Types of Exposure

Question 1

Translation Exposure

Answer 1

Accounting Exposure
Assets and liabilities dominated in foreign currency
Consolidation of the foreign subsidiary accounts into domestic home currency (only MNCs)
Observed at Pernod Ricard
Glaum 1990 describes this as purely of a paper nature
Book value not real value
Governed by accounting standards
Different translation methods give different exposures
Examples are current/non current or monetary/non monetary
Manipulation

Question 2

Transaction Exposure

Answer 2

A cash flow exposure
Short term economic exposure
The exposure of the companies payables and receivables to changes in exchange rates
Unfavourable changes at the time of receipt
Example Lakers

Question 3

Economic Exposure

Answer 3

A cash flow exposure
Also known as operating exposure
How changes in the exchange rate affect the competitive environment of a firm
Revenues and costs and therefore profits
This therefore applies to MNCs and purely domestic
Example of US car manufacturer
Glaum 1990 says this is consistent with the primary objective of the firm
Some say translation and transaction fall into this

Question 4

Why would a firm be concerned about these types of exposure?

Answer 4

Extent of worry depends on degree of assessment of exposure and risk aversion.
BMW
Netflix

Question 5

Explain what internal and external hedging means and describe the different techniques a multinational could employ in each strategy.

Answer 5

Internal - leading/lagging, netting, matching, pricing policy, asset and liability management
External - contractual relationships outside the firm
Forward/futures, options, swaps, money market

Question 6

Forward/Futures

Answer 6

Buy (Sell) foreign currency payables (receivables)

Question 7

Option

Answer 7

Call (Put) against foreign currency payables (receivables)

Question 8

Money market hedge

Answer 8

Borrow (lend) receivables (payables) 
If IRP holds then MM = forward contract
Both based on interest rate differentials
Spot is adjusted for IRD= forward
Expect S @ T = F @ t for maturity @ T

Question 9

Cross Hedge

Answer 9

Hedging minor currencies
Illiquid, very costly or impossible such as Thai Baht
Aggarwal (1997) says Japanese Yen is appropriate for hedging Thai Baht, Philippine Peso, Korean Won
Strength and stability of correlation

Question 10

Forward vs Futures

Answer 10

OTC v Exchange Traded
Customisable v Standardised
Credit risk
Settlement @ maturity v Daily Settlement