Exposure

Management

Sonal Shirude- 152

Gunit Jain- 119
Raj Avlani- 144
Sunil Patel- 153
Chandan Jagtap- 113
Definitions • Exposure is a state or condition of being
unprotected and open to damage, danger,
risk of suffering a loss in a transaction, or
uncertainty.
• Risk Exposure is a quantified potential for
loss that might occur as a result of some
activity.
• Foreign Exchange Risk (FX Risk) refers to
the potential for loss from exposure to
foreign exchange rate fluctuations.
• Foreign Exchange Exposure refers to the
degree(sensitivity) to which a company is
affected by Exchange Rates.
 Examples
“When a US Company sells to a foreign buyer and accepts the buyers currency for the
payment, the US Company bears the risk that the foreign currency depreciates and that
it will receive fewer dollars once the foreign currency is converted back into the dollar.”
“let's assume XYZ Company is a Canadian company and pays interest and principal on a
$1,000 bond with a 10% coupon rate in Canadian dollars (CAD). If the exchange rate at
the time of purchase is $1 CAD: $1 USD, then the 10% coupon payment is equal to $100
Canadian, and because of the exchange rate, it is also equal to US$100.Now let's assume a
year from now the exchange rate is 1:0.85. Now the bond's 10% coupon payment, which
is still $100 Canadian, is worth only US$85”

Bearers of FX Risk :
• Import Export Businesses
• International Investors
• International Lenders/ Borrowers
 Transaction
Exposure

Types
Of FX
Risk
Accounting Operation
Exposure Exposure
(Translation (Economic
Exposure) Exposure)
Transaction • Transaction exposure is the risk, faced in
international trade, that currency exchange

Exposure rates will change after the companies have

already entered into financial obligations.

• Such exposure to fluctuating exchange rates

can lead to major losses for firms.

• The risk of transaction exposure is generally

one-sided, as it is only felt by the company,
sending funds in a foreign currency, and not
by the entity receiving the funds.
Transaction exposure can arise
from the following activities:
•Purchasing or
selling foreign
goods and
services on
credit.

Borrowing or
lending in
another
currency.

Foreign
exchange
contracts.
 Time and Events

t1 t2 t3 t4
Seller quotes Buyer places Seller ships Buyer settles A/R
a price to buyer firm order with product and with cash in
(in verbal or seller at price bills buyer amount of currency
written form) offered at time t1 (becomes A/R) quoted at time t1

Quotation Backlog Billing

Exposure Exposure Exposure

Time between quoting Time it takes to Time it takes to

a price and reaching a fill the order after get paid in cash after
contractual sale contract is signed A/R is issued
 Exposure Netting
• A method of hedging currency risk by offsetting exposure in one currency
with exposure in the same or another currency.
• It is especially applicable in the case of a large company with multiple
currency exposures, since it would be impractical to hedge each and every
currency exposure individually.
• If the correlation between exposure currencies is positive, a company would
adopt a long-short strategy for exposure netting.
• Conversely, if the correlation is negative, a long-long strategy would result in
an effective hedge in the event of currency movement.
 Hedging Remain

Transactio unhedged

n Exposure Hedge in the

forward
market

Hedge in the
money
market

Hedge in the
options
market
 Accounting Exposure
• Accounting exposure is the risk that a company's equities, assets,
liabilities or income will change in value as a result of exchange rate
changes.

• This occurs when a firm denominates a portion of its equities, assets,

liabilities or income in a foreign currency.

• It is also known as Translational exposure.

Current Method
An accounting technique where all current assets
and liabilities of a foreign subsidiary are converted to
domestic currency using the current exchange rate.

Non current Method

An accounting technique where all non current, or
long-term, assets and liabilities are converted at the
exchange rate in effect when the asset was obtained
or when the liability was incurred (historical rates).
Current Rate
A method of foreign currency translation where most items in
the financial statements are translated at the current exchange
rate. The exception would be income statements items, which
are translated at actual exchange rates.

Historical Rate
A temporal method is a method of foreign currency translation
that uses exchange rates based on the time assets and liabilities
are acquired or incurred.
Monetary Method

Under this translation method, monetary items (e.g. cash,

accounts payable and receivable, and long-term debt) are
translated at the current rate.

Non Monetary Method

Under this translation method, non-monetary items (e.g.
inventory, fixed assets, and long-term investments) are
translated at historical rates.
International Financial Reporting Standards
• They are the standards issued by the IFRS Foundation and the International
Accounting Standards Board (IASB) to provide a common global language
for business affairs so that company accounts are understandable and
comparable across international boundaries.

• They are a consequence of growing international shareholding and trade

and are particularly important for companies that have dealings in several
countries.

• They are progressively replacing the many different national accounting

standards.

• They are the rules to be followed by accountants to maintain books of

accounts which are comparable, understandable, reliable and relevant as
per the users internal or external.
 Standard IFRS Requirements
•Statement of Financial Position: This is also known as a balance sheet. IFRS
influence the ways in which the components of a balance sheet are reported.

•Statement of Comprehensive Income: This can take the form of one

statement, or it can be separated into a profit and loss statement and a
statement of other income, including property and equipment.

•Statement of Changes in Equity: Also known as a statement of retained

earnings, this documents the company's change in earnings or profit for the
given financial period.

•Statement of Cash Flow: This report summarizes the company's financial

transactions in the given period, separating cash flow into Operations,
Investing, and Financing.

