Foreign exchange exposure is classified into three types viz. Transaction, Translation and Economic Exposure. Transaction exposure deals with actual foreign currency transaction. Translation exposure deals with the accounting representation and economic exposure deals with little macro level exposure which may be true for the whole industry rather than just the firm under concern. If a British firm sells products to a US Firm, cash inflow of British firm is exposed to foreign exchange and in a case of the US based firm cash outflow is exposed to foreign exchange. Why we are so skeptical about this exposure? It is because the exchange rates tend to change or fluctuate. In the above situation, we saw how a firm directly involved in the foreign currency dealing is exposed to the risk of foreign exchange. It may be surprising to know that a firm with no such direct connection exposure also be found exposed to foreign currency risk. Just to share an example, if a company producing small electronics products in Sri Lanka is competing against the products imported from China. Now if the price of Chinese Yuan per Sri Lankan Rupee is decreased, there will be a decreased in cost advantage to the importers over that Sri Lankan company. It is evident from the example that the firm having no direct access to forex can also be impacted. Commonly, the exposure is classified into three types of foreign currency exposure:. The simplest kind of foreign currency exposure which anybody can easily think of is the transaction exposure. As the name itself suggests, this exposure pertains to the exposure due to an actual transaction taking place in business involving foreign currency. In a business, all monetary transactions are meant for profits as its end result. There are all forex chances of that final objective getting hampered if it is a foreign currency transaction and the currency market moves towards the unfavorable direction. If you have bought goods from a foreign country and payables are in foreign currency to be paid after 3 months, you may end up paying much higher on the due date as currency value may increase. This will increase your purchase price and therefore the overall costing of the product compelling the profit percentage to go down or even convert to lose. This exposure is also well known as accounting exposure. Forex is because the exposure is due to the translation of books of accounts into the home currency. Translation activity is carried out on account of reporting the books to the shareholders or legal bodies. It makes sense also as the translated financial statements show the position of the forex as on a date in its home currency. Gains or losses arising out of translation exposure do not have more meaning over and above the reporting requirements. Such exposure can even get reversed in the next year translation if currency market moves in the favorable direction. This kind of exposure does not require too much of management attention. The impact and importance of this type of exposure are much higher compared to the other two. Economic exposure directly impacts the value of a firm. That means, the value of the firm is influenced by the foreign exchange. The value of a firm is the function of operating cash flows and the assets it possesses. The economic exposure can have bearings on assets as well as operating cash flows. Identification and measuring of this exposure is a difficult task. Although, the asset exposure is still measurable and exposure in books but the operating exposure has links to various factors such as competitiveness, entry barriers, etc which are quite subjective and interpretation of different experts may be different. These three types of foreign currency exposures are very important to understand for an international finance manager. He is passionate about keeping and making things simple and exposure. Running this blog since and trying to explain "Financial Management Concepts in Layman's Terms". Notify me of follow-up comments by email. Notify me of new posts by email. Enter your email address to subscribe to this blog and receive notifications of new posts by email. About Us Site Map Contact Us. Sources of Exposure Working Capital Financing Corporate Finance Financial Management Investment Decisions Financial Analysis Financial Leverage Mergers and Acquisitions Dividend Decisions Financial Accounting Corporate Restructuring International Financial Management Derivatives Costing Terms Budgeting Zero Based Budgeting Financial Management Sources of Finance Working Capital Financing Financial Analysis Investment Decisions Dividend Decisions Financial Accounting Financial Leverage International Forex Management Mergers and Acquisitions Costing Terms Budgeting Zero Based Budgeting. Types of Foreign Exchange Currency Exposure Foreign exchange exposure is classified into forex types viz. Share it in comments below. Sajin Paul August 9, Sridhar December 8, Thanks for the information. NALULE ANITA April 5, Leave a Reply Cancel reply Notify me of follow-up comments by email. 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