What are the Elements of Exposure?

We follow established tradition in using the concept of exchange rateexposure around which to build our analysis of how firms are affectedby exchange rate variability. Exposure measures what one has at risk.The most commonly accepted definition stems from Adler and Dumas(1984). A good summary of their definition is found in Levi (1990,p. 187). The definition runs as follows: ‘Foreign exchange exposure isthe sensitivity of real domestic currency value of assets, liabilities, oroperating incomes to unanticipated changes in exchange rates.’ Sercuand Uppal’s (1995) way of stating Adler and Dumas’ definition ofexposure is: Exposure of firm to ei = (Total unexpected change in the financialposition of the firm as measured in the home currency)/ unexpectedchange in ei, where ‘financial position’ includes financial statements as well as cash flows and ei is the exchange rate against a specific currency which we denote i (for instance D-marks, Hong Kong dollars, or what have you). To take a very simplistic example of exposure, assume that my firm is expecting payment of 500 US dollars. My domestic currency is the kronor, this is where I spend my money. What is my exposure against the dollar if I, for the sake of this example, assume that all my other incomes and net asset holdings are unaffected by the dollar exchange rate?