Meaning And Nature Of Foreign Exchange Exposure

The values of a firm's assets, liabilities and operating income vary continually in response to changes in myriad economic and financial variables such as exchange rates, interest rates, inflation rates, relative prices and so forth. We can label these uncertainties as macro-economic environmental risks. In addition, uncertainties related to its operating business such as interruptions in raw materials supplies, labour troubles, success or failure of a new product or technology and so forth obviously have an impact on the firm's performance. These can be grouped under the heading of core business risks.  While core business risks are specific to firm, macro-economic uncertainties affect all firms in the economy. However, the extent and nature of impact of even macro-economic risks crucially depend upon the nature of a firm's business. For instance, fluctuations of exchange rate will affect net importers and net exporters quite differently; the impact of interest rate fluctuations will be very different on a bank from that on a manufacturing firm; oil price gyrations will affect an airline in one way and an oil producer in a quite different way.  The nature of macro-economic uncertainty can be illustrated by a number of commonly encountered situations. An appreciation of the value of a foreign currency (or equivalently, a depreciation of the domestic currency), increases the domestic currency value of a firm's assets and liabilities denominated in the foreign currency-foreign currency receivables and payables, bank deposits and loans, etc. It will also change domestic currency cash flows from exports and imports. An increase in interest rates reduces the market value of a portfolio of fixed-rate bonds and may increase the cash outflow on account of interest payments. Acceleration in the rate of inflation may increase the value of unsold stocks, the revenue from future sales as well as the future costs of production. Thus the firm is "exposed" to uncertain changes in a number of variables in its environment. These variables are sometimes called Risk Factors.