L03 15 Exposure - Exchange Rate Exposure: Measurement and...

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1 Exchange Rate Exposure: Measurement and Management What is exposure? Should it be managed? How can it be managed? Multinational Corporations A firm that has incorporated on one country and has production and sales operations in other countries. There are about 60,000 MNCs in the world. Many MNCs obtain raw materials from one nation, financial capital from another, produce goods with labor and capital equipment in a third country and sell their output in various other national markets.
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2 Top 10 MNCs Germany Daimler-Benz AG 10 Switzerland Nestlé SA 9 Germany Volkswagen Group 8 United States IBM 7 Japan Toyota 6 United States Exxon Corporation 5 United States General Motors 4 Netherlands/U.K. Royal Dutch/Shell Group 3 United States Ford Motor Company 2 United States General Electric 1 Classical Exchange Rate Theory Classical Exchange rate Exposure theory states that a depreciation in home country currency will help the home country firm and hurt foreign firms. Extensions that impact this theory include; consumer, supplier, competitor, and political reactions
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3 Classical Exchange Rate Theory - Extensions Consumer reaction - Consumers are affected by exchange rate changes especially through the affect in their purchasing power. This will impact the firms cash flows. The elasticity of demand of the firms product. Competitor reactions - Competitors will also react to the exchange rate changes. The exchange rate change may have an impact on the competitors costs and thus impact reaction. Supplier reactions Suppliers will pass the impact of the real change on the prices that it charges the firm. This is important because of the denomination of the costs. To Hedge Or Not To Hedge? Why Hedge? Should firms hedge at all? MNCs produce a multitude of cash flows that are sensitive to changes in exchange rates, interest rates and commodity prices.
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Hedging Hedging is used to manage exposures. How and Why? A firm hedges by taking a position that will rise in value to offset a drop in an existing position, such as, acquiring a cash flow, asset or contract. Firm Value - Theory Financial theory states that the value of the firm is the NPV of the expected future cash flows. It says nothing about the certainty of the
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L03 15 Exposure - Exchange Rate Exposure: Measurement and...

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