Explain how MNC can reduce transaction exposure
Multinational corporations (MNCs) can take several steps to reduce transaction exposure, which refers to the risk of financial loss arising from fluctuations in exchange rates between the time a transaction is initiated and the time it is settled. Here are some ways MNCs can mitigate transaction exposure:
1. Forward Contracts: MNCs can enter into forward contracts, which are agreements to buy or sell a currency at a predetermined exchange rate on a future date. By locking in the exchange rate in advance, MNCs can eliminate the uncertainty associated with currency fluctuations.
2. Currency Hedging: MNCs can hedge against transaction exposure by using financial instruments such as options, futures, or swaps. These instruments allow companies to protect against potential losses from adverse exchange rate movements. For example, a company can buy a put option that gives them the right to sell a currency at a predetermined rate, which would effectively limit their losses if the currency depreciates.
3. Netting and Matching: MNCs can reduce transaction exposure by coordinating and consolidating their foreign currency cash flows through netting and matching. This involves balancing the inflows and outflows of currencies from various transactions to minimize the need for foreign currency conversions.
4. Invoice Currency Selection: MNCs can negotiate with their trading partners to transact in their own currency or a currency that is stable and less volatile. This reduces the need for currency conversions and exposure to exchange rate fluctuations.
5. Centralized Treasury Management: By centralizing and optimizing their treasury management functions, MNCs can gain better control and oversight of their foreign currency exposures. This includes consolidating cash flows, implementing efficient liquidity management strategies, and leveraging technology to monitor and manage exchange rate risks.
It is important to note that transaction exposure cannot be completely eliminated, but these strategies can help MNCs mitigate and manage the associated risks more effectively. It is recommended for MNCs to work closely with skilled financial professionals or consult with treasury management experts to determine the most appropriate and effective methods for reducing transaction exposure based on their specific circumstances.