give or collect payments that are denominated in the international market in future. The nature of transaction exposure is usually short-term to medium-term.

Translation exposure:

Translation exposure is due to currency volatility on a consolidated financial statement of a company, especially when the company has its sister company in the international market. In nature translation exposure is usually medium-term to long-term.

Operating or Economic exposure:


Economic exposure is less common than the above two, but no doubt is a crucial risk. This risk is generally arises due to the result of the unpredicted currency rise and fall on a future cash flow and market price of a company and is usually long-term.

The consequences of economic exposure can be considerable, as unexpected currency rate fluctuates can widely influence a competitive position of a company, yet the company does not have any branch in foreign market or sell anything in the international market.

For instance, a furniture company in the U.S. who only trades locally still has to compete with the importers of Asia and Europe, whose furniture may be much cheaper and therefore more competitive.

Note that the economic exposure is usually unexpected – for the management of the company makes their budget and predicts on certain currency rate assumptions that symbolize their estimated change in exchange rates.