International Financial Management

Abridged 10th Edition

by Jeff Madura

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 12
Managing Economic Exposure and Translation
Exposure
Chapter Objectives
This chapter will:

A. Explain how an MNC’s economic exposure can be hedged

B. Explain how an MNC’s translation exposure can be hedged

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 Managing Economic Exposure

1. Definition: economic exposure represents the impact

of exchange rate fluctuations on a firm’s future cash
flows.
2. Assessing economic exposure
3. Restructuring to reduce economic exposure, e.g.:
a. Increase sensitivity of revenues to exchange rate movements
b. Decrease sensitivity of expenses to exchange rate movements

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 Issues Involved in the Restructuring
Decision

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 Exhibit 12.4 Hedging Economic Exposure

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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 A Case on Hedging Economic Exposure:
Savor Co., a U.S. firm with exposure to the Euro
1. Assessment of economic exposure: assess the
relationship between the euro’s movement and each
unit’s cash flows over last 9 quarters.
a. Assessment of each unit’s exposure using regression analysis
b. Identifying the source of each unit’s exposure
2. Possible strategies to hedge economic exposure:
a. Pricing policy
b. Hedging with forward contracts
c. Purchasing foreign supplies
d. Financing with foreign funds
e. Revising operations of other units

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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 A Case on Hedging Economic Exposure:
Savor Co., a U.S. firm with exposure to the Euro
1. Savor’s Hedging Solutions: instruct other units to do
their financing in Euros as well
2. Limitations of Savor’s Optimal Hedging Strategy:
impact of Euro’s movements on Savor’s cash
outflows is known with certainty but impact on cash
inflows is uncertain.

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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Hedging Exposure to Fixed Assets

1. Hedging the sale of fixed assets by:

a. Selling the currency forward in long-term forward contract
b. Creating a liability in that currency that matches the expected
value of the assets in the future.
2. Limitations of hedging the sale of fixed assets:
a. MNC may not know the date when it will sell the assets
b. MNC may not know the price in the local currency at which
it will sell them.

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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Managing Translation Exposure

1. Translation exposure occurs when an MNC translates

each subsidiary’s financial data to its home currency
for consolidated financial statements.
2. Hedging with forward contracts
3. Limitations of hedging translation exposure:
a. Inaccurate earnings forecasts
b. Inadequate forward contracts for some currencies
c. Accounting distortions
d. Increased transaction exposure

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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.