Chapter Twelve Management of Economic exposure 12 Chapter objectives This chapter provides a way to measure economic exposure, discusses its determinants, and presents methods for managing and hedging economic exposure
INTERNATIONAL FINANCIAL MANAGEMENT EUN / RESNICK Second Edition 12 Chapter Twelve Management of Economic Exposure Chapter Objectives: This chapter provides a way to measure economic exposure, discusses its determinants, and presents methods for managing and hedging economic exposure
Chapter Outline o Three Types of Exposure o How to measure economic exposure O perating Exposure: Defil inition An Illustration of Operating Exposure Determinants of Operating Exposure Managing Operating Exposure McGraw-Hilylrwoin 12-1 Copyright@ 2001 by The McGraw-Hill Companies, Inc. All rights
McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 12-1 Chapter Outline ⚫ Three Types of Exposure ⚫ How to Measure Economic Exposure ⚫ Operating Exposure: Definition ⚫ An Illustration of Operating Exposure ⚫ Determinants of Operating Exposure ⚫ Managing Operating Exposure
Three Types of Exposure ● Economic Exposure Exchange rate risk as applied to the firms competitive position o Transaction Exposure Exchange rate risk as applied to the firms home currency cash flows. The subject of Chapter 13 Translation Exposure Exchange rate risk as applied to the firms consolidated financial statementS. The subject of Chapter 14 McGraw-Hilylrwoin 12-2 Copyright@ 2001 by The McGraw-Hill Companies, Inc. All rights
McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 12-2 ⚫ Economic Exposure ◼ Exchange rate risk as applied to the firm’s competitive position. ⚫ Transaction Exposure ◼ Exchange rate risk as applied to the firm’s home currency cash flows. The subject of Chapter 13. ⚫ Translation Exposure ◼ Exchange rate risk as applied to the firm’s consolidated financial statements. The subject of Chapter 14 Three Types of Exposure
How to measure Economic exposure o Economic exposure is the sensitivity of the future home currency value of the firms assets and liabilities and the firm's operating cash flow to random changes in exchange rates o There exist statistical measurements of sensitivity McGraw-Hilylrwoin 12-3 Copyright@ 2001 by The McGraw-Hill Companies, Inc. All rights
McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 12-3 How to Measure Economic Exposure ⚫ Economic exposure is the sensitivity of the future home currency value of the firm’s assets and liabilities and the firm’s operating cash flow to random changes in exchange rates. ⚫ There exist statistical measurements of sensitivity
How to measure Economic exposure o If a u.s. mnc were to run a regression on the dollar value(p) of its British assets on the dollar pound exchange rate, S($/f), the regression would be of the form P=a+b×S+e Where a is the regression constant and e is the random error term with mean zero. The regression coefficient b measures the sensitivity of the dollar value of the assets(p) to the exchange rate, S McGraw-Hilylrwoin 124 Copyright@ 2001 by The McGraw-Hill Companies, Inc. All rights
McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 12-4 How to Measure Economic Exposure ⚫ If a U.S. MNC were to run a regression on the dollar value (P) of its British assets on the dollar pound exchange rate, S($/£), the regression would be of the form: P = a+bS +e Where a is the regression constant and e is the random error term with mean zero. The regression coefficient b measures the sensitivity of the dollar value of the assets (P) to the exchange rate, S
How to measure Economic exposure The exposure coefficient. b, is defined as follows b CovP, S) Var(s) Where Cov(P s) is the covariance between the dollar value of the asset and the exchange rate, and var(s) is the variance of the exchange rate McGraw-Hilylrwoin 12-5 Copyright@ 2001 by The McGraw-Hill Companies, Inc. All rights
McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 12-5 How to Measure Economic Exposure The exposure coefficient, b, is defined as follows: Var( ) Cov( , ) S P S b = Where Cov(P,S) is the covariance between the dollar value of the asset and the exchange rate, and Var(S) is the variance of the exchange rate
How to measure Economic exposure The exposure coefficient shows that there are two sources of economic exposure: thethe variance of the exchange rate and the covariance between the dollar value of the asset and exchange rate COVP,S) Var(s) McGraw-Hilylrwoin 12-6 Copyright@ 2001 by The McGraw-Hill Companies, Inc. All rights
McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 12-6 How to Measure Economic Exposure The exposure coefficient shows that there are two sources of economic exposure: the the variance of the exchange rate and the covariance between the dollar value of the asset and exchange rate. Var( ) Cov( , ) S P S b =
Operating exposure: Definition o The effect of random changes in exchange rates on the firms competitive position, which is not readily measurable a good definition of operating exposure is the extent to which the firm 's operating cash flows are affected by the exchange rate McGraw-Hilylrwoin 12-7 Copyright@ 2001 by The McGraw-Hill Companies, Inc. All rights
McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 12-7 Operating Exposure: Definition ⚫ The effect of random changes in exchange rates on the firm’s competitive position, which is not readily measurable. ⚫ A good definition of operating exposure is the extent to which the firm’s operating cash flows are affected by the exchange rate
An lllustration of Operating Exposure o Recently, there was an enormous shortage in the shipping market from Asia, due to the asian currency crIsIs This affected not only the shipping companies Which enjoyed"boom times o But also retailers who experienced increased costs and delays McGraw-Hilylrwoin 12-8 Copyright@ 2001 by The McGraw-Hill Companies, Inc. All rights
McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 12-8 An Illustration of Operating Exposure ⚫ Recently, there was an enormous shortage in the shipping market from Asia, due to the Asian currency crisis. ⚫ This affected not only the shipping companies, which enjoyed “boom times”. ⚫ But also retailers, who experienced increased costs and delays
An lllustration of Operating Exposure o note that the exposure for the retailers has two components The Competitive effect Difficulties and increased costs of shipping The Conversion effect Lower dollar prices of imports due to foreign currency exchange rate depreciation McGraw-Hilylrwoin 12-9 Copyright@ 2001 by The McGraw-Hill Companies, Inc. All rights
McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 12-9 An Illustration of Operating Exposure ⚫ Note that the exposure for the retailers has two components: ◼The Competitive Effect ◆Difficulties and increased costs of shipping. ◼The Conversion Effect ◆Lower dollar prices of imports due to foreign currency exchange rate depreciation
