Final answer:
Operating exposure is the risk of currency fluctuations affecting a company's cash flow and competitive position. It is identified in three steps: examining the situation for currency risks, identifying knowns and unknowns including sensitive transactions, and creating strategies to manage exposure, such as using financial instruments or operational adjustments.
Step-by-step explanation:
Definition of Operating Exposure
Operating exposure, also known as economic exposure, refers to the risk that a company’s cash flow, profits, and competitive position could be affected by fluctuations in exchange rates. Identifying operating exposure can be broken down into a process that is generally considered to have three steps:
- Examine the situation to determine the degree of exposure to changes in exchange rates. This means looking at how currency fluctuations can impact the costs of inputs and the pricing of products in different currencies.
- Identify the knowns and unknowns within the problem, such as identifying the types of transactions that are sensitive to currency changes and the potential impacts on competitive position and financial results.
- Create strategies to manage the exposure, which might include financial instruments to hedge against currency risks, diversifying operations, or altering the structure of costs and pricing .Each step is integral to understanding and managing operating exposure comprehensively to safeguard the company's financial health.