Measuring Exposure to Exchange Rate Fluctuations
Is Exchange Rate Risk Relevant?
Transaction Exposure to “Net” Cash Flows in Each Currency
Measuring the Potential Impact of the Currency Exposure
Assessing Transaction Exposure Based on Value-at-Risk
Economic Exposure to Local Currency Appreciation
Economic Exposure to Local Currency Depreciation
Economic Exposure of Domestic Firms
Measuring Economic Exposure
Does Translation Exposure Matter?
Determinants of Translation Exposure
Examples of Translation Exposure
International Financial Management
This chapter distinguishes among three forms by which MNCs are exposed to exchange rate risk: (1)
transaction exposure, (2) economic exposure, and (3) translation exposure. It should be emphasized
that a firm sometimes benefits due to exposure. Yet, it typically would prefer to control its own
destiny and therefore be insulated from exposure. Each firm differs in degree of exposure. A firm
should be able to measure its degree of each type of exposure as described in this chapter. Then, it
can decide how to cover that exposure using methods described in the following two chapters.
Topics to Stimulate Class Discussion
Describe in general terms how you would measure the transaction exposure of a particular MNC.
What is the relationship between transaction exposure and economic exposure?
A small firm in New York City produces various metals and sells them to local manufacturers. It
has no foreign sales and purchases all supplies and materials locally. Does transaction exposure
exist for this firm? Does economic exposure exist for this firm?
Should Investors Care about an MNC’s
POINT: No. The present value of an MNC’s cash flows is based on the cash flows that the parent
receives. Any impact of the exchange rates on the financial statements is not important unless cash
flows are affected. MNCs should focus their energy on assessing the exposure of their cash flows to
exchange rate movements and should not be concerned with the exposure of their financial statements
to exchange rate movements. Value is about cash flows, and investors focus on value.
Investors do not have sufficient financial data to derive cash flows. They
commonly use earnings as a base, and if earnings are distorted, so will be their estimates of cash
flows. If they underestimate cash flows because of how exchange rates affected the reported earnings,
they may underestimate the value of the MNC. Even if the value is corrected in the future once the
market realizes how the earnings were distorted, some investors may have sold their stock by the time
the correction occurs. Investors should be concerned about an MNC’s translation exposure. They
should recognize that the earnings of MNCs with large translation exposure may be more distorted
than the earnings of MNCs with low translation exposure.
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