In addition to these basic reports, a company must also give a summary of its
accounting policies. The full report is often seen side by side with the previous
report, to show the changes in profit and loss. A parent company must create
separate account reports for each of its subsidiary companies.
 Operating Exposure
• Operating exposure, also called economic exposure, competitive
exposure, and even strategic exposure on occasion, measures any change
in the present value of a firm resulting from changes in future operating
cash flows caused by an unexpected change in exchange rates.
• Measuring Operating Exposure:
Measuring the operating exposure of a firm requires forecasting and
analyzing all the firm’s future individual transaction exposures.
So, we have to predict the firm’s future cash flows.

16
Operating & Financing Cash Flows
Financial Cash Flows

Dividend paid to parent

Parent invested equity capital
Interest on intrafirm lending
Intrafirm principal payments

Parent Subsidiary

Payment for goods & services

Rent and lease payments
Royalties and license fees
Management fees & distributed overhead

17
Operational Cash Flows
 Operating Exposure
Will altered profits of
INR Reporting Tata Steel India UK subsidiary, in Sterling
Pound, translate into
more/ less INR?

INR/£

Pound Tata Steel UK How sales, costs,

& profits of British
subsidiary change w/ INR/GBP

Tata Suppliers Tata Customers

Will costs change Will prices & sales volume change

w/ INR/GBP? w/ INR/GBP?
18

-- An unexpected depreciation in the value of the euro alters both the competitiveness of the subsidiary and
the financial results which are consolidated with the parent company.
Managing Operating Exposure
• Can partially manage exposure by operating/ financing
policies offsetting anticipated currency exposures.

• Common policies:

– Matching currency cash flows.

– Risk-sharing agreements.

– Back-to-back (parallel) loans.

– Currency swaps.

19
Matching Currency Cash Flows
Canadian Canadian
Corporation Bank
(buyer of goods) Exports (loans funds)
goods to
US Corp borrows
Canada
Canadian $ debt
from Canadian Bank

U.S.
Corporation
Payment for goods Principal & interest
in Canadian $ payments on debt
in Canadian $

Exposure: Inflow of Canadian $

Hedge: Canadian $ debt payments act as financial
20
hedge - an outflow of Canadian $
 Risk-sharing Currency Clauses
• Contractual arrangement: buyer & seller agree to “share” (split) currency
movement impacts on payments
– E.g.: Ford has to pay Mazda ¥ 25,000,000.
– Ford purchases from Mazda in Yen @ current spot if spot $ is between ¥115 &
¥125.
• If spot rate falls outside range, Ford & Mazda share difference.

• So, if spot ¥110/$, Mazda gets payment of -

 
 ¥25,000,000  ¥25,000,000
    $222,222.22
¥5.00/$ ¥112.50/$
 ¥115.00/$ - 
 2  21

If spot ¥110/$, risk-sharing favors Ford.

If spot ¥130/$, risk-sharing favors Mazda.
 Back-to-Back Loans
1. British firm wishes to invest funds 2. British firm identifies a Dutch firm wishing
in its Dutch subsidiary to invest funds in its British subsidiary

British
Royal Dutch
Petroleum
Indirect Shell
Financing
Direct loan Direct loan
in pounds in euros

Shell UK BP Holland
subsidiary subsidiary

3. British firm loans British pounds 4. British firm’s Dutch subsidiary loans
directly to the Dutch firm’s British euros to the Dutch parent
subsidiary
22

Provides method for parent-subsidiary cross border financing

w/out incurring direct currency exposure.
 Cross-Currency Swaps

Honda Japan Boeing US

Assets Liabilities & Equity Assets Liabilities & Equity

Inflow Inflow
Sales to US Debt in yen Sales to Japan Debt in US$
of US$ of yen

Receive Pay
yen yen
Pay Receive
dollars Swap Dealer dollars

Swap Swap 23
“pay dollars” & “receive yen” “pay yen” & “receive dollars”
Professional • Accounting
• Legal
Outsourcing
• Purchasing
• Information technology (IT)
• Administrative support
• Other specialized services
 IT • India IT companies currently serve two thirds of
the fortune 500 companies

Outsourcing • Created 40 lakhs direct jobs in India

• %154 billion Industry

• 13% Growth Rate Annually

• Export revenue standing at US$99 billion and

domestic revenue at US$48 billion

• 2.5-3 million new jobs will be created by 2025

• 4% in October 2016 to March 2017

• Indian technology startups employed 95,000 to

100,000 IT professionals, across more than 4,750
startups
 legal • When the LPO provider is based in another
country, the practice is called offshoring

process • LPO firms in India had predicted an annual

growth of 200%
outsourcing • Advantage:
– Most firms and corporations outsource
primarily to save cash
– Attorney in major legal markets such as the
US charge from $150 to $500 per hour when
performing rote service
• Disadvantage:
– Breaches of client confidentiality
– May not be bound to necessary ethical
standards
U.S. LPO market size, 2016 & 2024 (USD Million)
 • The term "Outsourcing" became popular in the
U.S. near the turn of the 21st century

Manufacturer • Transferring of blue collar jobs to a third

party for various reasons

Outsourcing – Expertise,
– Human capital,
– Time to market
– Cost factors
• Aerospace, defense, computer, semiconductor,
energy, medical, food manufacturing, personal
care, packaging, and automotive
BPO • Outsourcing of core information-related
business activities

& • KPO requires advanced analytical and

technical skills as well as a high degree of
KPO specialist expertise
• The world BPO market is worth US $234
billion
• The contribution from India, worth $5.7
billion