Economic v. Transaction Exposure

Comparing and contrasting transaction exposure and economic exposure

By definition, transaction exposure covers all the risks associated with changes in the exchange rates over the current investments. In essence, it measures the actual change in the future cash flows brought by uncertainty and changes in the market exchange rates under contracted investments (Riahi-Belkaoui, 2002). Transaction exposure thus reflects price stability, favorable balance of payment of a country while holding other economic factors constant. In line with this, the deterioration of economic conditions causes a significant change in the value of the currency. On the other hand, economic exposure, in general, relates to the entire investment of a country (Wang, 2005).

Secondly, transaction exposure outlines cash losses resulting from variations in exchange rates. It is important to note that there are difficulties in measuring and computing such losses (In Rahman, In Tan, & In Ullah, 2014)). However, to compute them requires the application of a simple financial accounting under the transaction exposure whereas, in economic exposure, computing losses in investment opportunities necessitate the use of a good variance accounting method to isolate the effect of disparities on sales and profit margins. However, the challenge with economic exposure is that firms do not have appropriate practices to compute the magnitude of opportunity lost.

Thirdly, the duration of transaction exposure covers the time of the contract con the other hand, economic exposure measures the duration and the impact of the exposure as the time lag in changing factors such as markets, technology, and products. It is also important to note that transaction exposure relates to nominal contracts with fixed value related to foreign currency. Furthermore, economic exposure relates to the impact of changes on cost, prices among other factors that affect cash flow. Finally, the source of uncertainty under transaction exposure is the future exchange rate whereas in economic exposure, is the uncertainty of the domestic cash flows subjected to foreign subsidiaries (Wang, 2005).

Notably, both transaction and economic exposures have some elements in common; both measure the future impact of any change in the exchange rates which has occurred or is likely to occur in the future. In other words, both economic and transaction exposure covers formal current investments opportunities. Furthermore, economic exposure explains how future cash flows correlate with exchange rate movements (Mathis, Keat, & Thunderbird School of Global Management, 2009)).

An intuitive explanation for the sale of stocks in Asian countries like Japan, Taiwan, and Singapore

In the wake of dollar appreciation, a firm selling its stock in the international market follows the standard economic condition that requires that prices be set to maximize dollar profits. That is, selling at a position where the marginal cost and revenues are at equilibrium. In making such a decision, profits will reflect the dollar value of any transaction (Döhring & European Commission, 2008). Appreciation of a foreign currency implies that firms to sell stock abroad consider hiking prices in foreign currency. The effect of this is that it gives domestic producers a competitive cost advantage that limits the chances of recouping dollar profits.

Excess inventory adversely affects capital flows in an economy. To illustrate this, it reduces interest and opportunity of holding stock for investors in the Asian market. From the physical perspective, an investor who had hoped for hedging incurs losses as stock prices rapidly drop. The firms that were likely to be affected by the dumping of stock in the Asian market include hedging and speculative firms.

References

Click, R. W., & Coval, J. (2002). The theory and practice of international financial management. Upper Saddle River, NJ: Prentice Hall.

Döhring, B., & European Commission. (2008). Hedging and invoicing strategies to reduce exchange rate exposure: A euro-area perspective. Brussels: European Commission.

In Rahman, M., In Tan, T. Y., & In Ullah, A. K. (2014). Migrant remittances in South Asia: Social, economic and political implications. University of Alaska anchorage: Department of Economics.

Mathis, F. J., Keat, P. G., & Thunderbird School of Global Management. (2009). Vanguard Security Corporation: International transaction dilemma. Glendale, AZ: Thunderbird School of Global Management.

Riahi-Belkaoui, A. (2002). International financial and managerial accounting. Westport, CT: Quorum Books.

Wang, P. (2005). The economics of foreign exchange and global finance. New York, NY: Springer.