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Chapter 12 Managing Economic Exposure and Translation Exposure Lecture Outline Economic Exposure Use of the Income Statement to Assess Economic Exposure How Restructuring Can Reduce Economic Exposure Issues Involved in the Restructuring Decision A Case Study in Hedging Economic Exposure Savor Co.’s Dilemma Assessment of Economic Exposure Identifying the Source of the Unit’s Exposure Possible Strategies to Hedge Economic Exposure Savor’s Hedging Solution Limitations of Savor’s Optimal Hedging Strategy Hedging Exposure to Fixed Assets Managing Translation Exposure Using Forward Contracts to Hedge Translation Exposure Limitations of Hedging Translation Exposure 187 188 International Financial Management Chapter Theme This chapter shows how an MNC can restructure its operations to reduce economic exposure. Such a strategy is related to the firm's long-run operations, unlike transaction exposure. This chapter also briefly describes how translation exposure can be reduced. Yet, it is advised that the limitations of hedging translation exposure receive as much attention as the hedging strategy itself. Topics to Stimulate Class Discussion 1. Identify the economic exposure of a small business that you are aware of. 2. Even if you believe translation exposure is relevant, is it worthwhile to hedge it? Explain. 3. Compare the degree of translation exposure between a small firm whose foreign subsidiary generates 50% of its business versus a huge exporting company with no subsidiaries. POINT/COUNTER-POINT: Can an MNC Reduce the Impact of Translation Exposure by Communicating? POINT: Yes. Investors commonly use earnings to derive an MNC’s expected future cash flows. Investors do not necessarily recognize how an MNC’s translation exposure could distort their estimates of the MNC’s future cash flows. Therefore, the MNC could clearly communicate in its annual report and elsewhere how the earnings were affected by translation gains and losses in any period. If investors have this information, they will not overreact to earnings changes that are period.... View Full Document

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