What is Transaction Exposure?

Transaction exposure is the risk of loss from a change in exchange rates during the course of a business transaction. This exposure is derived from changes in foreign exchange rates between the dates when a transaction is booked and when it is settled. This is a particular concern when there is a lengthy gap between the start of a transaction and when payment is received.

Transaction exposure is only applicable to the party in a transaction that has to pay or receive funds in a different currency; the party only dealing in its home currency is not subject to translation exposure. This can be a significant risk when the currencies involved in an international transaction have a history of significant fluctuations.

The basic rules for transaction exposure are noted below.

Transaction Exposure When Importing Goods

When a business is importing goods and its home currency weakens, the firm incurs a loss. If the home currency strengthens, it experiences a gain on the transaction.

Transaction Exposure When Exporting Goods

When a business is exporting goods and its home currency weakens, the firm experiences a gain. If the home currency strengthens, it incurs a loss on the transaction.

Example of Transaction Exposure

For example, a company in the United States may sell goods to a company in the United Kingdom, to be paid in pounds having a value at the booking date of $100,000. Later, when the customer pays the company, the exchange rate has changed, resulting in a payment in pounds that translates to a $95,000 sale. Thus, the foreign exchange rate change related to a transaction has created a $5,000 loss for the seller.

Hedging Strategy

When an organization does not want to run the risk of incurring a loss related to transaction exposure, it can adopt a hedging strategy, where it enters into a forward rate agreement, thereby locking in the current exchange rate.