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Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,*,*,*,Multinational Financial Management,Alan Shapiro7,th,Edition,J.Wiley&Sons,Power Points by,Joseph F.Greco,Ph.D.,California State University,Fullerton,1,CHAPTER 11,MEASURING AND MANAGING ECONOMIC EXPOSURE,2,CHAPTER OVERVIEW,I.FOREIGN EXCHANGE RISK AND ECONOMIC EXPOSURE,II.THE ECONOMIC CONSEQUENCES OF EXCHANGE RATE CHANGES,III.IDENTIFYING ECONOMIC EXPOSURE,IV.CALCULATING ECONOMIC EXPOSURE,V.AN OPERATIONAL MEASURE OF EXCHANGE RISK,VI.MANAGING OPERATING EXPOSURE,3,PART I.FOREIGN EXCHANGE RISK AND ECONOMIC EXPOSURE,I.FOREIGN EXCHANGE RISK,A.Economic exposure,focuses on the impact of currency,fluctuations on firms value.,1.Expectations about the fluctuation must be incorporated in all basic,decisions of the firm.,4,FOREIGN EXCHANGE RISK AND ECONOMIC EXPOSURE,2.Definitions:,a.Accounting exposure,impact on firms balance sheet,b.Economic exposure,1.)Transaction,2.)Operating,5,FOREIGN EXCHANGE RISK AND ECONOMIC EXPOSURE,THE REAL EXCHANGE RATE,6,FOREIGN EXCHANGE RISK AND ECONOMIC EXPOSURE,B.Real Exchange Rates and Risk,1.Nominal v.real exchange rates:,the real rate has been adjusted for price changes.,7,FOREIGN EXCHANGE RISK AND ECONOMIC EXPOSURE,3.SUMMARY,a.the economic impact of a currency change depends on the offset by the difference in inflation rates or the real exchange rate.,b.It is the relative price changes that ultimately determine a firms long-run exposure.,8,PART II.THE ECONOMIC CONSEQUENCES OF EXCHANGE RATE CHANGES,II.ECONOMIC CONSEQUENCES,A.Transaction exposure,1.On-balance sheet,2.Off-balance sheet,9,THE ECONOMIC CONSEQUENCES OF EXCHANGE RATE CHANGES,II.ECONOMIC CONSEQUENCES(cont),B.Operating Exposure:real rate change,1.Pricing flexibility is key,2.Product differentiation,3.Substitution of inputs,10,THE ECONOMIC CONSEQUENCES OF EXCHANGE RATE CHANGES,II.SUMMARY,The sector of the economy in which the,firm operates;,the sources of the firms inputs;,and,fluctuations in the real exchange rate,delineate the firms true economic,exposure.,11,PART III.IDENTIFYING ECONOMIC EXPOSURE,III.CASE STUDIES OF ECONOMIC EXPOSURE,A.ASPEN SKIING COMPANY,1.Firms exchange rate risk affected its sales revenues.,12,IDENTIFYING ECONOMIC EXPOSURE,A.ASPEN SKIING COMPANY(cont),2.Although there was no translation,risk,the global market with its exchange rate risk and its competitors impacted market demand.,13,IDENTIFYING ECONOMIC EXPOSURE,B.PETROLEOS MEXICANOS(PEMEX),1.The firms exchange rate risk,affected cost but not revenues.,2.Economic impact,a.Revenues:none,b.Costs:decreased,c.Net effect:increased US$flows,14,IDENTIFYING ECONOMIC EXPOSURE,C.TOYOTA MOTOR COMPANY,1.Exchange rate risk affected,BOTH,revenues and costs.,2.Flow back effect:,previously exported goods return,with increased domestic competition.,3.Lower profit margins domestically,15,PART IV.CALCULATING ECONOMIC EXPOSURE,IV.A quantitative assessment of economic,exposure depends on underlying assumptions concerning:,A.future cash flows;,B.sensitivity to exchange rate,changes.,16,PART V.AN OPERATIONAL MEASURE OF EXCHANGE RISK,V.NEED FOR A WORKABLE APPROACH,A.Regression Analysis,1.Variables,a.Independent:,changes in parents cash flows,b.Dependent:,Average nominal exchange rate change.,17,AN OPERATIONAL MEASURE OF EXCHANGE RISK,B.REGRESSION EQUATION,-approach based on the operational definition of the exchange risk faced by a parent or one of its affiliates:,-,a company faces exchange risk to the extent that variations in the dollar value of the units cash flows are correlated with variations in the nominal exchange rate,18,AN OPERATIONAL MEASURE OF EXCHANGE RISK,where CF,t,=CF,t,-CF,t-1,and,CF,t,is the dollar value of total affiliate(parent)cash flows in period t,EXCH,t,=EXCH,t,-EXCH,t-1,equals the average nominal exchange rate during period t,u =a random error term,19,AN OPERATIONAL MEASURE OF EXCHANGE RISK,1.Output measures:,a.Beta coefficient(,b),measures the association of changes in cash flows to exchange rate changes.,20,AN OPERATIONAL MEASURE OF EXCHANGE RISK,b.the higher the percentage change of cash flow to changes in exchange rates,the greater the economic exposure(higher beta values).,21,AN OPERATIONAL MEASURE OF EXCHANGE RISK,VI.SUMMARY:,A.The focus of the accounting profession on the balance sheet impact of currency changes has led to ignoring the important impact on future cash flows.,22,AN OPERATIONAL MEASURE OF EXCHANGE RISK,B.For firms incurring costs and selling products in foreign countries,the net effect of currency changes may be less important in the long run.,23,AN OPERATIONAL MEASURE OF EXCHANGE RISK,C.To measure exposure properly,you must focus on inflation-adjusted or real exchange rates instead of nominal or actual exchange rates.,24,AN OPERATIONAL MEASURE OF EXCHANGE RISK,D.It is difficult in practice to determine what the actual economic impact of a currency change will be.,25,PART VI.MANAGING OPERATING EXPOSURE,I.INTRODUCTION
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