Transaction exposure is a form of financial risk associated with transactions conducted in a foreign currency, where the exchange rate may change before settlement, forcing a company to pay more to finish the deal. This is also known as transaction risk and can be a concern for any company doing business internationally, as it may be engaged in deals in a number of currencies at any given point in time. There are steps companies can take to limit their transaction exposure, with the goal of protecting the company and the shareholders.
In a simple example, a company in Germany could enter a contract with a company in the United States to buy products for a set amount in US dollars. If the dollar appreciates, the German company would need to spend more Euros to meet the difference in the exchange rate, driving up the cost of the business transaction. This could result in passing a loss on to shareholders, or force the company to ask for more for the product from consumers in order to make up the difference. It might not be as competitive as a result, since consumers could seek out the same product at lower prices from other companies.
One option for controlling transaction exposure is being careful about the use of foreign currencies in transactions. Companies may decline to deal in extremely unstable currencies, asking for a different currency option for the transaction. This can reduce risk by limiting the chances of volatility between the time the contract is made and the time the bill comes due. There is also a chance of missing out on gains from drops in currency values, the flip side of transaction exposure, but companies are usually more concerned about the chances of a sudden spike in values.
Another option is to use derivatives to hedge the risk. A simple example is a currency swap, but other options may be available, depending on the nation, the transaction, and the company. These financial products allow companies to lock in deals at given rates, protecting them from transaction exposure and other potential risks of doing business. Company analysts and financial advisers can determine whether derivatives are advisable in a given situation, and what kinds of products the company should consider to meet its needs.
Companies with concerns about transaction exposure may also use various techniques at the bank to control the risk, like choosing a settlement date that seems unlikely to experience volatility. Mondays, for example, can be accompanied with radical swings in value as investors react to breaking news from the weekend, and can be a poor choice of settlement date as a result.
