Introduction:
Transaction exposure is the extent of uncertainty related to all business entities concerned in multinational trade activity. Particularly, trade exposure is the risk, which will affect the currency exchange rates cause fluctuations after an organisation has taken up a fiscal commitment. A high level of sensitivity to fluctuating exchange rate may cause a major financial loss for offshore businesses.
These organisations can restrict their exposure to fluctuating exchange rates by making use of various hedging strategies. By using the hedging strategy of forward rates, the business organisations can lock-in an advantageous currency exchange rate and alleviate their exposure to risk.
Transaction Exposure Risk:
The risk of transaction exposure is generally taken up by one side involved in the trade. The vulnerability or risk of currency exchange is borne by that business organisation which is going to execute a business transaction in a foreign currency. Those entities that are going to receive or settle a bill in its domestic currency will not be subject to the transaction exposure risk.
Generally, the buyer will take on purchasing the product with offshore cash. In this case, the possibility of risk is that the foreign currency will appreciate and the buyer will incur a higher cost as they have to spend much more than what was estimated to purchase the goods or products.
Example:
Consider that an American-based firm is willing to buy a product from an Indian-based company. The American entity will agree to work out a pact and will shell out for the goods in the Indian rupee. After the agreement is executed, the deal may not go through immediately. When the deal eventually happens, the Indian rupee may have appreciated and will cost the American firm a higher amount due to this. On the other hand, if the Indian currency slides, the American firm would benefit.
