f55 ER Ch09 Economic Exposure

f55 ER Ch09 Economic Exposure - 11/30/2010 Management of...

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11/30/2010 1 9 Chapter Nine Management of Economic Exposure Chapter Objective: This chapter provides a way to measure economic exposure, discusses its determinants, and presents methods for managing and hedging economic exposure. 9-0 Chapter Outline How to Measure Economic Exposure Operating Exposure: Definition An Illustration of Operating Exposure Determinants of Operating Exposure Managing Operating Exposure 9-1
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11/30/2010 2 Economic Exposure Changes in exchange rates can affect not only firms that are directly engaged in international trade but also purely domestic firms. If the domestic firm’s products compete with imported goods then their competitive position is affected by the strength or weakness of the local affected by the strength or weakness of the local currency. 9-2 Economic Exposure Consider a U.S. bicycle manufacturer who sources, produces and sells only in the U.S. Since the firm’s product competes against imported bicycles it is subject to foreign exchange exposure. Their customers are comparing the cost and Their customers are comparing the cost and features of the domestic bicycle against Japanese, British, and Italian bicycles. 9-3
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11/30/2010 3 Economic 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 Economic exposure can be defined as the extent to which the value of the firm would be affected by unanticipated changes in exchange rates. 9-4 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. Sensitivity of the future home currency values of the fi t d li biliti t d h i 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. 9-5
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11/30/2010 4 Asset exposure Channels of Economic Exposure Home currency Firm Value value of assets and liabilities Exchange rate fluctuation Operating exposure Future operating cash flows fluctuations 9-6 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 + b×S + e Where a is the regression constant e is the random error term with mean zero.
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This note was uploaded on 04/15/2011 for the course FINA 5500 taught by Professor Staff during the Spring '08 term at North Texas.

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f55 ER Ch09 Economic Exposure - 11/30/2010 Management of...

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