360-16 - Chapter 16 FX Risk Forecasting and International...

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Chapter 16 – FX Risk, Forecasting and International Investment Currency risk and currency risk management for MNCs and international investors depend on expectations of ex-rate changes, which involve ex-rate forecasting. For example, if the expectation/forecast is that the Euro will appreciate over the next year, that determines the appropriate risk strategy. For an exporter receiving Euro throughout the next year, or an investor with European investments, what might be a sensible strategy? _________________________. TYPES OF FX RISK EXPOSURE 1. Translation or accounting exposure , the effect of changes in the ex-rate on the dollar translation of foreign-currency denominated assets and liabilities. See Table 16.1 on p. 393, balance sheet of a U.S. MNC’s subsidiary in Saudi Arabia. The top balance sheet is in foreign currency, SARs. The second balance sheet reflects the figures after the SAR amount have been converted (translated) into US dollar amounts at ex-rate SAR4/$. The owner’s equity (E = TA – D) of the subsidiary is $1.5m ($2.75m - $1.25m). If the SAR depreciates (USD appreciates) to SAR5/$, the value of the owner’s equity falls to $1.2m, a 20% drop in value, third balance sheet. Rule: When the foreign currency is depreciating (appreciating) to the USD, the owner’s equity measured in USD will fall (rise). 2. Transaction exposure is the FX risk from the effect of ex-rate changes on future CFs, transactions like receivables and payables invoiced in a foreign currency (receive €10m in 3 months or pay €10m in 3 months). For example: Exporter will receive €10m in three months. Current ex-rate is $1.30/€. In 3 months: Ex-rate = $1.30/€, exporter will receive in USD ______________________. Ex-rate = $1.20/€, exporter will receive in USD ______________________. Ex-rate = $1.40/€, exporter will receive in USD ______________________. Worried about? ____________________. Importer will pay €10m in three months. Current ex-rate is $1.30/€. In 3 months: Ex-rate = $1.30/€, exporter will pay in USD ______________________. Ex-rate = $1.20/€, exporter will pay in USD ______________________. Ex-rate = $1.40/€, exporter will pay in USD ______________________. Worried about? ____________________. 360-16 1/23/2012 1
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3. Economic exposure is the exposure to changes in the firm’s value as ex-rates change. The firm’s value is the PV of future after-tax CFs, and as the CFs change, the firm value changes. Transaction exposure above is one type of economic exposure. Exchange rate changes can affect either the firms: a) income statement and/or the b) balance sheet, and both changes will alter the firm’s value. SUMMARY OF EX-RATE CHANGES FOR U.S. Firm (USING EURO) € APPRECIATES ($ DEP) € DEPRECIATES ($ APP) U.S. Exporter: +CFs(€) + (pos) --- (neg) U.S. Importer: -CFs(€) --- + U.S. firm using ---
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360-16 - Chapter 16 FX Risk Forecasting and International...

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