Chapter 11: Managing Transaction Exposure

Transaction exposure is the short-term FX risk created by a contractual foreign-currency payable or receivable. This page summarizes importing vs exporting exposure and provides hedging calculators for forward contracts, money market hedges, and options (call/put).

Theme
Core concepts

Summary Table: Transaction Exposure & Hedging Tools

What is Transaction Exposure? The risk from exchange rate fluctuations after entering a foreign-currency obligation (payable/receivable).
Who is affected? The party that must settle in foreign currency — typically the importer (payable) or exporter (receivable).
Example A U.S. firm must pay €100,000 in 30 days. If EUR appreciates, the USD cost rises.
Types of FX exposure
  • Transaction: short-term contract risk
  • Operating (economic): long-run cash flow/competitiveness
  • Translation: accounting revaluation of balance-sheet items

Hedging strategies overview

Hedging tool Best use case Action What it does
Forward contract Pay or receive FC Lock rate today Eliminates FX uncertainty (but no upside).
Money market hedge Pay or receive FC Borrow/invest using spot + interest rates Creates a “synthetic forward” using deposits/loans.
Call option Importing payable Buy call on foreign currency Caps the cost if FC appreciates; keeps upside if FC depreciates (premium is the cost).
Put option Exporting receivable Buy put on foreign currency Floors the revenue if FC depreciates; keeps upside if FC appreciates (premium is the cost).
Rule of thumb: Importer (payable) fears foreign currency appreciation → likes buying FC forward or buying a call. Exporter (receivable) fears foreign currency depreciation → likes selling FC forward or buying a put.
Importing Payable

In-class exercise: Importing (currency payable)

Norway salmon example (NOK payable)

You must pay 10,000 NOK in 30 days. Current spot: 1 NOK = $0.10 (expected cost ≈ $1,000). If NOK appreciates to $0.11, the USD cost becomes $1,100 (unexpected loss of $100).

Student tasks (short answers)
  1. If you do nothing and NOK strengthens: USD cost rises; you pay more dollars for the same NOK amount.
  2. Forward hedge: buy NOK forward for 30 days → locks the USD cost today; no uncertainty.
  3. Call option hedge: buy NOK call → if NOK appreciates above the strike, exercise; if NOK depreciates, let it expire and buy NOK cheaper at spot (loss limited to premium).
  4. Money market hedge: buy NOK “today” by borrowing USD, converting to NOK at spot, investing NOK so it grows to the needed payable by day 30; USD repayment becomes known.

Importer hedging map (what to do)

If you must PAY foreign currency…What you fearTypical hedge
Pay NOK / € / £ laterForeign currency appreciatesBuy FC forward or buy FC call or money market hedge
Pay later but want upsideStill fear appreciationCall option gives a cap with upside if FC depreciates
FC = foreign currency.
Exporting Receivable

In-class exercise: Exporting (currency receivable)

US bikes sold to Norway (NOK receivable)

You will receive 10,000 NOK in 30 days. Current spot: 1 NOK = $0.10 (expected $1,000). If NOK weakens to $0.09, you only receive $900 (loss of $100).

Student tasks (short answers)
  1. If you do nothing and NOK weakens: USD value of your receivable falls.
  2. Forward hedge: sell NOK forward → locks USD revenue today.
  3. Put option hedge: buy NOK put → if NOK depreciates below strike, exercise and sell at strike; if NOK appreciates, let it expire and sell at better spot (premium is cost).
  4. Money market hedge: borrow NOK today against the receivable, convert to USD now, invest USD; later use receivable to repay NOK loan → USD value becomes known.

Exporter hedging map (what to do)

If you will RECEIVE foreign currency…What you fearTypical hedge
Receive NOK / € / £ laterForeign currency depreciatesSell FC forward or buy FC put or money market hedge
Receive later but want upsideStill fear depreciationPut option sets a floor with upside if FC appreciates
Calculator Forward • MM • Options

Hedge calculators (plug-and-play)

Convention here uses exchange rate quoted as USD per 1 unit of foreign currency (e.g., $ / £, $ / €, $ / SF). For money market hedges, be sure the interest rates match the horizon (e.g., 6-month rate for 6 months).

Importer (payable): given FC payable, compute hedged USD cost

Output will appear here.
Formulas used
Forward cost = FC × F
Money market (payable):
Deposit today = FC / (1+i_f)^T
USD today needed = (FC/(1+i_f)^T) × S
USD cost at T = USD_today × (1+i_US)^T
Call “cap” (scenario):
If ST > K: exercise, USD cost = FC × (K + p)
If ST ≤ K: let expire, USD cost = FC × ST + FC × p
Note: option premium is paid up front in practice; here we keep it in per-unit terms for clarity.

Exporter (receivable): given FC receivable, compute hedged USD revenue

Output will appear here.
Formulas used
Forward revenue = FC × F
Money market (receivable):
Borrow today = FC / (1+i_f)^T
Convert to USD now = Borrow × S
Invest USD at i_US: USD_T = USD_now × (1+i_US)^T
Repay foreign loan at T using receivable (they match by construction).
Put “floor” (scenario):
If ST < K: exercise, USD revenue = FC × (K − p)
If ST ≥ K: let expire, USD revenue = FC × ST − FC × p
Options: premium reduces net proceeds. If currency moves favorably, you keep upside minus premium.
Homework Due with final

Homework (Chapter 11)

1) £10 million payable in 1 year (Forward / Money market / Call)
2) £10 million receivable in 1 year (Forward / Money market / Put)
Educational disclaimer: These solutions ignore bid–ask spreads, transaction costs, taxes, credit limits, option early exercise details, and real-world operational constraints. The purpose is to practice core mechanics.