Foreign Exchange Exposure Measurement

Introduction and Context

Foreign exchange (FX) exposure is the sensitivity of a firm’s economic value, reported financial statements, cash flows, or contractual obligations to changes in exchange rates. Exposure exists whenever the timing, amount, or value of a foreign-currency asset, liability, revenue, cost, investment, or commitment changes as exchange rates change.

Measurement is the foundation of FX risk management. A firm cannot choose an appropriate hedge, establish a risk limit, or evaluate treasury performance unless it first identifies the currency risk, measures its magnitude, and distinguishes temporary accounting effects from changes in underlying economic value. Exposure measurement therefore links international financial management with forecasting, budgeting, financial reporting, capital investment, and corporate governance.

The principal categories are:

• Transaction exposure: uncertainty in the domestic-currency value of contracted foreign-currency cash flows.
• Translation exposure: uncertainty in reported consolidated financial statements caused by translating foreign operations into the parent’s reporting currency.
• Economic exposure: uncertainty in the present value of future operating cash flows and competitive position.
• Contingent exposure: potential, but not yet certain, foreign-currency cash flows arising from bids, quotations, options, forecast transactions, or commercially probable events.

These categories overlap in practice. For example, a foreign subsidiary may create translation exposure through consolidation and economic exposure through its effect on group-wide revenues, costs, and competitive strategy.

Learning Objectives

After completing this chapter, the reader should be able to:

1. Distinguish transaction, translation, economic, and contingent exposure.
2. Map foreign-currency cash flows by currency, amount, date, and direction.
3. Calculate net exposure and explain the role of natural and financial netting.
4. Measure exposure using sensitivity analysis, scenario analysis, VaR, cash-flow-at-risk, and stress testing.
5. Interpret model assumptions, limitations, and confidence measures.
6. Apply exposure measurement to treasury decisions, budgeting, accounting, and governance.

1. The Measurement Architecture

A useful exposure-measurement system has five linked stages:

1. Identify: locate foreign-currency assets, liabilities, revenues, costs, commitments, and options.
2. Classify: determine whether the item is transaction, translation, economic, or contingent exposure.
3. Map: record currency, sign, amount, timing, probability, and relevant exchange-rate driver.
4. Aggregate: combine exposures after considering offsets, correlations, and legal entities.
5. Measure and interpret: calculate sensitivity, scenarios, probabilistic loss measures, and stress outcomes.

The fundamental mapping unit is a cash-flow record containing:

A disciplined map prevents common errors such as treating a foreign-currency receivable and payable as separate gross risks when they are economically offsetting, or treating a forecast sale as equally certain to a signed contract.

Exchange-rate conventions

Assume the exchange rate is quoted as domestic currency per unit of foreign currency:

Here, S_t is the spot exchange rate at time t, D_t is one unit of domestic currency, and F_t denotes one unit of foreign currency in the quotation convention. More precisely, the units of S_t are domestic-currency units per foreign-currency unit. An increase in S_t means that the foreign currency has appreciated against the domestic currency.

If a firm will receive Q_F foreign-currency units, the domestic-currency value is:

If it will pay Q_F foreign-currency units, the domestic-currency cash-flow value is economically negative:

The sign convention is crucial. A foreign-currency receipt has positive exposure to S_t; a foreign-currency payment has negative exposure.

2. Transaction Exposure

Transaction exposure arises from recognized or committed foreign-currency cash flows whose domestic-currency value is not fixed. Typical examples include:

• foreign-currency trade receivables and payables;
• foreign-currency loans and interest payments;
• dividends declared by a foreign subsidiary;
• imports ordered but not yet paid;
• exports invoiced but not yet collected;
• foreign-currency lease payments and royalty obligations.

A foreign-currency receivable creates a gain when the foreign currency appreciates and a loss when it depreciates. The reverse applies to a payable.

For a single cash flow, the change in domestic-currency value between the contracted or initially measured rate S₀ and the later rate S₁ is:

For a payment, Q_F is treated as negative. This formula assumes a linear exposure, a fixed foreign-currency amount, and no interest, credit, tax, transaction-cost, or timing effects. It is most appropriate for short-dated contractual cash flows.

