• Sourcing does not apply only to components, but also to “guest workers”. • e.g. Japan Air Lines hired foreign crews to remain competitive in international routes in the face of a strong yen, but later contemplated a reverse strategy in the face of a weak yen and rising domestic unemployment.
Diversification of the Market • Selling in multiple markets to take advantage of economies of scale and diversification of exchange rate risk. • Diversify by: • selling the same product in more than one country, and • selling several different product lines in more than one foreign market. • As long as ex-rates don't move together perfectly against the dollar, and as long as ex-rates don't affect each product line the same, the diversification will mitigate operating exposure to currency risk.
R&D and Product Differentiation • Successful R&D that allows for • cost cutting • enhanced productivity • product differentiation. • Successful product differentiation gives the firm less elastic demand— which may translate into less exchange rate risk.
Financial Hedging • The goal is to stabilize the firm’s cash flows in the near term. • Financial Hedging is distinct from operational hedging. • Financial Hedging involves use of derivative securities such as currency swaps, futures, forwards, currency options, among others .
How do Deal with Economic Exposure?
Extras: Transaction exposure
FX Risk Management Transaction Exposure • Overview • The three major foreign exchange exposures • Foreign exchange transaction exposure • Pros and cons of hedging foreign exchange transaction exposure • Alternatives of managing significant transaction exposure • Practices and concerns of foreign exchange risk management
Foreign Exchange Exposure • Types of foreign exchange exposure • Transaction Exposure – measures changes in the value of outstanding financial obligations due to exchange rate changes • Operating Exposure – also called economic exposure, measures the change in the present value of the firm resulting from any change in expected future operating cash flows caused by an unexpected change in exchange rates • Translation Exposure – also called accounting exposure , is the changes in owner’s equity because of the need to “translate” financial statements of foreign subsidiaries into a single reporting currency for consolidated financial statements • Tax Exposure – as a general rule only realized foreign losses are deductible for purposes of calculating income taxes
Foreign Exchange Exposure Moment in time when exchange rate changes Time Accounting exposure Changes in reported owners’ equity in consolidated financial statements caused by a change in exchange rates Operating exposure Change in expected future cash flows arising from an unexpected change in exchange rates Transaction exposure Impact of settling outstanding obligations entered into before change in exchange rates but to be settled after change in exchange rates
Why Hedge - the Pros & Cons • Opponents of hedging give the following reasons: •
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