FACAULTY OF BUSINESS SCIENCES
PROGRAM: FINANCE AND DIGITAL BANKING
FOREIGN EXCHANGE MARKETS AND INTERNATIONAL FINANCE (FDB208)
NAME SURNAME REG NUMBERS
1.TAFADZWA KURETE R2114771X
2.RUTH MANDIVENGEREI R2114242J
3.RUTENDO TARABUKU R2113135X
4.MITCHELL GAFA R2118944T
5.SANDRA ELLIAS R2011025Q
6.SIBONGINKOSI TSHUMA R199261G
7.SHENDA MUZONDO R2110419A
8.BLOSSOM MAPIKA R217245F
9. TINASHE MHLANGA R211993Z
10. KB NYAMUTITIMA R214766Q
Assignment 1
a) Explain what is meant by the terms foreign exchange translation exposure,
transactions exposure and economic exposure. [12 marks]
Foreign exchange exposure refers to the potential risk that a company faces due to fluctuations in
foreign exchange rates. There are three types of foreign exchange exposure: transaction exposure,
translation exposure, and economic exposure
1. Transaction exposure: Transaction exposure arises when a company has outstanding financial
obligations denominated in a foreign currency. If the exchange rate between the home currency and
the foreign currency changes before the payment is made, the value of the obligation will also change,
resulting in a gain or loss for the company.
2. Translation exposure: Translation exposure arises when a company consolidates its financial
statements from foreign subsidiaries into its home currency. If the exchange rate between the home
currency and the foreign currency changes, the value of the foreign subsidiary's assets and liabilities
will change, resulting in a gain or loss for the company.
3. Economic exposure: Economic exposure arises when a company's cash flows are affected by
changes in exchange rates. For example, if a company exports goods to a foreign country and the
exchange rate changes, the company may lose or gain competitiveness in that market.
What is the significance of these different types of exposure to the financial manager?
The significance of these types of exposure to the financial manager is that they represent risks that
can impact the company's financial performance. By understanding and managing these risks, a
financial manager can mitigate potential losses and ensure the company's financial stability.
Understanding the different types of foreign exchange exposure is important for a financial manager
because it helps them to identify, measure, and manage the risks associated with international
transactions. Each type of exposure has different implications for a company's financial statements,
cash flows, and profitability, and requires different hedging strategies to manage the risk.
Translation exposure affects a company's financial statements and can impact its financial
performance. Financial managers need to be aware of the potential impact of exchange rate
fluctuations on the translation of foreign currency financial statements to the reporting currency. They
may use hedging strategies such as forward contracts, currency options, or swaps to manage
translation exposure.
Transaction exposure affects the cost of goods or services, the value of investments, and the
profitability of international transactions. Financial managers need to be aware of the potential impact
of exchange rate fluctuations on the cash flows and profitability of the company. They may use
hedging strategies such as forward contracts, currency options, or swaps to manage transaction
exposure.
Economic exposure affects a company's competitiveness, market share, and profitability. Financial
managers need to be aware of the potential impact of exchange rate fluctuations on the company's
cash flows, revenues, and costs. They may use strategies such as diversification, local sourcing, or
pricing adjustments to manage economic exposure.
In summary, financial managers need to understand and manage each type of foreign exchange
exposure to minimize the risks associated with international transactions, protect the company's
financial performance and ensure its long-term success.
Evaluate three strategies that a multinational company can use to hedge against
transaction exposure
I. Forward contracts
A forward contract is an agreement between two parties to buy or sell a currency at a pre-determined
exchange rate on a future date. With a forward contract, a company can lock in the exchange rate for a
future transaction and protect itself from fluctuations in exchange rates. If the exchange rate moves
against the company, it will still be able to buy or sell the currency at the pre-determined rate. . This
helps to minimize the risk of loss due to exchange rate fluctuations.
II. Currency Options.
A currency option is a contract that gives the holder the right, but not the obligation, to buy or sell a
currency at a pre-determined exchange rate on a future date. With a currency option, a company can
protect itself against unfavorable movements in exchange rates while still being able to take
advantage of favorable movements. If the exchange rate moves against the company, it can exercise
the option and buy or sell the currency at the pre-determined rate. If the exchange rate moves in the
company's favor, it can simply let the option expire and buy or sell the currency at the better rate.
III. Money Market Hedge
A money market hedge involves borrowing or lending in the domestic or foreign money market to
offset transaction exposure. A multinational company can borrow in the foreign market in the
currency they need to pay for the transaction, and then convert it to their domestic currency. This will
lock in an exchange rate and help to minimize the risk of loss due to exchange rate fluctuations.
IV. Currency Swaps.
Currency Swaps is an agreement between two parties to exchange currencies at a pre-determined
exchange rate on a future date. With a currency swap, a company can protect itself against exchange
rate fluctuations by exchanging currencies with another party at a pre-determined rate. However,
currency swaps are only used for large transactions and can be more complex than other hedging
strategies.
References
Management and Control of Foreign Exchange Risk by Laurent L. Jacque, The Journal of Finance
Vol. 52, No. 5 (Dec., 1997)
Kent D. Miller, Jeffrey J. Reuer, Journal of International Business Studies, Vol. 29, No. 3 (3rd Qtr.
1998),
Eugene Flood, Jr., Donald R. Lessard, Financial Management, Vol. 15, No. 1 (1986)
Christine R. Hekman, Managerial and Decision Economics, Vol. 2, No. 4, Multinational Business
(Dec., 1981)
