Transaction vs Economic Exposure

‘Transaction vs Economic Exposure’ is equivalent to comparing short term vs. long-term impact on cash flow changes due to forex fluctuations in the market. Transaction and economic exposure differ on various aspects. Future receivables or payables in foreign currency drive transaction risk. On the other hand, future currency cash inflows /outflows drive economic exposure.

As a part of international financial management, companies are often exposed to cash flow variability purely on the account of exchange rate fluctuations. While some cash flow risk is short term in nature, others are longer term risks. Managing both transaction exposure and economic exposure is linked to cash flows management.

Transaction vs Economic Exposure

Transaction vs. Economic Exposure

The difference between Transaction and Economic  Exposure is organized in following 6 major points. Let’s look at each of the point.

Point of Difference Transaction Exposure Economic Exposure

Cash Flow

Transaction exposure is driven by transactions which have already been contracted for and hence they are of short term nature. For example: if Company A, based in the US has already supplied goods worth $100 Mio to another Company B in the UK and has agreed to receive the payment in GBP, it has already undertaken transaction risk on cash flows. Economic exposure is transaction exposure as well as operating exposure which is related to future cash flows. These cash flows are not realised or contracted for and the exposure is more anticipatory in nature. Economic exposure can arise due to change in future sales, volume, pricing or cost profile.

Nature of Risk

Risk associated is limited to the contract or transaction under discussion Risk associated impacts the core value of a business rather than one particular transaction or contract and is the risk to present value of future operating cash flows

Identification

Transaction risk is the most easily identifiable foreign exchange risk Given its anticipatory nature, economic exposure is not easy to identify

Cause and Scope

Transaction exposure arises only when you enter into a contract involving future receivables/payables in foreign currency. Hence the scope remains narrow. Economic exposure can arise without having any transaction exposure and hence the scope remains wide.

For example: domestic cash flows can be impacted due to foreign competition in domestic market, linked to foreign exchange difference. So if domestic currency weakens, foreign competition will increase sales in your domestic market, thus impacting your cash flows.

Characteristics

Transaction exposure is more technical and tactical in nature Economic exposure is linked to a firm’s strategy and hence is fundamental in nature

Hedging Application

Transaction exposures are hedged more frequently by most companies. Most firms seldom apply any hedging strategy for managing economic exposure and believe in natural hedging
Last updated on : June 18th, 2018

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