ch11 - INSTRUCTORS MANUAL MULTINATIONAL FINANCIAL...

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INSTRUCTORS MANUAL: MULTINATIONAL FINANCIAL MANAGEMENT , 9TH ED. CHAPTER 11 MEASURING AND MANAGING ECONOMIC EXPOSURE This chapter defines economic exposure as the extent to which a given currency change will change the value of a firm. Exchange risk is just the variability of a firm's value that is due to uncertain currency changes. With regard to managing currency risk, the key issue is the proper role of corporate financial management. To the extent that the firm is operating in efficient financial markets, the primary exposure management objective of financial executives should be to arrange their firm's finances in such a way as to minimize the real effects of exchange rate changes. The major burden of coping with exchange risk must be borne by the marketing and production people because they deal in imperfect product and factor markets where their specialized knowledge provides a real advantage. Their role is to design marketing and production strategies to deal with exchange risks. The appropriate marketing and production strategies are similar to those that would be suitable for any firm confronted with shifting relative output or input prices caused by any economic, political, or social factors. K EY P OINTS ON M EASURING E XCHANGE R ISK 1. Because the value of a firm is equal to the present value of future cash flows, accounting measures of exposure that are based on changes in the book values of foreign currency assets and liabilities need bear no relationship to reality . 2. Because currency changes are usually preceded by or accompanied by changes in relative price levels between two countries, it is impossible to determine exposure to a given currency change without considering simultaneously the offsetting effects of these price changes. This point is illustrated by the examples of Apex Spain, the Brazilian shoe manufacturer, and Chile. The latter two examples show what happens when the real exchange rate changes because inflation is not offset by exchange rate changes. Only foreign currency-denominated contractual cash flows are affected by nominal currency changes. Noncontractual operating cash flows are affected only by real currency changes. The domestic analogue is that only nominal cash flows are affected by inflation. Noncontractual domestic operating cash flows are affected only by relative price changes (i.e., by changes in the prices of the firm's inputs relative to its outputs). The impact of real exchange rate changes on a firm depends on the location of that firm's markets, its sources of inputs, and its degree of flexibility in shifting its marketing and production efforts. These points are brought out in Section 9.3 on identifying economic exposure. The cases of Aspen Skiing Company, Pemex, and Toyota Motor emphasize the fact that exchange risk is ubiquitous and that a thorough exchange risk analysis requires them to identify whether a company is selling and buying in a world market or a domestic market. The
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