(light music)
-: Currency prices can be volatile and organisations
with exposures to foreign currency can be significantly
impacted by unfavourable movements.
This is especially the case for importers and exporters
who have frequent transaction exposures on their buying
and selling activities.
It is also highly relevant for organisations
with foreign operations or dealings who may have
translation exposures for their assets and liabilities.
Organisations can have competitive exposures,
which refers to having competitors who source their goods
or services in a different currency.
An Australian importer will typically buy goods quoted
in a foreign currency.
It will need to sell Australian dollars to buy
the foreign currency to then pay for the goods.
When the Australian dollar falls or devalues then it
is more expensive for the Australian importer
to import goods priced in the higher currency.
For example, assume the cost of an imported good
is 1000 U.S. dollars.
If the exchange rate is 80 U.S. cents, then it costs 1250
Australian dollars to buy.
If the Australian dollar falls to 75 U.S. cents,
this increases the purchase price
to 1333 Australian dollars.
This highlights the transaction exposure for the importer.
In addition, a falling AUD can stimulate local production
by making Australian produces more competitive
in price against those foreign imports.
The Australian importer may have competitors that source
goods from these cheaper domestic sources providing it
with competitive exposure.
An Australian exporter may sell goods quoted in a foreign
currency, upon receipt of the foreign currency, it will
need to sell the foreign currency
and buy Australian dollars.
When the Australian dollar rises or appreciates,
then the Australian exporter receives less Australian
dollars from the foreign currency conversion.
For example, assume the sale of an exported good is 2000
U.S. dollars, if the exchange rate is 80 U.S. cents
then the exporter receives 2500 Australian dollars.
If the AUD rises for 85 U.S. cents, this reduces
the amount received to 2353 Australian dollars.
This highlights the transaction exposure for the exporter.
Note that if the exporter sells the goods in Australian
dollars, a rising AUD will mean that it costs more
for the foreign purchaser to buy the same amount of goods.
While the exporter may not have transaction exposure
in this situation, keep in mind that the foreign purchaser
may look to buy the goods from another source,
highlighting the potential for competitive exposure.
Consider the situation we're an Australian organisation
where the AUD as its functional currency has a borrowing
denominated in a foreign currency.
It needs to service the ongoing interest payments
and repay the loan at maturity.
And the Australian dollar value of these payments
will be affected by foreign exchange movements.
In addition, during the term of the loan, the organisation
reflects the value of the loan as the liability on its
balance sheet.
This value will fluctuate with movements in the foreign
exchange rate.
If the foreign borrowing is one million U.S. dollars
and the exchange rate is 80 U.S. cents, the organisation
has a liability of 1.25 million Australian dollars.
However, if the Australian dollar weakens to 75 U.S. cents,
the value of this liability increases to 1.33 million
Australian dollars.
This highlights the impact of the organization's
translation exposure, that is converting the value
of a foreign currency denominated asset or liability
back to the functional currency.
Identifying foreign exchange exposures is an extremely
important component of an organization's financial risk
management framework.
These exposures can take the form of transaction
exposure, translation exposure, and competitive exposure.