Week 12 Flashcards
What is economic exposure?
Any impact of exchange rate fluctuations on a firm’s future cash flows, a firm may have no transaction exposure but may still face economic exposure due to currency appreciation reducing demand from foreign customers.
If a MNC requires all transactions be in home currency does that remove transaction and economic exposure?
, if a MNC requires all transactions be in the home currency it does not remove transaction exposure as there may still be foreign loan payments, it also doesn’t remove economic exposure because changes in exchange rate may change our cash flowss.
Why is it useful for an MNC to measure its exposure to exchange rate movements?
MNC’s will measure their exposure to exchange rate movements, and use this information to manage their exposure, this will improve the MNC’S cash flow, reduce its cost of capital (reducing risk) and stabilise earnings (reducing risk). These factors will increase the MNC’s value.
What does economic exposure come from?
Economic exposure could come from financial and operating cash flows between parent and subsidiaries. The subsidiary may be concerned with their customers and supplies cost, an unexpected depreciation of the subsidiary currency will suddenly alter both the competitiveness of the subsidiary and the financial results consolidated with the parent.
How can we deal with depreciation in a subsidiary currency?
Sales price could be kept constant relative to foreign currency, subject to demand elasticity, the firm costs will increase due to raw material import costs, and inflation. The depreciation will increase demand for the subsidiary products, increasing sales volume.
What happens if the subsidiary currency depreciates and we don’t change our marketing strategy?
There will be reduced cash flow to the parent company. If the depreciation increases sales volume however, this may lead to an increase in value. If we increase the sales price it could also increase profits, a reasonable sales price could be derived from old price * new exchange rate.
How do we manage our operating exposure via operations and financing?
This can be done by diversifying operations via things like marginal shifts in sourcing, we could lengthen(if home currency depreciates ) or shorten (if home currency appreciates) our production runs in different countries, marketing in price competitive export markets, or by shifting production and sales to take advantage of changes in currency values.
We could also diversify financing, diversifying our risk due to high borrowing costs, domestic business cycles affecting future cash flows, government borrowing competition in capital markets, expropriation, war, blocked funds, and law changes, diversification in these cases can be done by diversifying internationally.
If economies of scale restrict production to an area then we can only diversify sales and financing, if they are unable to attract international financing then they can just diversify their sales internationally.
How can we manage operating exposure management using operating policies?
retiming the transfer of funds, such as paying hard currency debts using soft currency early(leading), or paying soft currency debts using hard currency late(lag), or collecting soft foreign currency receivables early, and collecting hard foreign currency receivables late.
Governments tend to limit payment shifts to stop companies doing this.
We could also attempt to match currency cash flows, which is achieved by acquiring debt denominated in currency of long exposure, or take out back-to-back loans, and currency swaps.
What are the main factors that affect the restructuring of debt decision?
Will this increase or decrease sales in new or existing foreign markets? Will this increase or decrease dependency on foreign suppliers? WIll this increase or decrease our level of debt denominated in foreign currencies?
What are some strategies for hedging economic exposure?
Pricing policy, reducing the home currency price when the foreign currency depreciates to remain competitive with foreign currency imports. Hedging with forward contracts, purchasing of foreign supplies, financing with foreign funds, and revising operations of other units is also possible.
When does translation exposure occur?t
When the MNC translates each subsidiary’s financial data to its home currency for consolidated financial statements, the concern is that this can reduce the MNC’s consolidated earnings and hence impact share price. It can be hedged using a forward or futures contract, by selling the currency forward that the foreign subsidiary receives as earnings, hedging against currency depreciation, though this may intrace transaction exposure. If a subsidiary’s currency increases and the MNC takes a hedge strategy at the beginning of the year it will face transaction loss that will affect the translation gain.
What are limitations of hedging translation exposure?
Inaccurate earnings forecasts, inadequate forward contracts for some currencies, accounting distortions (translation fain or loss caused by change in average exchange rate over the period in which earnings are generated), and increased transaction exposure.
