Outline three types of exposure how to measure

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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
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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
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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 .
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Channels of Economic Exposure Operating exposure Firm Value Home currency value of assets and liabilities Future operating cash flows Exchange rate fluctuations Asset exposure
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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.
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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.
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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 =
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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.
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