Consider the impact of a permanent 5 appreciation of

  • No School
  • AA 1
  • 109

This preview shows page 18 - 26 out of 109 pages.

Consider the impact of a permanent 5% appreciation of the US$, holding all other factors constant. The slope measures the exposure of the firm at the initial exchange rate.
Image of page 18
Empirical Evidence on Firm Profits, Share Prices, & Exchange Rates During the Bretton Woods pegged-rate period, the general stock market index tended to move up (down) immediately after a devaluation (revaluation) of the local currency. Studies also indicated that exposure coefficients vary from firm to firm within the same industry and over time, and that exchange rate changes can have a substantial impact on the overall economy.
Image of page 19
Arguments for Hedging Risks at the Corporate Level Shareholders may not favor hedging since they can select well-diversified portfolios to rid themselves of firm-specific risks. However, in view of transaction costs and taxes, hedging that reduces the volatility of cash flows may be favoured. If the tax credits of a firm which has incurred losses over several successive periods cannot be carried forward to reduce future tax payments, then another firm with a less volatile pattern of earnings will enjoy greater after-tax cash flows and a higher market value. A firm with more volatile cash flows is also more open to the costs of financial distress. For the same reasons, banks and bondholders will prefer firms with less volatile cash flows (holding average cash flows equal) and reward them with greater borrowing capacities and higher credit ratings.
Image of page 20
Financial Strategies Toward Risk Management An important step in the process of determining the appropriate financial hedging instruments for a firm is to analyze the nature of the firm’s currency cash flows .
Image of page 21
Financial Strategies Toward Risk Management Characteristics of Currency Exposure Suitable Financial Hedging Instruments Frequency of cash flows Single period Multiple periods Single contract (futures/options) Sets (“strips”) of contracts/swaps or present value hedge Currency dimension Single currency Multiple currencies Contracts on one currency Contracts on an index (ECU, US$) or synthetic hedge
Image of page 22
Financial Strategies Toward Risk Management Characteristics of Currency Exposure Suitable Financial Hedging Instruments Certainty about cash flows Certain, contractual cash flows Uncertain, estimated cash flows Naïve hedge to match contract size of financial instrument and exposure Option hedge or dynamic futures hedge to match probability of cash flows
Image of page 23
Financial Strategies Toward Risk Management Note that a hedging strategy may offset certain risks, while leaving open or increasing other risks .
Image of page 24
Policy Issues International Financial Managers Problems in Estimating Economic Exposure Using market data presumes that financial markets are efficient, and that share prices respond quickly and appropriately to exchange rate changes.
Image of page 25
Image of page 26

You've reached the end of your free preview.

Want to read all 109 pages?

  • Fall '19
  • Trident

What students are saying

  • Left Quote Icon

    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.

    Student Picture

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

  • Left Quote Icon

    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.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    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.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern

Ask Expert Tutors You can ask You can ask ( soon) You can ask (will expire )
Answers in as fast as 15 minutes