Transaction exposure can occur when one firm wants to either sell goods to another firm or purchase goods from another firm, but the two firms do not use the same currency. A futures foreign currency contract is then drawn up, so when payment is due, the seller can receive payment in their preferred currency rather than the currency the purchaser uses. As exchange rates change so does the value of the associated foreign currency that the payment was agreed upon. An example of this would be when a firm in London has a future currency contract that is associated with a sale denominated in U.S. dollars, or a U.S. firm who has a sale that is associated with a futures currency contract denominated in Euros.

As the exchange rate changes between these two firms who use different forms of currency, so does the value of the associated with the cash flows between the two firms before the transaction is settled. This leads to currency gains for the receiving firm if the purchaser uses currency that has devaluated against the currency used by the selling firm. Currency losses occur when the purchaser has currency that has increased in value against the selling firm’s currency.

Transaction exposure also plays a part in translation exposure and operations exposure for firms that operate internationally. Transaction exposure simultaneously affects translation exposure because when a firm is calculating its home currency revenue it needs to convert the currency used by its subsidiaries around the world. This can cause gains or losses in total revenue for headquarters if there is a large shift in the exchange rate for one currency to another.

Transaction exposure can affect operating exposure depending on the extent to which currency fluctuations can alter a company’s future operating cash flow. A company’s future operating cash flow is their future revenues and costs. If there is a large enough fluctuation in the exchange rate, a future currency contract could be devastating to a company’s future revenue when selling and also devastating to the company’s costs when operating abroad.

Due to the economic crisis that the world has been hit with, Washington is trying to create new regulations for corporations that use transaction exposure risk management in the form of futures contracts. Right now if future foreign currency contracts are used to avoid transaction exposure, both sides are not always backed. When the contracts are bought over the counter, the company guaranteeing to pay in the future does not need to have a portion of the contract set aside when signing the contract. This leads to the potential that one firm could suffer disastrous financial effects if the contract is not fulfilled, but also large firms enduring such huge losses also affect the financial state of the country it operates in or even the world. Such examples of companies that had this disastrous effect on the country it operates in and the world was Lehman Brothers and AIG.

New regulations would force corporations to make contracts on exchanges rather than other the counter. This way both parties are backed. The government also wants to make to create controls that force corporations to have a portion of the futures contract set aside when entering the contract.

Many national and multinational corporations are opposed to these new proposed regulations. This would also force many firms to put aside or come up with working capital when entering a contract. This form of transaction exposure is easy profits for the company when the exchange rate changes to their advantage, this could potentially be taken away if contracts are required to be sold on an exchange

References:

"Collateral Damage." Financial Times. Financial Times Limited 2009, 6 Oct. 2009. Web. 2 Nov. 2009. <http://www.ft.com/cms/s/0/ca00aa2a-b2aa-11de-b7d2-00144feab49a.html>.