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managing economic explosure & translational explosure

managing economic explosure & translational explosure

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Published by karan_tiff

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Published by: karan_tiff on May 15, 2010
Copyright:Attribution Non-commercial


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Managing Economic ExposureAnd Translation Exposure
What Does
 Economic Exposure
An exposure to fluctuating exchange rates, which affects a company'searnings, cash flow and foreign investments. The extent to which a
company is affected by economic exposure depends on the specificcharacteristics of the company and its industry.
 Economic Exposure
Most large companies attempt to minimize the risk of fluctuatingexchange rates by hedging with positions in the forex market.Companies that do a lot of business in many countries, such asimport/export companies, are at particular risk for economic liabilitiesor income in a foreign currency.exposure.
What Does
Translation Exposure
The risk that a company's equities, assets, liabilities or income willchange in value as a result of exchange rate changes. Thisoccurs when a firm denominates a portion of its equities, assets,
To explain how an MNC’s economic exposure can be hedged;and
To explain how an MNC’s translation exposure can be hedged.
The economic impact of currency exchange rates on us is complex because such changes are often linked to variability in real growth,inflation, interest rates, governmental actions, and other factors.These changes, if material, can cause us to adjust our financing and operating strategies.
Use of the Income Statement to an MNC can determine itsexposure by assessing the sensitivity of its cash inflows andoutflows to various possible exchange rate scenarios.
The MNC can then reduce its exposure by restructuring itsoperations to balance its exchange-rate-sensitive cash flows.Note that computer spreadsheets are often used to expedite theanalysis Assess Economic ExposureManagingMadison Inc.’s Economic Exposure
Madison’s earnings before taxes is inversely related to theCanadian dollar’s strength, since the higher expenses morethan offset the higher revenue when the Canadian dollarstrengthens.Madison may reduce its exposure by increasing Canadian sales,reducing orders of Canadian materials, and borrowing less inCanadian dollars
How Restructuring Can Restructuring to reduce economicexposure involves shifting the sources of costs or revenue toother locations in order to match cash inflows and outflows inforeign currencies.
The proposed structure is then evaluated by assessing thesensitivity of its cash inflows and outflows to various possibleexchange rate scenarios.
Reduce HedgWhen an MNC has fixed assets (such as buildingsor machinery) in a foreign country, the cash flows to bereceived from the sale of these assets is subject to exchangerate risk.
A sale of fixed assets can be hedged by creating a liability thatmatches the expected value of the assets at the point in thefuture when they will be sold.Exposure to Fixed Assets Economic Exposure
Translation exposure results when an MNC translates eachsubsidiary’s financial data to its home currency forconsolidated financial reporting.Translation exposure does not directly affect cash flows, but somefirms are concerned about it because of its potential impact onreported consolidated earningsslation ExposureUse of Forward Contracts to Hedge Translation ExposureTo hedge translation exposure, forward or futures contracts can beused. Specifically, an MNC may sell the currency that its foreignsubsidiary receive as earnings forward, thus creating an offsettingcash outflow in that currencyUse of Forward Contracts to Hedge Translation Exposure

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