The correct answer is: C. The home-currency value of financial assets and liabilities denominated in foreign currencies.
Economic exposure is the extent to which a company’s operating cash flows are affected by changes in exchange rates. It is a broader concept than translation exposure, which is the effect of exchange rate changes on the reported financial statements of a company.
Economic exposure can arise from a number of sources, including:
- Sales in foreign currencies: If a company sells its products in foreign currencies, its sales revenue will be affected by changes in exchange rates. For example, if a company sells its products in euros and the euro appreciates against the US dollar, the company’s sales revenue in US dollars will increase.
- Costs of production in foreign currencies: If a company has production facilities in foreign countries, its costs of production will be affected by changes in exchange rates. For example, if a company has a production facility in China and the Chinese yuan depreciates against the US dollar, the company’s costs of production in US dollars will decrease.
- Financing in foreign currencies: If a company borrows money in foreign currencies, its interest payments will be affected by changes in exchange rates. For example, if a company borrows euros and the euro appreciates against the US dollar, the company’s interest payments in US dollars will increase.
Financial managers need to consider economic exposure when making decisions about a company’s financing, investment, and operating activities. They need to identify the sources of economic exposure and assess the potential impact of changes in exchange rates on the company’s financial performance.
Option A is incorrect because it refers to sales prospects in foreign markets. This is a factor that can affect a company’s operating cash flows, but it is not the same as economic exposure.
Option B is incorrect because it refers to the product market, the factor market, and the capital market. These are all important factors that can affect a company’s financial performance, but they are not the same as economic exposure.
Option D is incorrect because it refers to the costs of labor and other inputs to be used in overseas production. This is a factor that can affect a company’s costs of production, but it is not the same as economic exposure.