Worked example: transaction exposure

A United States importer must pay €2,000,000 in 60 days. The current rate is $1.08/€, and the rate in 60 days is $1.12/€. The dollar value changes by:

∆V_D = €2,000,000 × ($1.12 − $1.08) = $80,000

Because this is a payment, the importer experiences an $80,000 loss relative to the value at the initial rate. If the euro instead falls to $1.04, the importer experiences a gain of $80,000 relative to the initial value. A forward contract could fix the dollar cost; an option could provide protection while retaining some benefit from a favourable movement.

Net transaction exposure

When several cash flows are denominated in the same currency and mature in the same measurement horizon, their signed amounts may be summed:

where Q_i is positive for a receipt and negative for a payment. Under a common exchange-rate movement and identical timing, the portfolio change is:

This is a special case. Different maturities should normally be placed in time buckets because forward rates, interest rates, and exchange-rate volatility vary across time. Exposures in different currencies should not be added as if they shared one risk factor.

3. Translation Exposure

Translation exposure, also called accounting exposure, arises when a foreign subsidiary’s financial statements are translated into the parent’s presentation currency. It affects reported assets, liabilities, income, equity, and ratios even when no immediate cash flow occurs.

Under common translation approaches, balance-sheet items may be translated at closing rates, income-statement items at transaction-date or average rates, and equity at historical rates. The exact treatment depends on the applicable accounting framework and the functional currency of the foreign operation. Translation adjustments may be reported in other comprehensive income or a comparable equity category rather than current profit, subject to the relevant standards.

A simplified net asset exposure is:

where A_F is foreign-currency assets exposed to the closing rate and L_F is foreign-currency liabilities exposed to that rate. The approximate translation effect of a rate change is:

This approximation assumes that all net assets are translated at the same rate and ignores income-flow translation, historical-rate items, tax effects, and intra-group eliminations.

Example: translation exposure

A foreign subsidiary has assets of ¥900 million and liabilities of ¥650 million that are both translated at the closing rate. Its simplified net asset exposure is ¥250 million. If the reporting rate rises by $0.0005 per yen, the approximate translation gain is:

¥250,000,000 × $0.0005/¥ = $125,000

This is a reporting effect, not necessarily a realized cash gain. Management should not automatically hedge every translation adjustment. The decision depends on leverage covenants, investor expectations, tax consequences, accounting treatment, and whether the foreign investment is intended to be permanent.

4. Economic Exposure

Economic exposure is the broadest category. It is the sensitivity of the firm’s expected future operating cash flows, competitive position, and enterprise value to exchange-rate changes. It includes transaction exposure but extends beyond currently contracted amounts.

Exchange rates may influence:

• the domestic-currency price of exports;
• the cost of imported materials;
• foreign competitors’ prices;
• demand in domestic and foreign markets;
• the location of production;
• the domestic-currency value of foreign revenues and costs;
• investment decisions and supply-chain configuration.

A simple operating-cash-flow model illustrates the mechanism. Suppose domestic-currency operating cash flow is:

where P_D(S) is the domestic-currency selling price, Q(S) is quantity demanded, C_D(S) is variable operating cost, and F_D is fixed domestic-currency cost. Economic exposure is the change in expected operating cash flow as S changes:

The derivative notation represents a local, marginal sensitivity and is meaningful only when the functions are sufficiently smooth and the change is not so large that the business model changes discontinuously.

Example: revenue and cost offsets

A firm exports 1,000,000 units at €10 each and incurs €6 of variable cost per unit. It therefore has net euro cash flow of €4,000,000 before fixed costs. If the euro appreciates by $0.05, the approximate dollar increase in operating cash flow is:

€4,000,000 × $0.05/€ = $200,000

This calculation assumes that volume, euro prices, and euro costs remain constant. In reality, a stronger euro may reduce demand, encourage competitors to cut prices, or alter sourcing. Consequently, economic exposure must be analysed through business relationships rather than only through accounting balances.

Elasticity-based analysis

A useful managerial measure is the percentage sensitivity of a variable to the exchange rate:

Y may represent sales volume, selling price, cost, or cash flow. Elasticity is dimensionless. It allows comparison across business units, but it should not be interpreted as a stable structural parameter unless supported by evidence.

5. Contingent Exposure

Contingent exposure exists when a foreign-currency cash flow will occur only if a specified event happens. Examples include:

• a quotation to an overseas customer;
• a bid for an infrastructure project;
• a probable but unsigned purchase order;
• a foreign-currency acquisition under negotiation;
• a sales forecast with uncertain volume;
• a lawsuit or guarantee denominated in foreign currency;
• an option-like commercial commitment.

Contingent exposure differs from transaction exposure in certainty, not necessarily in economic importance. Hedging it too early can create over-hedging if the business does not materialize. Ignoring it can leave the firm exposed to a large adverse movement during a competitive tender.

A probability-weighted expected exposure can be calculated as:

where p_i is the probability of outcome i, Q_i is the associated signed foreign-currency amount, and the probabilities sum to one. Expected exposure is useful for planning but does not describe the full risk distribution. A low-probability, high-value outcome may require separate stress analysis.

6. Exposure Netting and Exposure Mapping

Netting reduces the amount that must be hedged by offsetting receipts and payments. It can be:

• Natural netting: matching revenues and costs in the same currency.
• Operational netting: locating production, sourcing, or financing to create currency offsets.
• Internal netting: using intercompany settlements or a central netting centre.
• Financial netting: using forwards, futures, swaps, or options.

A netting system must respect legal-entity boundaries, settlement dates, transfer-pricing rules, local exchange controls, and counterparty credit limits. Gross exposure remains important for liquidity, settlement, and operational risk even when the economic net exposure is small.

A practical exposure map groups cash flows by currency and maturity:

The plus and minus signs refer to foreign-currency receipts and payments. A treasury system should retain gross records and calculate net positions only after applying documented rules.

7. Sensitivity Analysis

Sensitivity analysis asks: “What is the change in value for a specified change in one risk factor?” For a portfolio with several currency exposures:

where δ_j = ∂V/∂S_j is the sensitivity to currency j, and ∆S_j is its exchange-rate change. For a simple foreign-currency cash flow, δ_j equals the signed foreign-currency amount, subject to the quotation convention.

Sensitivity analysis is transparent and easy to communicate. It is useful for limits, hedge ratios, and “one-cent” or “one-percent” reports. Its limitations are that it is local, usually linear, and unable to capture interaction effects, volatility changes, or nonlinear option payoffs.

For a percentage shock, the change may be approximated by:

where r is the proportional exchange-rate change. Units are consistent: foreign-currency amount multiplied by domestic currency per foreign currency produces domestic currency.

8. Scenario Analysis

Scenario analysis evaluates exposure under specified, internally coherent assumptions. A scenario may combine exchange rates with interest rates, inflation, volumes, margins, and competitor responses. Unlike a one-factor sensitivity, it can capture managerial narratives such as “regional recession,” “rapid appreciation,” or “supply-chain disruption.”

A scenario table should state:

1. the baseline rate and date;
2. the shocked rate or path;
3. operating assumptions;
4. the affected cash flows;
5. the time horizon;
6. the resulting profit, cash flow, liquidity, and covenant effects.

Scenario analysis is not a probability forecast unless probabilities are explicitly assigned. Its purpose is to understand vulnerability and support decisions under uncertainty.

9. Value at Risk and Cash-Flow-at-Risk

Value at Risk

Value at Risk (VaR) is a quantile measure of potential loss over a specified horizon and confidence level. If L is the loss over the horizon and α is the confidence level, VaR is commonly defined as:

Thus, one-day 99% VaR of $2 million means that, under the model and assumptions, losses are expected to exceed $2 million on approximately 1% of days. It does not mean that the maximum loss is $2 million.

For a linear portfolio with normally distributed exchange-rate changes, zero mean for simplicity, and one currency exposure δ, the standard-deviation loss is approximately:

and:

where σ_S is the standard deviation of the exchange-rate change and z_α is the standard-normal quantile. This formula excludes expected return and is appropriate only as a simplified linear-normal approximation.

For several currencies, the portfolio variance is:

where δ is the vector of currency sensitivities, Σ is the covariance matrix of exchange-rate changes, and δ′ is the transpose of δ. Covariances create diversification benefits or concentration effects.

VaR methods include historical simulation, parametric variance–covariance models, and Monte Carlo simulation. Historical simulation replays observed changes; parametric models impose a distribution; Monte Carlo generates many possible outcomes from specified stochastic assumptions.

Expected shortfall

Expected Shortfall (ES), also called Conditional VaR, measures the average loss in the tail beyond VaR:

ES is often more informative than VaR for portfolios with fat tails or options because it describes tail severity, not only a cutoff. Its reliability still depends on the quality of the model and data.

