Exposure Analysis In Foreign Exchange

An exposure in forex trading can be defined as a Contracted, Projected or Contingent Cash Flow whose magnitude is not certain at the moment. The magnitude depends on the value of variables such as currency exchange rates and interest rates. Adverse changes in the rate of exchange between a pair of currencies can have significant effects upon a firm's profits. It is very important to understand exposure analysis in foreign exchange.

The task of gauging the impact of exchange rate changes on an enterprise begins with measuring its exposure that is, the amount, or value, at risk. The nature of this impact needs to be analyzed by reference to the type of exposure. You need to identify the different types of exposures that arise and also how these exposures can be analyzed so as to trade more successfully in forex market.

Exposure analysis in forex is very important to minimize risks.One needs to understand the importance of exposure analysis while trading in forex so as to minimize the risk associated in forex trading. You need to focus on the more specific type of exposures, including accounting exposures, economic exposures, transaction exposures and translation exposures.

Accounting Exposure refers the change in the value of a firm's foreign currency denominated accounts due to a change in exchange rates. Transaction exposure refers to the extent to which the future cash transactions of the firm may be affected by any changes in the currency exchange rate. Economic exposure measures the impact of changes in exchange rate on the firm's cash flows and earnings. Translation exposure is the risk of adverse effects on a firm's financial statements that may arise from changes in exchange rates.

One should also consider cash flows or transactions for the purpose of exposure management. However the cash flows or transactions that should be consider for forex exposure analysis are Foreign Currency Cash Flows, Foreign Interest Rates, whether Floating or Fixed, Cash Flows from Hedge Transactions and Projected or Contingent Cash Flows. Moreover, the transaction types can be Capital & Revenue, Interest Payments or Receipts and Open hedge transactions.

Therefore we can see that foreign exchange exposure analysis and at the same time study of the aspects such as Foreign Currency Cash Flows or Schedules , Variability of Cashflows Inflow-Outflow Mismatches / Gaps, Time Mismatches / Gaps, Currency Portfolio Mix and Floating / Fixed Interest Rate ratio hold a great importance.