Outline three types of exposure how to measure

• No School
• AA 1
• 109

This preview shows page 32 - 40 out of 109 pages.

Outline Three Types of Exposure How to Measure Economic Exposure Operating Exposure: Definition An Illustration of Operating Exposure Determinants of Operating Exposure Managing Operating Exposure
Economic Exposure Exchange rate risk as applied to the firm’s competitive position. Extent to which the value of the firm is affected by unanticipated changes in ERs Transaction Exposure Exchange rate risk as applied to the firm’s home currency cash flows. Sensitivity of “realized” domestic currency values of the firm’s contractual CFs denominated in foreign currencies to unexpected ER changes Translation Exposure Exchange rate risk as applied to the firm’s consolidated financial statements. Potential that the firm’s consolidated financial statements can be affected by changes in ERs. Three Types of Exposure
Economic Exposure Changes in exchange rates can affect not only firms that are directly engaged in international trade but also purely domestic firms. Consider a Canadian bicycle manufacturer who sources and sells only in Canada. Since the firm’s product competes against imported bicycles it is subject to foreign exchange exposure .
Channels of Economic Exposure Operating exposure Firm Value Home currency value of assets and liabilities Future operating cash flows Exchange rate fluctuations Asset exposure
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 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.
How to Measure Economic Exposure If a Canadian 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 + bS + e Where a is the regression constant e is the random error term with mean zero. The regression coefficient b measures the sensitivity of the dollar value of the assets ( P ) to the exchange rate, S Exposure is the regression coefficient b.
How to Measure Economic Exposure The exposure coefficient, b , is defined as follows: Where Cov( P,S ) is the covariance between the dollar value of the asset and the exchange rate, and Var( S ) is the variance of the exchange rate. Cov( P,S ) Var( S ) b =
Example Suppose a Canadian firm has an asset in Britain whose local currency price is random. For simplicity, suppose there are only three states of the world and each state is equally likely to occur.

You've reached the end of your free preview.

Want to read all 109 pages?

• Fall '19
• Trident

What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern