Professional Documents
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10
Measuring Exposure To Exchange Rate Fluctuations
Chapter Objectives
To discuss the relevance of an MNCs exposure to exchange rate risk; To explain how transaction exposure can be measured; To explain how economic exposure can be measured; and To explain how translation exposure can be measured.
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by price movements.
PPP does not necessarily hold.
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corporate exposure. They have the capabilities to correctly and efficiently insulate their individual exposure too.
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somewhat insulated against losses experienced by an MNC due to exchange rate risk.
Many MNCs are similarly affected by
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Types of Exposure
Although exchange rates cannot be
forecasted with perfect accuracy, firms can at least measure their exposure to exchange rate fluctuations.
Transaction Exposure
The degree to which the value of future
cash transactions can be affected by exchange rate fluctuations is referred to as transaction exposure.
in each currency, and measure the potential impact of the exposure to those currencies.
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Euro
Japanese Yen
Swedish Krona
.35
.91 .71 .83
1.00
.48 .12 .57 1.00 .67 .92 1.00 .64 1.00
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Japanese Yen
Swedish Krona
+Q
+Q
+Q
+Q +Q
+Q
+Q Q
Slightly positive
Negative Highly positive
Moderate
Low Low
+Q
+Q
Q
Q
Slightly positive
Negative
Moderate
High
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Transaction Exposure
The value-at-risk (VAR) method makes use
of currency volatility and correlations to determine the potential maximum one-day loss on the value of an MNCs positions.
Transaction Exposure
The VAR method can also be used to
assess exposure to multiple currencies and over longer time horizons.
Economic Exposure
Economic exposure refers to the degree to
which a firms present value of future cash flows can be influenced by exchange rate fluctuations.
No change
No change
Decrease
Decrease
Increase
Increase
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Economic Exposure
Economic exposure can be measured by
assessing the sensitivity of the firms earnings to exchange rates. This involves reviewing how the earnings forecast in the firms income statement changes in response to alternative exchange rate scenarios.
Economic Exposure
Economic exposure can also be measured
by assessing the sensitivity of the firms cash flows to exchange rates through regression analysis.
Economic Exposure
The model may be revised to handle
additional currencies by including them as additional independent variables.
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Translation Exposure
The exposure of an MNCs consolidated
financial statements to exchange rate fluctuations is known as translation exposure.
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consolidated reporting purposes does not by itself affect an MNCs cash flows.
However, a weak spot rate today may result
in a weak exchange rate forecast (and hence a weak expected cash flow) for the point in the future when subsidiary earnings are to be remitted.
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its consolidated earnings and many investors tend to use earnings when valuing firms, the MNCs valuation may be affected.
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Translation Exposure
An MNCs degree of translation exposure
is dependent on:
the proportion of its business conducted by
foreign subsidiaries,
the locations of its foreign subsidiaries,
and
the accounting methods that it uses.
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Translation Exposure
In the 20002001 period, the weakness of
the euro caused several U.S.-based MNCs to report lower earnings than what they had expected.
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