Economic Exposure The extent to which the value of the firm will change on account of a change in exchange rates. Such exposure may arise from two sources Transaction Exposure due to gains or losses on foreign currency denominated contracts. Operating Exposure due to changes in future revenues and/or costs. Can a US company that solely uses US production and US raw materials and sells only to US consumers be exposed to foreign exchange operating exposure? Real Exchange Rate change vs Nominal Exchange Rate change If PPP holds true, the nominal rate changes with inflation but real exchange does not. Assuming that all costs and revenues of the multinational company rise equally at the rate of inflation, then a change in the nominal without a change in the real does not alter the competitive position of domestic or foreign firm. Example: Apex Spain sells medical imaging devices in Spain and headquarters in US. Current Exchange Rate = $0.01 / Peseta Cost of producing one unit = 40,000 Pta = $400 Sales price = 100,000 Pta = $1000 Profit Margin = 60,000 Pta = $600 Say inflation in Spain = 20% in next year and 0% in US. If PPP holds, what will be new exchange rate in terms of $/Pta? New Sales price = 1.20 * 100,000 = 120,000 New Cost = 1.2 * 40,000 = 48,000 New Profit Margin = 72,000 Pta = ? $ Since PPP does not hold in the short run, an appreciation of the real value of a currency does hurt the exporters as well as industries competing with imports Eg. Swiss watch makers could not raise price in US but dollar cost of Swiss watch manufacture was rising. Yen went from 240Yen/$ to 90Yen/$ from 1985 – 1995. This appreciation was much more than what was warranted by the difference in inflation rates. Industrias Penoles, a Mexican firm that refines silver, increased profits by more than 200% when Mexican peso devauled in 1982 and also in 1995 when there was a devaluation. Costs denominated in pesos were constant. Revenues determined by intl price silver, not affected by value of peso. Devaluation of Thai Baht in 1997 Delta Electronics: Share price increased dramatically after devaluation (increase both in $ terms and Baht terms) Thai Petrochemical Industries – share price dropped by 50% after devaluation? Why? Aspen skiing company – operates ski resorts in Colarado Rockies, buys supplies in $, uses American labor .., guests pay in $. How would it be affected by value of $? Petroleos Mexicanos (Pemex): Largest company in Mexico – oil company in exploration, drilling and production. Costs – are they domestic or international? If all the oil is sold abroad, is there significant exchange rate risk? If all oil is sold in Mexico, is there significant exchange rate risk?
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