Economic Exposure


DEFINITION of 'Economic Exposure'

A type of foreign exchange exposure caused by the effect of unexpected currency fluctuations on a company’s future cash flows. Also known as operating exposure, economic exposure can have a substantial impact on a company’s market value, since it has far-reaching effects and is long-term in nature.

Unlike transaction exposure and translation exposure (the two other types of currency exposure), economic exposure is difficult to measure precisely and hence challenging to hedge. Economic exposure is also relatively difficult to hedge because it deals with unexpected changes in foreign exchange rates, unlike expected changes in currency rates, which form the basis for corporate budgetary forecasts.

BREAKING DOWN 'Economic Exposure'

For example, assume that a large U.S. company that gets about 50% of its revenues from overseas markets has factored in a gradual decline of the U.S. dollar against major global currencies – say 2% per annum – into its operating forecasts for the next few years. If the U.S. dollar appreciates instead of declining gradually in the years ahead, this would represent economic exposure for the company. The dollar’s strength means that the 50% of revenues and cash flows the company receives from overseas will be lower when converted back into dollars, which will have a negative effect on its profitability and valuation.

Increasing globalization has made economic exposure a source of greater risk for companies. The degree of economic exposure is directly proportional to currency volatility. Economic exposure increases as foreign exchange volatility rises, and decreases as it falls.

Economic exposure is obviously greater for multinational companies that have numerous subsidiaries overseas and a huge number of transactions involving foreign currencies. However, economic exposure can arise for any company regardless of its size and even if it only operates in domestic markets.

For example, small European manufacturers that only sell in their local markets and do not export their products would be adversely affected by a stronger euro, since it would make imports from other jurisdictions such as Asia and North America cheaper and increase competition in European markets.

Economic exposure can be mitigated either through operational strategies or currency risk mitigation strategies. Operational strategies involve diversification – of production facilities, end-product markets and financing sources, since currency effects may offset each other to some extent if a number of different currencies are involved. Currency risk-mitigation strategies involve matching currency flows, risk-sharing agreements and currency swaps.

  1. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  2. Overnight Limit

    The number of currency positions a trader can carry over from ...
  3. Hedge

    Making an investment to reduce the risk of adverse price movements ...
  4. Export

    A function of international trade whereby goods produced in one ...
  5. Import

    A good or service brought into one country from another. Along ...
  6. Forex - FX

    The market in which currencies are traded. The forex market is ...
Related Articles
  1. Options & Futures

    A Primer On The Forex Market

    Moving from equities to currencies requires you to adjust how you interpret quotes, margin, spreads and rollovers.
  2. Forex Education

    Getting Started In Foreign Exchange Futures

    Learn how these futures are used for hedging and speculating, and how they are different from traditional futures.
  3. Options & Futures

    Getting Started In Forex

    Before entering this market, you should define what you need from your broker and from your strategy.
  4. Bonds & Fixed Income

    6 Factors That Influence Exchange Rates

    Find out how a currency's relative value reflects a country's economic health and impacts your investment returns.
  5. Economics

    The 4 Countries That Produce the Most Food

    Learn about the four food superpowers -- China, India, the United States and Brazil -- and what sets them apart from the rest of the world.
  6. Economics

    These Will Be the World's Top Economies in 2020

    Discover the current economic forces that are anticipated to significantly shift the landscape of the world's most powerful economies over the next decade.
  7. Fundamental Analysis

    Emerging Markets: Analyzing Colombia's GDP

    With a backdrop of armed rebels and drug cartels, the journey for the Colombian economy has been anything but easy.
  8. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  9. Economics

    Is the U.S. Economy Ready for Liftoff?

    The Fed continues to delay normalizing rates, citing inflation concerns and “global economic and financial developments” in explaining its rationale.
  10. Economics

    Oil Is Cheaper Than Bread In Venezuela...The Country Is In Chaos

    Venezuela is floundering, and the story has more to do with just the falling price of oil.
  1. How are foreign exchange rates affected by commodity price fluctuations?

    In the foreign exchange (forex) market, currency valuations move up and down as a result of many factors, including interest ... Read Full Answer >>
  2. When do I need a letter of credit?

    A letter of credit, sometimes referred to as a documentary credit, acts as a promissory note from a financial institution, ... Read Full Answer >>
  3. When has the United States run its largest trade deficits?

    In macroeconomics, balance of trade is one of the leading economic metrics that determines the trading relationship of a ... Read Full Answer >>
  4. Which is more important to a nation's economy, the balance of trade or the balance ...

    There is no question the composition of a country's balance of payments is more important than its balance of trade. This ... Read Full Answer >>
  5. What is the difference between cost and freight (CFR) and cost, insurance and freight ...

    The difference between cost and freight (CFR) and cost, insurance and freight (CIF) is essentially the requirement under ... Read Full Answer >>
  6. What is the difference between Cost and Freight (CFR) and Free on Board (FOB)?

    The difference between cost and freight (CFR) and free on board (FOB) lies in who has responsibility for various shipping ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  2. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  3. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  4. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  5. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  6. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!