Cash-flow-at-risk

Cash-flow-at-risk (CFaR) measures the adverse deviation of future cash flow from a target or expected level over a specified horizon. If C is forecast cash flow and c_α is its lower α-quantile, then a lower-tail shortfall measure is:

provided the target exceeds the adverse quantile. CFaR is particularly relevant to firms concerned with debt service, working capital, dividend capacity, capital expenditure, or covenant compliance. Unlike VaR on mark-to-market value, CFaR incorporates transaction timing, operating forecasts, taxes, and liquidity needs.

10. Stress Testing

Stress testing examines extreme but plausible outcomes that may be poorly represented in ordinary historical data. Examples include:

• a 15% overnight depreciation of the domestic currency;
• simultaneous appreciation of two currencies that normally offset each other;
• a breakdown of a natural hedge because a supplier changes its invoice currency;
• failure of a major customer to pay;
• market illiquidity and widened bid–ask spreads;
• a sudden devaluation combined with capital controls.

Stress tests should include reverse stress testing: identify the exchange-rate movement or combination of events that would breach a liquidity, leverage, or covenant limit. Stress results should be linked to actions, such as increasing liquidity buffers, reducing hedge tenor, revising prices, or diversifying suppliers.

VaR and stress testing are complementary. VaR describes a modelled percentile under specified conditions; stress testing challenges the model with severe scenarios outside ordinary assumptions.

11. Integrated Illustrative Case: Meridian Components Ltd.

Background

Meridian Components Ltd., a UK-based manufacturer, sells machinery in euros and purchases electronic components in US dollars. It also owns a Polish subsidiary whose net assets are denominated mainly in Polish zloty. The parent reports in pounds sterling.

Problem

At 1 April, the treasury team identifies the following three-month exposures:

• EUR 3.0 million export receivable;
• USD 2.0 million component payable;
• PLN 40 million net assets in the Polish subsidiary;
• a probable EUR 1.5 million tender with an estimated 60% probability of success.

Management wants to estimate near-term transaction exposure, translation exposure, contingent exposure, and the effect of a severe exchange-rate movement.

Analysis

Assume the following rates and sensitivities:

Suppose a sensitivity report considers a 5% appreciation of each foreign currency, holding other variables constant. The transaction effects are calculated using current domestic values or, equivalently for a small proportional shock, the signed foreign amount multiplied by the rate change. The EUR receivable benefits, whereas the USD payable loses value. The PLN net asset produces a translation gain. The tender is not included in committed transaction exposure, but its probability-weighted amount is EUR 0.9 million for planning:

E[Q_tender] = 0.60 × €1.5m = €0.9m

Treasury should not hedge the full tender automatically. It could use a flexible option, hedge only the probable core amount, or wait until award if the commercial cost of waiting is acceptable.

Approach and solution

Meridian establishes three reporting layers:

1. Committed layer: the EUR receivable and USD payable are hedged according to approved hedge ratios.
2. Forecast and contingent layer: the tender is reported separately with probability, decision date, and maximum exposure.
3. Strategic layer: the Polish net asset and the operating relationship between euro revenues and dollar costs are assessed over a longer horizon.

The treasury dashboard reports gross and net exposures by currency, maturity, hedge instrument, and legal entity. A scenario combines a 5% appreciation of both EUR and USD. The EUR receivable gains, but the USD payable loses; the net outcome depends on the sterling values and rates. A second stress scenario assumes a 15% appreciation of USD, a 10% depreciation of EUR, cancellation of the tender, and delayed customer collection. This scenario is evaluated for both profit and liquidity.

Outcome

The integrated approach prevents three errors. First, it avoids treating the tender as a certain receivable. Second, it avoids confusing the Polish translation adjustment with an immediate cash flow. Third, it recognises that a currency can create both a direct transaction effect and an indirect operating effect through input prices and competitiveness.

Learning points

• Exposure should be mapped before it is measured.
• Probabilities are useful for planning but cannot replace tail analysis.
• Netting must preserve information about gross settlement and liquidity obligations.
• A hedge decision should reflect the type, horizon, and objective of the exposure.
• Exposure reports should connect numerical results to managerial actions.

12. Governance, Data, and Technology

Exposure measurement depends on reliable data. Common data problems include inconsistent currency codes, stale forecasts, incorrect maturity dates, duplicated intercompany balances, and failure to capture embedded foreign-currency clauses. A strong control framework includes ownership, independent review, version-controlled assumptions, documented valuation methods, and reconciliation to the general ledger and cash forecast.

