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    Transaction Exposure-Techniques

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    Mital Parmar
    The document discusses various financial and operational techniques for managing transaction exposure. The main financial techniques mentioned are forward contracts, futures contracts, money market hedges, and options. These allow firms to lock in exchange rates for future foreign currency transactions. Operational techniques include risk shifting, currency risk sharing between parties, leading/lagging cash flows, and using reinvoicing centers to centralize foreign currency management.

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    Transaction Exposure-Techniques

    Uploaded by

    Mital Parmar
    64 views16 pages
    The document discusses various financial and operational techniques for managing transaction exposure. The main financial techniques mentioned are forward contracts, futures contracts, money market hedges, and options. These allow firms to lock in exchange rates for future foreign currency transactions. Operational techniques include risk shifting, currency risk sharing between parties, leading/lagging cash flows, and using reinvoicing centers to centralize foreign currency management.

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    Transaction exposure-Techniques

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    The document discusses various financial and operational techniques for managing transaction exposure. The main financial techniques mentioned are forward contracts, futures contracts, money market hedges, and options. These allow firms to lock in exchange rates for future foreign currency transactions. Operational techniques include risk shifting, currency risk sharing between parties, leading/lagging cash flows, and using reinvoicing centers to centralize foreign currency management.

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    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    64 views16 pages

    Transaction Exposure-Techniques

    Uploaded by

    Mital Parmar
    The document discusses various financial and operational techniques for managing transaction exposure. The main financial techniques mentioned are forward contracts, futures contracts, money market hedges, and options. These allow firms to lock in exchange rates for future foreign currency transactions. Operational techniques include risk shifting, currency risk sharing between parties, leading/lagging cash flows, and using reinvoicing centers to centralize foreign currency management.

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    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 16

    Financial Techniques to Manage Transaction Exposure

    • The main feature of a transaction exposure is


    the ease of identifying its size. Additionally, it
    has a well-defined time interval associated
    with it that makes it extremely suitable for
    hedging with financial instruments.
    • The most common methods for hedging
    transaction exposures are −
    • Forward Contracts − If a firm has to pay (receive)
    some fixed amount of foreign currency in the
    future (a date), it can obtain a contract now that
    denotes a price by which it can buy (sell) the
    foreign currency in the future (the date). This
    removes the uncertainty of future home currency
    value of the liability (asset) into a certain value.
    • Futures Contracts − These are similar to
    forward contracts in function. Futures
    contracts are usually exchange traded and
    they have standardized and limited contract
    sizes, maturity dates, initial collateral, and
    several other features. In general, it is not
    possible to exactly offset the position to fully
    eliminate the exposure.
    • Money Market Hedge − Also called
    as synthetic forward contract, this method
    uses the fact that the forward price must be
    equal to the current spot exchange rate
    multiplied by the ratio of the given currencies'
    riskless returns. It is also a form of financing
    the foreign currency transaction. It converts
    the obligation to a domestic-currency payable
    and removes all exchange risks.
    • Options − A foreign currency option is a
    contract that has an upfront fee, and offers
    the owner the right, but not an obligation, to
    trade currencies in a specified quantity, price,
    and time period.
    • Note − The major difference between an option and
    the hedging techniques mentioned above is that an
    option usually has a nonlinear payoff profile. They
    permit the removal of downside risk without having
    to cut off the profit from upside risk.
    • The decision of choosing one among these different
    financial techniques should be based on the costs
    and the penultimate domestic currency cash flows
    (which is appropriately adjusted for the time value)
    based upon the prices available to the firm.
    Operational Techniques for Managing Transaction Exposure

    • Operational strategies having the virtue of


    offsetting existing foreign currency exposure
    can also mitigate transaction exposure. These
    strategies include −
    • Risk Shifting − The most obvious way is to not
    have any exposure. By invoicing all parts of the
    transactions in the home currency, the firm
    can avoid transaction exposure completely.
    However, it is not possible in all cases.
    • Currency risk sharing − The two parties can
    share the transaction risk. As the short-term
    transaction exposure is nearly a zero sum
    game, one party loses and the other party
    gains%
    • Leading and Lagging − It involves playing with
    the time of the foreign currency cash flows.
    When the foreign currency (in which the
    nominal contract is denominated) is
    appreciating, pay off the liabilities early and
    collect the receivables later. The first is known
    as leading and the latter is called lagging.
    • Reinvoicing Centers − A reinvoicing center is a
    third-party corporate subsidiary that uses to
    manage one location for all transaction
    exposure from intra-company trade. In a
    reinvoicing center, the transactions are carried
    out in the domestic currency, and hence, the
    reinvoicing center suffers from all the
    transaction exposure.
    • Reinvoicing centers have three main advantages −
    • The centralized management gains of transaction
    exposures remain within company sales.
    • Foreign currency prices can be adjusted in advance to
    assist foreign affiliates budgeting processes and
    improve intra affiliate cash flows, as intra-company
    accounts use domestic currency.
    • Reinvoicing centers (offshore, third country) qualify for
    local non-resident status and gain from the offered tax
    and currency market benefits.

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