Currency exposure is a term referring to the vulnerability of an investment, cash flow, or financial position to variations in the exchange rate of two currencies.
Currencies are constantly exposed to fluctuations in exchange rates in the global foreign exchange market, which makes them inherently volatile.
Holders of a given currency are vulnerable to its depreciation against other currencies.
Companies that work in multiple currencies are particularly exposed to this risk.
The greater the number of currencies and the volumes of money involved, the greater the exposure or, in other words, the greater the potential threat to the company’s profit margins and bottom line.
Currency exposure can be quantified as the total amount of capital involved in all transactions divided by the total amount of capital involved in currency exchange transactions.
The larger the resulting volume, the greater the currency exposure, and the greater the need to implement a robust currency exposure management strategy.
In order to protect their profit margins, companies implement strategies to manage currency exposure.
These can range from simple forward contracts to more sophisticated alternatives like dynamic hedging, which allows them to fully automate their FX risk management.