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International Banking and Trade Finance. Chpt 12. Managing Economic Exposure and Translation Exposure . Chapter 12. Exchange Rate Exposure. Reminder: There are 3 forms by which a MNC is exposed to exchange rate fluctuations 1. Transaction exposure 2. Economic Exposure - Chapter 12

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Presentation Transcript
slide1

International Banking

and Trade Finance

Chpt

12

exchange rate exposure
Exchange Rate Exposure

Reminder: There are 3 forms by which a MNC is exposed to exchange rate fluctuations

  • 1. Transaction exposure
  • 2. Economic Exposure - Chapter 12
  • 3. Translation Exposure
slide4
Economic Exposure
  • is essentially the fact that the cash flows of the MNCs are sensitive to exchange rate movements
  • if the exchange rate goes up, or down, usually this is caused by economic circumstances in the particular country - this is why we call it Economic Exposure
managing economic exposure
Managing Economic Exposure
  • Economic exposure
    • any impact of exchange rate fluctuations on future cash flows
      • affect cash flows in manner not associated with currency transactions
    • an MNC would examine how all cash flow is affected by exchange rate movement
slide6
Transaction Exposure
  • is the fact that you have to make conversions of the currency into foreign currency for some parts of the intl business
  • Economic Exposure
  • is the fact that once you make that conversion - the currency could go up or down - and give you advantages or disadvantages
sometimes hedging is not relevant
Sometimes Hedging isnot relevant
  • “Corporate cash flows can sometimes be effected by exchange rate movements in ways not directly associated with foreign exchange transactions”
  • “Thus firms cannot JUST focus on hedging - they have to determine how cash flows will be affected
managing economic exposure8
Managing Economic Exposure
  • Example: British Laker Airlines
  • What happened?
  • Revenues generated in pounds
  • large amount of expenses in dollars
  • when dollar strengthens, expenses creep up
  • bank loan also denominated in dollars

Laker went bankrupt

managing economic exposure9
Managing Economic Exposure
  • Assessing economic exposure
    • examine sensitivity of revenues and costs to exchange rate fluctuation
      • an imbalance between costs and revenues creates higher exposure level
    • determine sensitivity of earnings to exposure
restructuring
Restructuring

Page 378

  • You can increase advertising costs and hope to increase sales
  • you can borrow money from one country, to pay back loans in another
economic exposure
Economic Exposure

Measuring exposure for US MNC Y

  • US firm with subsidiary in Japan
    • most revenue raised in the US dollars
    • most costs occur in Japanese yen
    • most borrowing occurs in Japan
      • a currency imbalance exists between costs and revenues
    • Income statement becomes sensitive to currency fluctuations
economic exposure12
Economic Exposure

Measuring exposure for US MNC Y

  • Income statement becomes sensitive to currency fluctuations
    • effect of currency imbalance among costs and revenues

Net earnings

Costs

Revenues

economic exposure13
Economic Exposure

Measuring exposure for US MNC Y

  • Impact if yen were to strengthen
    • increases MNC Y’s production costs
    • increases MNC Y’s interest expenses
    • decreases net earnings

Costs

Net earnings

economic exposure14
Economic Exposure

Measuring exposure for US MNC Y

  • Response to a strong yen over time
    • MNC Y may change emphasis of the two sites
      • increase Japanese revenue
      • shift costs to US
    • attempt to reduce effect of currency imbalance
analysis with computer spreadsheets
Analysis with Computer Spreadsheets
  • Allows you to understand the results of different scenarios because you can plug in the different exchange rate changes - and see the subsequent results

Page 380

when deciding to restructure
When Deciding to Restructure

One must address the following questions

Each of these 4 questions is important because they reflect a different part of the firm’s income statement

when deciding to restructure17
When Deciding to Restructure

One must address the following questions

  • Should the firm attempt to increase or decrease sales
  • Should the firm increase or decrease its dependency on foreign suppliers
when deciding to restructure18
When Deciding to Restructure

the following questions, , , ,

  • Should the firm establish or eliminate production facilities
  • Should the firm increase or reduce its level of debt denominated in foreign currencies
slide19
By making cars in the U.S.A., they pay for parts in dollars, and sell the cars for dollars, and pay employees in dollars,
  • so if dollars change in respect to Yen, it doesn’t mean much cause very little has to be paid for in Yen, and very little goes back to Japan in Yen
summary
Summary
  • Economic exposure
    • balances sensitivity of revenues and expenses to exchange rate fluctuations