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CHAPTER 10
TRANSACTION EXPOSURE
1. Foreign Exchange Exposure. Define the three types of foreign exchange exposure.
The three main types of foreign exchange exposure are transaction, translation, and operating:
Transaction exposure measures changes in the value of outstanding financial obligations incurred
Operating exposure, also called economic exposure, competitive exposure, or strategic exposure,
2. Currency Exposure and Contracting. Which of the three currency exposures relate to cash flows
already contracted for, and which of the exposures do not?
3. Currency Risk. Define currency risk.
4. Hedging. What is a hedge? How does that differ from speculation?
5. Value of the Firm. What—according to financial theory—is the value of a firm?
6. Cash Flow Variability. How does currency hedging theoretically change the expected cash flows of
the firm?
7. Arguments for Currency Hedging. Describe four arguments in favor of a firm pursuing an active
currency risk management program?
8. Arguments Against Currency Hedging. Describe six arguments against a firm pursuing an active
currency risk management program?
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6. Efficient market theorists believe that investors can see through the “accounting veil” and
therefore have already factored the foreign exchange effect into a firm’s market valuation.
Hedging would only add cost.
9. Transaction Exposure. What are the four main types of transactions from which transaction
exposure arises?
10. Life Span of a Transaction Exposure. Diagram the life span of an exposure arising from selling a
product on open account. On the diagram define and show quotation, backlog, and billing exposures.
11. Unperformed Contracts. Which contract is more likely not to be performed: a payment due from a
customer in foreign currency (a currency exposure) or a forward contract with a bank to exchange the
foreign currency for the firm’s domestic currency at a contracted rate (the currency hedge)?
12. Cash Balances. Why do foreign currency cash balances not cause transaction exposure?
13. Contractual Currency Hedges. What are the four main contractual instruments used to hedge
transaction exposure?
14. Money Market Hedges. How does a money market hedge differ for an account receivable versus
that of an account payable? Is it really a meaningful difference?
58 Eiteman/Stonehill/Moffett | Multinational Business Finance, 14th Edition
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A money market hedge for an account payable requires the company to exchange money now to be
placed on deposit in a foreign currency financial account in an amount which, upon maturity, will
satisfy the account payable in full.
Whether there is a meaningful difference between the two is debatable and somewhat situational. A
heavily indebted firm will not find taking on additional debt obligations (hedging the A/R) because
that will increase all debt-based financial metrics and ratios. A firm that does not enjoy ready access
to affordable capital will find the foreign currency deposit (hedging the A/P) difficult, as it means
putting scarce capital into an account for earning nothing but interest when capital is hard to come by.
15. Balance Sheet Hedging. What is the difference between a balance sheet hedge, a financing hedge,
and a money market hedge?
16. Forward versus Money Market Hedging. Theoretically, shouldn’t forward contract hedges and
money market hedges have the same identical outcome? Don’t they both use the same three specific
inputs—the initial spot rate, the domestic cost of funds, and the foreign cost of funds?
17. Foreign Currency Option Premia. Why do many firms object to paying for foreign currency option
hedges? Do firms pay for forward contract hedges? How do forwards and options differ if at all?
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Option premiums may also be significant in size. If a firm is purchasing a number of large options,
this may require a larger amount of capital than the firm has budgeted for treasury and currency
operations. Many firms simply object to spending money, option premiums, for a risk product that
may or may not be ultimately used.
18. Decision Criteria. Ultimately, a treasurer must choose among alternative strategies to manage
transaction exposure. Explain the two main decision criteria that must be used.
19. Risk Management Hedging Practices. According to surveys of corporate practices, which currency
exposures do most firms regularly hedge?
20. Hedge Ratio. What is the hedge ratio? Why would the hedge ratio ever be less than one?