c h a p t e r 12 managing economic exposure and translation exposure

C H A P T E R 12C H A P T E R 12

Managing Economic Exposure Managing Economic Exposure and Translation Exposureand Translation Exposure

Chapter OverviewChapter Overview

A. Economic ExposureA. Economic Exposure

B. A Case Study in Hedging B. A Case Study in Hedging Economic Exposure Economic Exposure

C. Hedging Exposure to Fixed C. Hedging Exposure to Fixed AssetsAssets

D. Managing Translation ExposureD. Managing Translation Exposure

Chapter 12 ObjectivesChapter 12 Objectives

This chapter will:This chapter will:

A. Explain how an MNC’s economic A. Explain how an MNC’s economic exposure can be hedgedexposure can be hedged

B. Explain how an MNC’s translation B. Explain how an MNC’s translation exposure can be hedgedexposure can be hedged


1. Use of the Income Statement to 1. Use of the Income Statement to Assess Economic ExposureAssess Economic Exposure

2. How Restructuring Can Reduce 2. How Restructuring Can Reduce Economic Economic ExposureExposure

a. Expediting the Analysis with a. Expediting the Analysis with Computer SpreadsheetsComputer Spreadsheets


12.312.3

Economic Exposure Based on the Original and Proposed Operating Structures


3. Issues Involved in the Restructuring 3. Issues Involved in the Restructuring DecisionDecision• • Should the firm attempt to increase or Should the firm attempt to increase or reduce reduce sales in new or existing foreign sales in new or existing foreign markets?markets?

• • Should the firm increase or reduce its Should the firm increase or reduce its dependency on foreign suppliers?dependency on foreign suppliers?

• • Should the firm establish or eliminate Should the firm establish or eliminate production facilities in foreign markets?production facilities in foreign markets?

• • Should the firm increase or reduce its level Should the firm increase or reduce its level of debt denominated in foreign currencies?of debt denominated in foreign currencies?

B. A Case Study in Hedging B. A Case Study in Hedging Economic ExposureEconomic Exposure

1. Savor Co.’s Dilemma1. Savor Co.’s Dilemma

2. Assessment of Economic Exposure2. Assessment of Economic Exposure

3. Assessment of Each Unit’s Exposure3. Assessment of Each Unit’s Exposure

4. Identifying the Source of the Unit’s 4. Identifying the Source of the Unit’s Exposure Exposure


5. Possible Strategies to Hedge 5. Possible Strategies to Hedge Economic ExposureEconomic Exposure

a. Pricing Policya. Pricing Policy

b. Hedging with Forward Contractsb. Hedging with Forward Contracts

c. Purchasing Foreign Suppliesc. Purchasing Foreign Supplies

d. Financing with Foreign Fundsd. Financing with Foreign Funds

e. Revising Operations of other e. Revising Operations of other UnitsUnits


6. Savor’s Hedging Solutions6. Savor’s Hedging Solutions

7. Limitations of Savor’s Optimal 7. Limitations of Savor’s Optimal Hedging StrategyHedging Strategy

C. Hedging Exposure to Fixed C. Hedging Exposure to Fixed AssetsAssets

When an MNC has fixed assets (such as buildings or machinery) in a foreign country, the dollar cash flows to be received from the ultimate sale of the assets is subject to exchangerate risk.


1. Use of Forward Contracts to Hedge Translation 1. Use of Forward Contracts to Hedge Translation ExposureExposurea. use forward contracts or futures a. use forward contracts or futures

contracts to hedge translation exposurecontracts to hedge translation exposure

b. sell the currency forward that their foreign b. sell the currency forward that their foreign subsidiaries receive as earnings subsidiaries receive as earnings

c.c. Result: create a cash outflow in the Result: create a cash outflow in the currency currency to offset the earnings received in that to offset the earnings received in that

currencycurrency


2. Limitations of Hedging Translation 2. Limitations of Hedging Translation ExposureExposure

a. Inaccurate Earnings Forecastsa. Inaccurate Earnings Forecasts

b. Inadequate Forward Contracts b. Inadequate Forward Contracts for Some Currenciesfor Some Currencies

c. Accounting Distortionsc. Accounting Distortions

d. Increased Transaction Exposured. Increased Transaction Exposure

c h a p t e r 12 managing economic exposure and translation exposure

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