Foreign exchange risk is related to
the variability of the domestic currency values of assets, liabilities or
operating income due to unanticipated changes in exchange rates, whereas
foreign exchange exposure is what is at risk. Foreign currency exposure and the
attendant risk arise whenever a business has an income or expenditure or an
asset or liability in a currency other than that of the balance-sheet currency.
Indeed exposures can arise even for companies with no income, expenditure,
asset or liability in a currency different from the balance-sheet currency.
When there is a condition prevalent where the exchange rates become extremely
volatile the exchange rate movements destabilize the cash flows of a business
significantly. Such destabilization of cash flows that affects the
profitability of the business is the risk from foreign currency exposures.
We can define exposure as the degree
to which a company is affected by exchange rate changes. But there are
different types of exposure, which we must consider.
Adler and
Dumas defines foreign exchange
exposure as ‘the sensitivity of changes in the real domestic currency value
of assets and liabilities or operating income to unanticipated changes in
exchange rate’.
In simple terms,
definition means that exposure is the amount of assets; liabilities and
operating income that is ay risk from unexpected changes in exchange rates.
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