Treasury management systems can automate exposure aggregation, rate sourcing, hedge valuation, and limit monitoring. Analytics and machine-learning tools may improve forecast distributions by detecting patterns in sales, procurement, and collections. However, AI-generated forecasts can reproduce historical bias, fail during regime changes, and obscure causal assumptions. Human review remains essential, especially for contingent exposures and stress scenarios.

Governance should address:

• board-approved risk appetite and escalation limits;
• segregation of dealing, confirmation, valuation, and settlement;
• counterparty and collateral risk;
• model validation and back-testing;
• accounting and disclosure requirements;
• privacy, cybersecurity, and auditability of treasury data.

A risk measure is not a control by itself. The organization must specify who acts when a limit is breached and how exceptions are documented.

13. Limitations and Best Practices

Principal limitations

1. Model risk: estimated volatility, correlation, and probabilities may be wrong.
2. Nonlinearity: options and commercial responses make exposure change nonlinearly.
3. Basis risk: the hedge currency, maturity, or index may not match the underlying exposure.
4. Forecast error: economic exposure depends on uncertain prices, volumes, and costs.
5. Liquidity risk: a measured exposure may be difficult or expensive to hedge in stressed markets.
6. Accounting mismatch: economic hedges may produce timing differences in reported earnings.
7. Aggregation risk: group-level netting can conceal legal, tax, or settlement constraints.
8. Tail dependence: correlations can change sharply during crises.

Best practices

• Maintain a complete, time-stamped exposure register.
• Separate committed, forecast, probable, and contingent cash flows.
• Use signed amounts and explicit quotation conventions.
• Report gross exposure, net exposure, and hedge-adjusted exposure.
• Combine sensitivity, scenarios, VaR or CFaR, and stress testing.
• Reconcile forecasts to actual outcomes and investigate errors.
• Back-test VaR and review exceptions without assuming past performance guarantees future accuracy.
• Use multiple horizons, including settlement, budget, and strategic horizons.
• Link risk metrics to liquidity, pricing, sourcing, and investment decisions.
• Document assumptions, model limitations, and escalation procedures.

Chapter Summary

Foreign exchange exposure measurement identifies how exchange-rate movements affect contractual cash flows, reported accounts, operating performance, and uncertain future events. Transaction exposure concerns committed receipts and payments; translation exposure concerns consolidation of foreign operations; economic exposure concerns future operating cash flows and competitiveness; and contingent exposure concerns potential cash flows whose occurrence is uncertain.

Exposure mapping records currency, direction, amount, timing, probability, hedge status, and accounting treatment. Signed cash flows enable netting, but maturity, currency, legal, and liquidity differences must be retained. Sensitivity analysis provides transparent local measures, scenario analysis evaluates coherent narratives, VaR estimates a model-based loss quantile, CFaR focuses on cash-flow shortfall, and stress testing examines severe but plausible outcomes. No single measure is sufficient. Effective practice combines quantitative metrics with governance, data controls, managerial judgment, and explicit action plans.

Key Terms

Transaction exposure: Risk that the domestic-currency value of a contracted foreign-currency cash flow will change.

Translation exposure: Reporting uncertainty created by translating foreign operations into the parent’s currency.

Economic exposure: Sensitivity of future operating cash flows and enterprise value to exchange rates.

Contingent exposure: Potential foreign-currency exposure dependent on an uncertain event.

Exposure map: Structured record of currency cash flows, timing, direction, certainty, and hedges.

Natural hedge: Operational offset between foreign-currency revenues and costs.

Net exposure: Signed exposure remaining after permitted offsets.

Gross exposure: Total absolute foreign-currency obligations or receipts before offsets.

Sensitivity: Change in value associated with a specified change in a risk factor.

Scenario analysis: Evaluation of outcomes under specified coherent assumptions.

Value at Risk: Quantile estimate of potential loss over a stated horizon and confidence level.

Expected Shortfall: Average loss beyond a specified VaR threshold.

Cash-flow-at-risk: Adverse deviation of future cash flow from a target or expected amount.

Stress testing: Analysis of severe but plausible adverse conditions.

Basis risk: Risk that a hedge does not move identically with the underlying exposure.

Covariance: Measure of how two risk-factor changes move together.

Hedge ratio: Proportion of an exposure covered by a hedge.

Functional currency: Currency of the primary economic environment in which an entity operates.

Back-testing: Comparison of model forecasts with subsequently observed outcomes.

