economic and translation exposures - Chapter 9 10 Managing...

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Chapter 9+10Managing Economic and Translation Exposures
Changes in exchange rates can affect not only firms that are directly engaged in international trade but also purely domestic firms.Consider a U.S. bicycle manufacturer who sources and sells only in the U.S.Since the firm’s product competes against imported bicycles it is subject to foreign exchange exposure.Economic/Operating Exposure
Exchange rate risk as applied to the firm’s competitive position.Any anticipated changes in the exchange rates would have been already discounted and reflected in the firm’s value. Economic exposure can be defined as the extent to which the value of the firm would be affected by unanticipated changes in exchange rates.Economic Exposure
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.Economic Exposure: Definition
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.Sensitivity of the future home currency values of the firm’s assets and liabilities to random changes in exchange rates.Sensitivity of the firm’s operating cash flows to random changes in exchange rates.How to Measure Economic Exposure
Operating exposureChannels of Economic ExposureFirm ValueHome currency value of assets and liabilitiesFuture operating cash flowsExchange rate fluctuationsAsset 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 Illustration of Economic Exposure
Note that the exposure for the retailers has two components:An Illustration of Economic ExposureThe Competitive EffectDifficulties and increased costs of shipping.The Conversion EffectLower dollar prices of imports due to foreign currency exchange rate depreciation.
Recall that economic exposure cannot be readily determined from the firm’s accounting statements as can transaction exposure.The firm’s operating exposure is determined by:Determinants of Economic ExposureThe firm’s ability to adjust its markets, product mix, and sourcing in response to exchange rate changes.The market structureof inputs and products: how competitive or how monopolistic the markets facing the firm are.
Operational HedgingSelecting Low Cost Production SitesFlexible Sourcing PolicyDiversification of the MarketR&D and Product DifferentiationFinancial HedgingManaging Economic Exposure
A firm may wish to diversify the location of

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