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Economic Exposure. Changes in the exchange rate can affect the competitiveness of both MNCs and purely “domestic” businesses. How Changing FX Rates can Affect Firm Value.

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economic exposure

Economic Exposure

Changes in the exchange rate can affect the competitiveness of both MNCs and purely “domestic” businesses.

slide3

This study measures industry stock market performance against over-all market performance and the US$ fx rate for USA firms.

slide4

Statistical Review

* We are going to want to measure the sensitivity of business performance to changes in the exchange rate.

* These coefficients are also known as “betas”.

slide6

Example of Economic (Asset Exposure)

Case 1: When UK£ gets stronger, internationally, local UK£ prices go up.

Case 2: When UK£ gets stronger, internationally, local UK£ prices go fall.

Case 3: When UK£ gets stronger, internationally, local UK£ prices stay same.

imperfect forward hedging
Imperfect Forward Hedging
  • Only when there is no local price risk (Case 3) is perfect forward hedging possible.
  • To continue with example
    • Assume forward rate F( ) is $1.50/£.
    • Sell £ forward: contract size equal to beta (Case 1: £1,700; Case 3: £1,000).
    • Win/Lose forward contract size x $(F – S).
slide9

Example (cont.): Imperfect Benefits of Forward Hedge

Only when FX risk is the ONLY risk can a currency hedge reduce ALL the risk!

operating exposure example
Operating Exposure: Example
  • USA computer company with UK subsidiary “Albion”.
  • Albion makes and sells computers in the UK.
  • Albion imports computer chips from Intel (USA) for $512 (currently £320, part of variable costs).
  • Current sport rate $1.60/£.
  • Tax rate in UK = 50%.
example cont
Example (cont.)
  • Now, suppose sterling falls in value from $1.60/£ to $1.40/£. (*Computer chips now cost £366 each).
  • Competitive Effect: Weaker pound may effect Albion’s competitive position.
  • Conversion Effect: A given £ cash flow will be worth less in $ to the USA parent .
slide14

Example (cont.): CASE 1. Nothing changes except the price of the imported computer chips.

* Albion is assumed NOT to be able to raise prices due to UK competition.

slide15

Example (cont.): CASE 2. Albion is able to raise the price of its computers in response to the increase in the price of the imported computer chips.

slide16

Example (cont.): CASE 3. Albion is able to raise the price of its computers in response to the increase in the price of the imported computer chips and local input prices, but loses some customers.

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