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FRM Part I · FRM Exam Part I · How Do Firms Manage Financial Risk?

A US-based manufacturer has signed a contract to receive EUR 5 million from a German customer in 90 days. Which description best characterizes the exposure that a forward sale of EUR for USD would hedge?

It is transaction exposure. The firm has a contractual EUR receipt on a known date, so a forward sale of euros locks in the USD proceeds. Translation exposure relates to consolidating foreign subsidiaries, and economic exposure relates to long-term competitive effects on uncontracted cash flows.

  1. ATransaction exposure on a contracted foreign-currency cash flowCorrect
  2. BTranslation exposure on the consolidated balance sheet
  3. CEconomic exposure arising from long-run competitiveness shifts
  4. DSovereign exposure arising from capital controls

Explanation

A known foreign-currency cash flow with a fixed settlement date creates transaction exposure. A forward sale of EUR fixes the USD amount received. Translation exposure concerns consolidation of foreign subsidiaries, and economic exposure concerns uncontracted, long-run effects on competitiveness.

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