Measurement of Exchange Rate Exposure: Capital Market Approach versus Cash Flow Approach

Exchange rate exposure is the uncertainty created by the unintuitive movement in the exchange rates between the currencies. The exchange rate exposures can be categorized into three types 1. Transaction exposure; 2. Translation exposure; and 3. Economic exposure. Economic exposure is also called as residual risk and affects the firms long term cash flows. These exposures affects the firm value in many ways, therefore it is very important for the firms to manage the exposure. Measurement of the exposure becomes critical to manage the expsousre. In the literature we broadly see two methods used to measure the exposure. This study carried out the comparision between both the methods using the sample of 30 listed Indian firms. The results indicate that the cash flow model would be more useful to take strategic decisions to manage the economic exposure and also in the carrying out the further analysis.