What does exposure mean?

Example of exposure

For example, if an investor has $10,000 invested in stocks, the exposure to stocks, in dollar terms, is $10,000.

Calculating the investor’s exposure in percentage terms depends on the size of the investor’s portfolio. If the investor’s entire portfolio is worth $10,000 and $10,000 is invested in stocks, then the investor has 100% exposure to stocks. Yet, if the investor’s entire portfolio is worth $20,000 and with $10,000 invested in stocks, then their exposure to stocks is 50%.

Types of exposure

The term exposure is used in many different ways in finance. Exposure can vary based on its method of expression, the market you are exposed to and what you are risking.

Market exposure

Market exposure refers to the division of assets within an investment portfolio. It refers to the amount invested in a particular type of security, investment, sector or geographic region. Market exposure can be expressed in money terms or as a percentage, although it is more commonly expressed as a percentage. For example, if a $10,000 portfolio has $3,000 allocated to gold, the portfolio’s market exposure to gold is 30%. If the portfolio has $2,000 allocated to US stocks, the market exposure to US stocks is 20%. If the portfolio holds no property investments, the market exposure to property is 0%.

Financial exposure

Financial exposure, on the other hand, refers to the amount of money that can potentially be lost on an investment. For example, if an investor buys $5,000 worth of Facebook shares, the financial exposure is $5,000. The investor could potentially lose the entire $5,000 on the investment. It’s worth noting that leverage can increase an investor’s financial exposure.

Leverage exposure

Leverage gives a trader access to larger trades for a smaller initial outlay. For example, if an investor uses leverage of 10:1, a $10,000 trade could be placed with an outlay of just $1,000. In this scenario, the investor’s financial exposure is $10,000, even though the outlay is only $1,000. So by using leverage, the investor could lose more than the initial investment.

Currency exposure

Currency exposure refers to an investor’s exposure to a particular currency. Currencies such as the US dollar, pound sterling and euro are constantly fluctuating in value. That means that holders of a particular currency are vulnerable to movements in exchange rates.

If the value of an investment can be affected by movements in currencies, then the investor has currency exposure. For example, if a UK-based investor owns a portfolio of US-listed stocks, the investor has currency exposure to the US dollar. If the US dollar weakens against the pound, the portfolio of US-listed stocks will be worth less in sterling terms.

Companies that operate globally need to continually monitor their currency exposure. For instance, if a UK-based company buys raw materials from Europe and pays in euros, it has currency exposure to the euro. If the euro increases against the pound, the company’s costs will be higher.

Risk exposure

Risk exposure refers to the amount of risk an investor has taken on a particular investment. It refers to the quantified loss potential of an investment or activity.

Stock exposure

Lastly, stock exposure refers to an investor’s exposure to a particular stock. Stock exposure can be expressed in monetary terms or in terms of the proportion of the investor’s portfolio. For example, if an investor owns £5,000 of Unilever shares, then the stock exposure in monetary terms is £5,000. If the investor’s entire portfolio is worth £20,000, the investor’s stock exposure to Unilever is 25% of the portfolio.

For example, say one investor has 50% stock exposure to Unilever and another investor has 5% stock exposure to Unilever. In this scenario, the investor with 50% stock exposure faces significantly more stock-specific risk.

How to determine exposure

Exposure depends on an individual’s goals and risk tolerance. There is no single way to determine it.

Here’s an example of breaking down market exposure: consider a UK investor who is bullish on US stocks and neutral on European stocks. This investor might allocate 30% of their portfolio to US stocks and 10% to European stocks.

Similarly, consider an investor who is bullish on technology stocks, but bearish on utility stocks. This investor might allocate 15% of their portfolio to technology stocks and 0% to utility stocks.

Investors that are comfortable with risk often allocate a higher proportion of their portfolio to equities, and a smaller proportion to bonds. In contrast, risk-averse investors often have less exposure to equities and more exposure to bonds.

To lower risk, investors need to ensure that they are not overexposed to any particular investment type. Exposure can be reduced by selling an asset, by diversification or through hedging.

How to reduce financial exposure

There are many ways in which one can reduce risk of financial exposure, including diversification and investing in exchange-traded funds (ETF). The simplest way to eliminate exposure to a certain asset is to sell it.

Diversification

Another way to reduce financial exposure is through diversification. This involves having a variety of different investments in one portfolio. For example, instead of just owning one stock and having a 100% exposure to that stock, an investor could buy 20 different stocks.

Similarly, instead of just owning one ETF and having a 100% exposure to that ETF, an investor could buy four different ETFs.

Hedging

Hedging is a risk management technique used to minimise losses from a particular investment. It involves taking an offsetting position in an asset to try and reduce the potential for losses in an existing asset.

Summary

In finance, exposure refers to the amount of money invested in a particular asset. It represents the amount that an investor could lose on an investment.

Monitoring exposure is an important part of risk management in investing and trading. It’s important to understand that having a high exposure to one particular investment increases overall risk.