Which type of exchange rate risk involves cash flows in foreign currency?

Transaction exposure specifically relates to the risk that a company's cash flows will be affected by changes in exchange rates due to transactions that involve foreign currencies. This type of exposure occurs when a company engages in international business activities, such as purchasing goods or services from a foreign supplier or selling products to a foreign customer.

For instance, if a U.S. company agrees to pay a European supplier in euros for goods, any fluctuations in the exchange rate between the euro and the dollar prior to the actual cash flow (the payment) can lead to differences in the amount the company will ultimately pay in terms of its own currency. Thus, transaction exposure is crucial for businesses that regularly deal in foreign currencies as it directly impacts the cash flows associated with those transactions, potentially leading to financial losses or gains based on the timing and currency fluctuations.

On the other hand, translation exposure involves the impact of exchange rate movements on the reported financial statements of a company that has subsidiaries in foreign currencies. Economic exposure refers to the overall long-term effect of exchange rate changes on a company's market value and can affect future cash flows but is not limited to specific transactions. Credit exposure generally pertains to the risk associated with a counterparty's potential failure to meet its obligations and is not directly tied to currency