ABSTRACT
This chapter provides an explanation of what constitutes an economic risk. Economic exposure to exchange rate risk refers to the impact of unexpected foreign exchange rate fluctuations on dollar value of cash flows generated by an overseas business venture. In the first case, economic exposure is labeled operating cash flow exposure. In the second instance, it is referred to as equity exposure. To provide an intuitive explanation of operating exposure and how to measure it, the chapter focuses on the case of a US multinational corporation having a Swiss subsidiary. Conversion exposure refers to uncertainty surrounding dollar value of a foreign currency cash flow at consolidation. Pure conversion exposure is very rare, because it is assumed that the only factor affecting the foreign cash flows is the variation in the exchange rate. Price exposure refers to the ability of the subsidiary of a US multinational to adjust its domestic and export prices in response to a dollar appreciation or depreciation.
