Economic Exposure in Forex Trading

Posted by Arthur on July 15, 2009 under Forex Trader Review | Be the First to Comment

Economic exposure or operating exposure in Forex trading relates to the effect of unexpected rates of exchange on the future operating cash flows of the company.  In the management of finance, a firm is valued by the net present value of the future cash flows.  A change in the rate of exchange may bring about changes in the cash flows of the company directly by reflecting its revenues as well as costs and indirectly by affecting its competitiveness by the action of its consumers as well as competitors.  As a result, the net present value may differ from the one anticipated.

The economic exposure in Forex trading is less clearly perceived but has wider ramification with far reaching effects than the accounting exposure.  Accounting exposure of trading Forex is more readily seen and provided for.  Economic exposure in forex trading is insidious, more difficult to measure as well as more difficult to manage.

Economic exposure in Forex online, we talk of unexpected changes in the rates of exchange because the expected changes are reflected in the quotations of market in the form of forward margin as well as it is taken note by the companies.  In budgeting for the future, a company with Forex online exposure will base its calculations on the forward rates and not on the spot rates. Therefore, it is only the unexpected movements in the rates of exchange that affect the cash flows anticipated in trading Forex.

Real trading online rate of exchange between two currencies is the nominal rate of exchange adjusted for difference in the rate of inflation in the countries concerned.  If the power of purchasing parity holds, the currency of the countries with inflation higher will depreciate in nominal terms, but the relating power of purchasing of the currencies will remain the same.  In other words, the real trading online rate of exchange will not change.

If the trading online rate of exchange remains static, even though there is a change in the nominal rate of exchange, the cash flows of the company will not be affected.  This is because the relative powers of purchasing of the currencies remain the same.  There is no change in the competitiveness of the product due to price fluctuations.

In certainty, it is seen that the power of purchasing parity holds only in the long run.  In the short run, the rates of exchange tend to vary in real terms giving rise to economic exposure.

Thus, the exact impact the rate of exchange change will have on the cash flows of the company is dependent on so many factors, measuring economic exposure becomes difficult.  Many are the factors over which the company has no control. All that is possible is to estimate with certain basic assumptions regarding the impact likely on each item of the cash flow of the company.  Following are the some of the assumptions of trading online that can be made:

• Costs will decrease or increase; sales price remains constant.
• Volume of the sales will decrease or increase; sales costs and price remains constant.
• Price of the sales decreases or increases; costs will also decreases or increases but by a lesser degree.
• Price of the sales decreases or increases; costs will remain the same.
• All variables remain the same.