Transaction
Transaction Exposure (Note 11; Ch 8)
1. Transaction Exposure
2. Hedging
Foreign exchange exposure is a measure of the potential for a firm’s profitability, net cash flow, and market value to change because of a change in exchange rates These three components (profits, cash flow and market value) are the key financial elements of how we evaluate the relative success or failure of a firm
1. Transaction Exposure: measures changes in the value of outstanding financial obligations incurred prior to a change in exchange rates but not due to be settled until after the exchange rate changes
Transaction exposure measures gains or losses that arise from the settlement of existing financial obligations whose terms are in a foreign currency. The situations include • Purchasing or selling on credit goods or services when prices are stated in foreign currencies • Borrowing or lending funds when repayment is to be made in a foreign currency • Being a party to an unperformed forward contract • Acquiring assets or incurring liabilities denominated in foreign currencies
[pic]
Example (purchasing or selling): Leo Srivastava is the director of finance for Pixel Manufacturing, a U.S.-based manufacturer of hand-held computer systems for inventory management. Pixel has completed the sale of a bar-code system to a British firm, Grand Metropolitan (UK), for a total payment of £1,000,000. The following exchange rates were available to Pixel on the following dates corresponding to the events of this specific export sale. Assume each month is 30 days.
[pic]
(a) Assume Leo decides not to hedge the transaction exposure. What is the value of the sale as booked? What is the foreign exchange gain (loss) on the sale?
( The sale is booked at the exchange rate existing on June 1, when the product is shipped to Grand Met, and the shipment is categorized as an account receivable (A/R).
Value as settled = £1,000,000* $1.7290/£ = $1,729,000
Value
1. Transaction Exposure
2. Hedging
Foreign exchange exposure is a measure of the potential for a firm’s profitability, net cash flow, and market value to change because of a change in exchange rates These three components (profits, cash flow and market value) are the key financial elements of how we evaluate the relative success or failure of a firm
1. Transaction Exposure: measures changes in the value of outstanding financial obligations incurred prior to a change in exchange rates but not due to be settled until after the exchange rate changes
Transaction exposure measures gains or losses that arise from the settlement of existing financial obligations whose terms are in a foreign currency. The situations include • Purchasing or selling on credit goods or services when prices are stated in foreign currencies • Borrowing or lending funds when repayment is to be made in a foreign currency • Being a party to an unperformed forward contract • Acquiring assets or incurring liabilities denominated in foreign currencies
[pic]
Example (purchasing or selling): Leo Srivastava is the director of finance for Pixel Manufacturing, a U.S.-based manufacturer of hand-held computer systems for inventory management. Pixel has completed the sale of a bar-code system to a British firm, Grand Metropolitan (UK), for a total payment of £1,000,000. The following exchange rates were available to Pixel on the following dates corresponding to the events of this specific export sale. Assume each month is 30 days.
[pic]
(a) Assume Leo decides not to hedge the transaction exposure. What is the value of the sale as booked? What is the foreign exchange gain (loss) on the sale?
( The sale is booked at the exchange rate existing on June 1, when the product is shipped to Grand Met, and the shipment is categorized as an account receivable (A/R).
Value as settled = £1,000,000* $1.7290/£ = $1,729,000
Value