Final answer:
Economic exposure is the impact of exchange rate fluctuations on a company's long-term cash flows and market value, broader than transaction or translation exposure, and can affect competitiveness, costs, and profits.
Step-by-step explanation:
The extent to which the value of the firm would be affected by unexpected changes in the exchange rate is referred to as economic exposure. This type of exposure considers how a company's long-term cash flows and market value can be influenced by exchange rate fluctuations. Economic exposure is broader than transaction exposure, which pertains to the effects on existing financial obligations, and translation exposure, which relates to the conversion of financial statements of foreign subsidiaries to the parent company's currency.
Firms may encounter exchange rate risks that can result in economic exposure impacting their competitiveness, sales, and profits. For instance, if a company relies heavily on imported materials or exports goods, a strong fluctuation in currency values can significantly alter cost structures and revenue.
The banking sector is also sensitive to currency fluctuations, where mismatches between lending and borrowing currencies can create financial risks. International financial capital flows and trade balances can be affected by exchange rates, potentially leading to economic instability if not managed properly.
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