International Finance: Putting Theory Into Practice

524 CHAPTER 13. MEASURING EXPOSURE TO EXCHANGE RATES

Table 13.6:Economic v Translation Exposure: summary

1. Economic exposure relates to changes in
   genuine cash flows and theirPV.

Accounting exposure focuses on book val-

ues with, usually, no cashflow repercus-

sions. (One possible exception is through

taxes, if translation gains are taxed.)

2. Economic exposure is forward looking: it
   relates to future cash flows.

Accounting exposure is backward looking:

it relates to past decisions on assets and li-

abilities as recorded on the balance sheet.

3. Economic exposure covers all cash flows,
   whether or not they can be found in the
   current financial statements.

Accounting exposure is confined toA&L

andP&Litems.

4. Economic exposure exists for virtually all
   firms.

Accounting exposure only exists when

there arefc-denominatedA&Litems or

subsidiaries whose accounts need to be

consolidated.

5. Economic exposure depends on economic
   facts, like the contracts the firm signed or
   the economic environment it operates in.

Accounting exposure depends on the

translation method chosen or prescribed,

without reference to the economic frame-

work.

13.5 Test Your Understanding: contractual exposure

8.8.1 Quiz Questions

True-False Questions

1. Exchange risk describes how volatile a firm’s cash flows are with respect to a
   particular exchange rate.


2. Exchange exposure is a measure of the sensitivity of a firm’s cash flows to a
   change in the spot exchange rate.


3. Hedging exposure means eliminating all risk from a net position in a foreign
   currency.


4. If you need to hedge a series of exposures with different maturities and you use
   duration hedging, it is best to hedge the negative exposures separately from
   the positive exposures.


5. Contractual exposure is the absolute change in the firm’s cash flows for a unit
   change in the spot exchange rate.