Effect of Exchange Rate Fluctuations on Cross-Border Transactions

1. Exchange rates fluctuate constantly. What is the effect of this on cross-
border transactions?
Exchange rate fluctuations affect all types of businesses whether it is multinationals, large, or small &
medium enterprises.
Three types of risk caused by currency volatility:
Transaction Exposure:
Whenever there is a commitment to pay currency at a future date, any fluctuation in the
exchange rates will determine the domestic currency value of the transactions. Importers are
subjected to transactions exposure.
Translation Exposure:
Movement in exchange rate in either case would have its impact on domestic currency value
of these transactions and if the exchange movements are wide and transactions are large it
would have a serious impact on the financial position of the company. Between two Balance
sheets dates, it may alter the net asset value and gearing ratio, it occurred in medium to
long-term in nature.
Economic or operating exposure
Economic exposure arises due to the effect of unpredicted currency rate fluctuations on the
company’s future cash flows and market value. Unanticipated exchange rate fluctuations can
have a huge effect on a company’s competitiveness.In cross border trade, the strength of
currency of competitors, relative cost and prices in each country have a bearing on
exchange rate and the structure of the business.
While transaction and translation exposure can be predicted but Economic exposure is
unpredictable.
2. Discuss the implications of contagion and capital flight in today's
interconnected society. Can you find any examples?
Without proper eco-system it is impossible to keep foreign investors confidence intact, it encourages
capital out flow by foreign investor. And anyway, particularly the least-developed countries attract very
less capital inflow into their country, which make their economies very vulnerable and unstable. A long
term capital inflow that is foreign direct investment (FDI) are a positive force in raising economic
prosperity of any country, particularly, in those countries which lack sufficient capital to carry forward
their economic development.
Unless sound macroeconomic indicators and ease of doing business it is very difficult to prevent
financial crisis and become economically stable. Attention should also be given to external
vulnerability and financial sector stability. With proper economic, financial sector reforms and
favourable business environment, commitment and continuity in reform process any nation could
achieve sound economic indicators which will boost economic development.
The contagion effect of capital flight was recently visible in countries like Argentina, then Turkey, then
Brazil, then South Africa; it also threatened to spread in countries like Indonesia, India. Depreciating
currency in these countries have administered a shock to retailers, as prices of imported goods rises
and people reduced their spending. In an after effect of Argentinean crisis, people in emerging
markets started hedging against rising domestic inflation and a depreciating home currency by shifting
savings into US dollars which led to the capital flight.