MEASUREMENT OF TRANSACTION EXPOSURE

Transaction exposure measures gains or losses that arise from the settlement of existing financial obligation whose terms are stated in a foreign currency.

STEPS for measuring transactions exposure are:

1. Determine the projected net amount of currency inflows or outflows in each foreign currency.

2. Determine the overall exposure to those currencies.

The first step in transaction exposure is the projection of the consolidated net amount of currency inflows or outflows for all subsidiaries, classified by currency subsidiary.

For example:

· Incase of a centralized approach, while assessing the MNC’s exposure, it is advisable, to determine the MNC’s overall position in each currency as a first step.

Like, Subsidiary A may have net inflows of $ 6, 00, 000 while subsidiary B may have net outflows of $ 7, 00, 000. The consolidated net inflows here would be - $ 1, 00 ,000. If the other currency depreciates, Subsidiary A will be adversely affected while Subsidiary B will be favorably affected. The net effect of the Dollars depreciation on the MNC”S is minor since an affecting effect takes place. It could have been substantial if most subsidiaries of the MNC”S had future inflows of US dollars.

· Incase of a non-centralized approach, each subsidiary acts independently & assesses & manages its individual exposure to exchange rate risk. Such an approach gives important responsibilities to each subsidiary to plan out its future strategy in accordance with currency movements.

Like, MNC’s has two subsidiaries in France. One subsidiary receives 10 million British pounds each month as a result of exports sent to UK. The other subsidiary pays 10 million pounds per month to purchase supplies from a UK firm. The subsidiaries act independently to hedge their exposure & the local bank that helps both subsidiaries has a bid-ask spread of approx 1% on its forward rates. Thus, it provides French francs in exchange for pounds to one subsidiary & sells these pounds to the other subsidiary in exchange for French francs for 1% more. The spread on 10 million pounds represents 1, 00,000 pounds per month or 1.2 million pounds per year. If the MNC’s were to centralize its exposure management, hedging would not be necessary as the exposures of the individual subsidiary would offset each other. The transaction fee paid to the bank could also be avoided.