Managing Economic Exposure

The economic exposure risks can be removed through operational strategies or currency risk mitigation strategies.

Operational strategies

●      Diversifying production facilities and markets for products − Diversification mitigates the risk related with production facilities or sales being concentrated in one or two markets. However, the drawback is the company may lose economies of scale.

●      Sourcing flexibility − Having sourcing flexibilities for key inputs makes strategic sense, as exchange rate moves may make inputs too expensive from one region.

●      Diversifying financing − Having different capital markets gives a company the flexibility to raise capital in the market with the cheapest cost.

Currency risk mitigation strategies

The most common strategies are −

●      Matching currency flows − Here, foreign currency inflows and outflows are matched. For example, if a U.S. company having inflows in Euros is looking to raise debt, it must borrow in Euros.

●      Currency risk-sharing agreements − It is a sales or purchase contract of two parties where they agree to share the currency fluctuation risk. Price adjustment is made in this, so that the base price of the transaction is adjusted.

●      Back-to-back loans − Also called as credit swap, in this arrangement, two companies of two nations borrow each other’s currency for a defined period. The back-to-back loan stays as both an asset and a liability on their balance sheets.

●      Currency swaps − It is similar to a back-to-back loan, but it does not appear on the balance sheet. Here, two firms borrow in the markets and currencies so that each can have the best rates, and then they swap the proceeds.

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