International Corporate Finance Chp 9:Transaction exposure Xin Chen Visiting Associate Professor Aarhus School of Business
1 International Corporate Finance Chp 9: Transaction exposure Xin Chen Visiting Associate Professor Aarhus School of Business
Foreign Exchange Exposure Foreign exchange exposure is a measure of the potential for a firm's profitability,net cash flow,and market value to change because of a change in exchange rates. Key financial goals of a firm are to maximize-- profitability,net cash flow,and market value Each of the goals can be affected by foreign exchange rates change. Firm value is equal to NPV of all expected future cash flows
Foreign Exchange Exposure Foreign exchange exposure is a measure of the potential for a firm’s profitability, net cash flow, and market value to change because of a change in exchange rates. Key financial goals of a firm are to maximize-- profitability, net cash flow, and market value Each of the goals can be affected by foreign exchange rates change. Firm value is equal to NPV of all expected future cash flows
Exhibit 9.1 Conceptual Comparison of Transaction,Operating,and Translation Moment in time when exchange rate changes Translation exposure Operating exposure Changes in reported owners'equity Change in expected future cash flows in consolidated financial statements arising from an unexpected change in caused by a change in exchange rates exchange rates Transaction exposure Impact of settling outstanding obligations entered into before change in exchange rates but to be settled after change in exchange rates Time
Exhibit 9.1 Conceptual Comparison of Transaction, Operating, and Translation Foreign Exchange Exposure
Transaction exposure Transaction exposure measures changes in the value of outstanding financial obligations incurred prior to a change in exchange rates but not due to be settled until after the exchange rates change. Changes in cash flows resulting from existing contractual obligations
Transaction exposure Transaction exposure measures changes in the value of outstanding financial obligations incurred prior to a change in exchange rates but not due to be settled until after the exchange rates change. Changes in cash flows resulting from existing contractual obligations
Operating exposure Operating exposure,also called economic exposure, measures the change in the present value of the firm resulting from any change in future operating cash flows of the firm caused by an unexpected change in exchange rates. Future obligations (future sales volume,prices or costs) Long-term analysis where exchange rates changes are unpredictable and unexpected
Operating exposure Operating exposure, also called economic exposure, measures the change in the present value of the firm resulting from any change in future operating cash flows of the firm caused by an unexpected change in exchange rates. Future obligations (future sales volume, prices or costs) Long-term analysis where exchange rates changes are unpredictable and unexpected
Foreign Exchange Exposure Transaction exposure and operating exposure exist because of unexpected changes in future cash flows The difference between the two is that transaction exposure is concerned with future cash flows already contracted for,while operating exposure focuses on expected (not yet contracted for)future cash flows that might change because a change in exchange rates has altered international competitiveness
Foreign Exchange Exposure Transaction exposure and operating exposure exist because of unexpected changes in future cash flows. The difference between the two is that transaction exposure is concerned with future cash flows already contracted for, while operating exposure focuses on expected (not yet contracted for) future cash flows that might change because a change in exchange rates has altered international competitiveness
Accounting exposure Accounting exposure,also called translation exposure,is the potential for accounting- derived changes in owner's equity to occur because of the need to "translate"foreign currency financial statements of foreign subsidiaries into a single reporting currency to prepare worldwide consolidated financial statements
Accounting exposure Accounting exposure, also called translation exposure, is the potential for accounting- derived changes in owner’s equity to occur because of the need to “translate” foreign currency financial statements of foreign subsidiaries into a single reporting currency to prepare worldwide consolidated financial statements
Tax Consequence The tax consequence of foreign exchange exposure varies by country. As a general rule,however,only realized foreign exchange losses are deductible for purposes of calculating income taxes. Similarly,only realized gains create taxable income. "Realized"means that the loss or gain involves cash flows
Tax Consequence The tax consequence of foreign exchange exposure varies by country. As a general rule, however, only realized foreign exchange losses are deductible for purposes of calculating income taxes. Similarly, only realized gains create taxable income. “Realized” means that the loss or gain involves cash flows
Why Hedge? MNEs possess a multitude of cash flows that are sensitive to changes in exchange rates, interest rates,and commodity prices. These three financial price risks are the subject of the growing field of financial risk management. Many firms attempt to manage their currency exposures through hedging
Why Hedge? MNEs possess a multitude of cash flows that are sensitive to changes in exchange rates, interest rates, and commodity prices. These three financial price risks are the subject of the growing field of financial risk management. Many firms attempt to manage their currency exposures through hedging
Why Hedge? Hedging is the taking of a position,acquiring either a cash flow,an asset,or a contract (including a forward contract)that will rise (fall)in value and offset a fall (rise)in the value of an existing position. While hedging can protect the owner of an asset from a loss,it also eliminates any gain from an increase in the value of the asset hedged against
Why Hedge? Hedging is the taking of a position, acquiring either a cash flow, an asset, or a contract (including a forward contract) that will rise (fall) in value and offset a fall (rise) in the value of an existing position. While hedging can protect the owner of an asset from a loss, it also eliminates any gain from an increase in the value of the asset hedged against