A Closer Look at Economic Exposure

12/03/2014 9:00 am EST

Focus: FOREX

In this article, Zahir Shah, at FXCC.com, discusses the three types of currency volatility risks and shares why he feels learning how to handle risk should be a top priority for newbie forex traders if they wish to succeed.

With the increasing level of globalization dove-tailed by higher volatility among currencies, several changes or movements are observed in the exchange rates. If you wish to be successful or to generate substantial profits from the trade, you need to be abreast of the issues and pertinent information about these factors.

The volatility of the exchange rate does not only affect large companies and multinational corporations. In fact, it has a big impact on medium- and small-scale businesses and enterprises, as well as the locals. Having a deep understanding of the proper methods of handling risks in exchange rate should be a top priority of foreign exchange investors because it has a great effect on their respective businesses.

According to experts, there are three types of currency volatility risks:

  1. Exposure in transaction: This happens as a result of the effect of the fluctuations of the exchange rate to the obligations of the company, be it forwarding or receiving payments that come in the currency that is concerned. Usually, it is quite easy to get over this type of exposure. By nature, it is medium- to short-term.
  2. Exposure in translation: This type of exposure is a result of the fluctuations in the currency on the financial statements that are consolidated by the company, most especially if the company has branches outside the territory. The exposure can either be long-term or medium-term depending on the factors involved.
  3. Exposure in operations (economic exposure): This is also a relevant type of risk, but it is not as popular as transaction and translation exposure. The major cause of this exposure is the unexpected fluctuation in the currency and its effects on the cash flow of the company in the future. Usually, the competitive position of the entire corporation is deeply affected by this. This is one of the most difficult to cope up with because of the fact that there is no way of anticipating this. One needs to have a deep understanding of different concepts so that this risk can be dealt with sufficiently and accordingly.

Deeper Analysis of Economic Exposure

There are two factors that have to be analyzed so as to gain a deeper understanding of economic exposure. First, the product prices and costs of inputs of the firm need to be considered because these are very sensitive to the fluctuations of the currency. Next, the flexibility of the market should also be looked at. This factor is important because this is inversely proportional to the risk involved in the operations. Simply put, if the market has high level of flexibility, the risks of being affected by currency fluctuations are low and vice versa.

Having a deep level of awareness of the impacts of several risks to the profitability of investments, trade, and businesses is highly important if you wish to proper in the world of foreign exchange. Having the working knowledge will definitely help you lessen the impact of the risks involved. Business, after all, is having a daily dose of calculated confrontation with risks. Usually, higher risks imply higher potential returns if handled properly.

By Zahir Shah, Forex Expert, FXCC.com