Transaction Exposure is one of many risks that are encountered by companies doing business internationally. It is the risk that once the company is in an obligation to pay or receive payment in a foreign currency, the exchange rate will change dramatically. This in turn will cause the company to either receive a higher or lower rate of return. The company, of course, is afraid of the latter. There are several ways companies can mitigate the risk of transaction exposure with the use of hedging and non-hedging methods. The first non-hedging technique is transferring transaction exposure. Transferring transaction exposure is making the company on the other side of the deal pay in your home currency, which is transferring the exposure to the importing company.

Another method of transferring transaction exposure is making the importing company pay in their home currency, but right when the deal is made. This technique is counting on the exporting company to exchange the money into their home currency immediately so the spot rate at the time of the deal can be counted on as the exchange rate into the home currency. Netting transaction exposure is another non-hedging method used mainly by large companies who export and import within a foreign country often. The theory behind this technique is that when a company is exporting and importing in the same foreign currency on a continuing basis, the ups and downs of the exchange rate will net out over an extended period of time. Hedging techniques include forward and futures contracts. A forward contract is a contract made by the exporter and a bank. It can be made for any size and is usually for length of time under a year. The contract will say how many units of currency and for what exchange rate. Once the contract is created, it must be followed through, even if the importer delinquent on their payment. Then there are future contract, which are contracts bought and sold in an exchange. The exporting company, with an accounts receivable in the importers currency, would sell short the foreign currency. This creates an equalizing effect because if the currency strengthens, the exporter loses value in his future contract but gains in his contract with his importer, and it is the opposite if the currency weakens.

Citation:

http://www.vsb.org/docs/valawyermagazine/jj01kelley.pdf

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