Exposure Management

Techniques
Steps in exposure management strategy
It involves four steps:
• Forecasting the degree of exposure in each major currency in
which the MNC operates.
• Developing a reporting system to monitor exposure and
exchange rate movement to assist in protecting the MNC from
risk.
• Assigning responsibility for hedging exposure and determining
whether to centralize or decentralize exposure management.
• Selecting appropriate hedging tools including diversification of
the MNC’s operations, a balance sheet hedge, and exposure
netting.
 Strategies for Exposure Management
• Low Risk: Low Reward
It is the simplest way of approach or manage
exposure but may not be considered the best strategy.
All exposure are hedged in the forward market as
soon as they occur without considering whether it is
the best choice. Under this strategy the company
knows its cash flow receipts with certainty and the
cost associated with it.
• Low Risk: Reasonable Reward
The company can opt this strategy only when it feels
that it can spend more time and effort and also
hedging is adopted if it feels that it can avoid more loss
with hedging.
The rewards on the other hand are more as company
puts lot of serious efforts to quantify the future
expectations and then decides to hedge. More over the
rewards depends upon the accuracy of the prediction.
• High Risk: Low Reward
when the company leaves movement of
foreign currencies open and decides not to
hedge any exposure, it obviously takes very high
risk. Since the exposure are always kept open,
rewards are uncertain, cash flows are not stable,
but the advantage is management need not
spend any time to manage their exposure.
• High Risk: High Reward
This strategy involves active trading in the currency
market through continuous cancellations and re-
bookings of forward contracts. It is the most
aggressive method of managing exposure.
Frequent booking and cancellations to get the best
rate for the exposures increases transaction costs
and generally adopted by large companies.
Exposure Management Techniques
EMT
Internal External
Netting Forward contracts
Matching Short-term borrowings
Leading & Lagging Discounting
Pricing policies Factoring
Asset & Liability Mgt. Govt. exchange risk
guarantees
 Internal Techniques
• Netting: it is a technique of optimizing cash flow
movements with the joint efforts of subsidiaries and is
typically used by companies with a number of affiliates in
different countries.
A netting agreement is a contract where by each party agrees to
set off amount it owes against amount owed to it.
The process involves the reduction of administration and
transaction costs that result from currency conversion.
Overall exposure netting is a portfolio approach to hedging,
according to which a firm may manage its trade transaction in such
a way that exposures in one currency will be offset by exposures in
the same or other currencies.
• Matching: the terms netting and matching are
often used interchangeably. But the netting
used only for inter company flows.
Matching can be applied to both third party as well
as inter-company cash flows, and it can be used by
the exporters/importers as well as multinational
company.
• Leading and Lagging: it refers to the adjustment of
intercompany “Credit Term”.
– Leading: Prepayment of a trade obligation
– Lagging: a delayed payment.
Leading and Lagging can be used as part of either a risk-
minimizing strategy to facilitate matching or an aggressive
strategy to maximize expected exchange gains.
Overall shifting the timing of receipt or payment of
foreign currency in accordance with expectations of
future exchange rate movements.
• Asset and Liability Management: this
technique can be used to manage balance
sheet, income statement or cash flow
exposure.
They can be used aggressively or defensively.
 External Techniques
• Forward Exchange: forwards exchange contracts
are derivatives which can be used for exchange
rate risk management. It helps to lock the price
and give definite amount of cash flows exposure
• Short term borrowings: an alternative to hedging
on the forward market is the short term borrowing
technique. A company can borrow either dollar or
some other foreign currency or the local currency
to manage exposed difficulty and exchange rate.
• Discounting: discounting can be used to cover
only export receivables. It cannot be used to
cover foreign currency payables or to hedge a
translation exposure.
Where an export receivables is to be settled by bill
of exchange the exporter can discount the bill and
thereby receive payment before the receivable
settlement date.
• Factoring: it means the receivables can be assigned as
collateral for selected bank financing under which
circumstance such as service will give protection against
exchange rate changes.
• Government exchange risk guarantees: to encourage
exports, government agencies in many countries offer
their exporters insurance against export credit risk and
special export financing schemes like
– Risk insurance to their exporters
– Export credit guarantees
– Exchange risk guarantee schemes