Review Questions

5 Short Answer Questions

1. Define transaction exposure and provide two examples.
2. Why is translation exposure not necessarily an immediate cash-flow exposure?
3. What information should an exposure map contain?
4. Distinguish natural netting from financial netting.
5. What does a 99% one-day VaR measure, and what does it not measure?

5 Long Answer Questions

1. Explain the conceptual and managerial differences among transaction, translation, economic, and contingent exposure.
2. Discuss how a multinational enterprise should aggregate foreign-currency cash flows while preserving information about maturity and legal entity.
3. Compare sensitivity analysis, scenario analysis, VaR, CFaR, and stress testing, including the principal strengths and weaknesses of each.
4. Explain how economic exposure can persist even when a firm has no recognized foreign-currency receivable or payable.
5. Design a governance framework for a corporate FX exposure-measurement program.

3 Analytical / Application Questions

1. A firm will receive €4 million and pay €1.5 million in the same month. Using the convention domestic currency per euro, explain the sign and approximate effect of a €0.06 appreciation of the euro. State the assumptions required for netting.
2. A foreign subsidiary has foreign-currency assets of 120 million and liabilities of 85 million translated at the closing rate. Calculate the simplified net asset exposure and explain why the resulting translation effect may differ from the reported accounting adjustment.
3. A company has a 70% probability of winning a foreign-currency contract worth 2 million, but the contract would require a 1.2 million foreign-currency purchase if awarded. Construct a probability-weighted net exposure and explain why management should also examine maximum and stress exposures.

Multiple Choice Questions with Answers

Question 1

A company will receive €2 million, quoted at $1.10/€. If the euro appreciates to $1.14/€, what is the approximate change in dollar value?

A. $40,000 gain

B. $40,000 loss

C. $80,000 gain

D. $2,280,000 loss

Correct Answer: A. $40,000 gain

Question 2

Which item is most directly classified as translation exposure?

A. An unpaid euro export invoice

B. A forecast dollar purchase

C. Translation of a foreign subsidiary’s net assets into the parent’s currency

D. A foreign-currency option premium

Correct Answer: C. Translation of a foreign subsidiary’s net assets into the parent’s currency

Question 3

Under a signed-receipt-positive convention, which exposure is negative?

A. A foreign-currency receivable

B. A foreign-currency payable

C. A foreign-currency dividend receipt

D. A foreign-currency export sale

Correct Answer: B. A foreign-currency payable

Question 4

A probable foreign-currency tender that occurs only if the bid is accepted is best classified as:

A. Translation exposure

B. Contingent exposure

C. Settlement exposure only

D. Historical-rate exposure

Correct Answer: B. Contingent exposure

Question 5

If a firm receives $5 million and pays $3 million in the same currency and period, its simplified net exposure is:

A. A $8 million receipt

B. A $2 million receipt

C. A $2 million payment

D. Zero gross exposure

Correct Answer: B. A $2 million receipt

Question 6

Which measure focuses specifically on a lower-tail shortfall in future cash flow?

A. Translation adjustment

B. Cash-flow-at-risk

C. Closing-rate exposure

D. Gross notional value

Correct Answer: B. Cash-flow-at-risk

Question 7

A 99% VaR of $1 million implies that:

A. The maximum possible loss is $1 million

B. The firm will lose exactly $1 million every 100 days

C. Under the model, losses greater than $1 million are expected on about 1% of observations

D. The firm has no exposure in the remaining 99% of observations

Correct Answer: C. Under the model, losses greater than $1 million are expected on about 1% of observations

Question 8

Which technique is designed to examine severe but plausible conditions that may not be well represented in ordinary historical data?

A. Stress testing

B. Simple netting

C. Historical translation

D. Invoice matching

Correct Answer: A. Stress testing

Question 9

For a linear portfolio, the variance expression σ_V² = δ′Σδ incorporates:

A. Only the largest exposure

B. Currency sensitivities and covariances among exchange-rate changes

C. Only accounting translation rules

D. Only hedge transaction fees

Correct Answer: B. Currency sensitivities and covariances among exchange-rate changes

Question 10

Why should a contingent exposure not automatically be hedged as if it were a certain transaction?

A. It has no possible exchange-rate effect

B. It may not occur, creating a risk of over-hedging

C. Contingent exposures are always immaterial

D. It can only be measured through translation accounting

Correct Answer: B. It may not occur, creating a risk of over-hedging