FOREIGN EXCHANGE RISK AND ECONOMIC EXPOSURE by alicejenny

VIEWS: 2 PAGES: 26

									           Multinational Financial
                Management
                Alan Shapiro
                 9th Edition
              J.Wiley & Sons




Power Points by
Joseph F. Greco, Ph.D.
California State University, Fullerton
       CHAPTER 11


Measuring and Managing
Economic Exposure
         FOREIGN EXCHANGE RISK
         AND ECONOMIC EXPOSURE

    I.     FOREIGN EXCHANGE RISK
           A. Economic exposure
              focuses on the impact of currency
              fluctuations on firm’s value
              1 . The most important aspect of
                  foreign exchange risk management:
                  Incorporate expectations about the
                  risk into all basic decisions of the
                  firm

3
    FOREIGN EXCHANGE RISK AND
    ECONOMIC EXPOSURE

      2. Definition:
         Economic exposure =Transaction exposure +Operating exposure


         Operating exposure:
         arises because currency fluctuations alter a
         company’s future revenues and expenses




4
    FOREIGN EXCHANGE RISK AND
    ECONOMIC EXPOSURE

     To measure operating exposure requires a longer-
     term perspective.

     i.e. Cost and price competitiveness could be
     affected by exchange rate changes




5
    FOREIGN EXCHANGE RISK AND
    ECONOMIC EXPOSURE

     Operating Exposure begins:
     the moment a firm starts to invest in a market subject
     to foreign competition or in sourcing goods or inputs
     abroad




6
    FOREIGN EXCHANGE RISK AND
    ECONOMIC EXPOSURE

    The new investment includes:
         New product development
         A distribution network
         Brand name development
         Marketing
         Foreign supply contracts
         Production facilities


7
    FOREIGN EXCHANGE RISK AND
    ECONOMIC EXPOSURE

     B. Real Exchange Rates Changes and
        Risk
         Nominal v. real exchange rates:
         real rate has been adjusted for
         price changes.




8
    FOREIGN EXCHANGE RISK AND
    ECONOMIC EXPOSURE

     C. Implications
       1. If nominal rates change with an equal
          price change, no alteration to cash
          flows

       2. If real rates change, it causes relative
          price changes and changes in purchasing
          power


9
     FOREIGN EXCHANGE RISK AND
     ECONOMIC EXPOSURE

      A decline in the real value of a currency:
       makes exports and import-competing goods more
       competitive
       An appreciating currency makes:
       imports and export-competing goods more
       competitive




10
     FOREIGN EXCHANGE RISK AND
     ECONOMIC EXPOSURE

     During an appreciation of home currencies:
          Exporters face two choices:
          #1 keep prices constant (but lose sales)
                or
          #2 adjust prices to foreign currency to
             maintain market share (lose profits)




11
     FOREIGN EXCHANGE RISK AND
     ECONOMIC EXPOSURE

      3. SUMMARY
        a. the economic impact of a
           currency change depends on the
           offset by the difference in inflation
           rates or the change in real exchange
           rates
        b. It is the relative price changes that
           ultimately determine a firm’s long-run
           exposure

12
          THE ECONOMIC CONSEQUENCES OF
          EXCHANGE RATE CHANGES

     I.     ECONOMIC CONSEQUENCES
            The impact on Operating Exposure of a real rate
            change depends upon:
               Pricing flexibility and
               1. Price elasticity of demand
               2. Degree of product differentiation
               3. The Ability to shift production and
                   the substitution of inputs


13
     If HC Appreciates



     Pricing Flexibility is key



14
     If HC Appreciates

     Can the firm maintain its profit margins both at
     home and abroad?

           If price elasticity of demand is low, the more
           price flexibility a firm has
           i.e. Availability of good substitutes




15
     If HC Appreciates

     Product Differentiation
          price elasticity depends on the degree of
          differentiation

          The greater the differentiation, themore the firm
          can control its prices

          e.g. Mercedes Benz autos

16
     If HC Appreciates

      The Ability to Shift Production and to source
      inputs from other countries

         e.g. The lack of ability of Japanese car makers
               in the late 1980’s




17
     MANAGING OPERATING EXPOSURE

     I. INTRODUCTION
      Operating exposure management requires long-
      term operating adjustments and the involvement of all
      departments.




18
     MANAGING OPERATING EXPOSURE

     II. Marketing Strategy
          A. Market Selection:
             use competitive advantage to carve
             out market share when currency
             values change




19
     MANAGING OPERATING EXPOSURE

      B. Pricing strategy: Expectations are critical
         1. If HC depreciates, exporter gains competitive
            advantage by increasing unit profitability or
            market share
         2. The higher price elasticity of demand, the
            more currency risk the firm faces by other
            product substitution




20
     MANAGING OPERATING EXPOSURE

      C. Product Strategy
         exchange rate changes may alter
         1.    The timing of new product
               introductions
         2.    Product deletion
         3.    Product innovations




21
     MANAGING OPERATING EXPOSURE

     III.   Product Management Adjustments
            A.   Input mix “shop the world”
            B.   Shift production among plants
            C.   Plant relocation
            D.   Raising productivity




22
     MANAGING OPERATING EXPOSURE

     IV. Planning For Exchange-Rate Changes
       A. Develop contingency plans with plausible
          scenarios before the impact of a currency
          change makes itself felt
          e.g. flexible mfg systems




23
     MANAGING OPERATING EXPOSURE

     V. Financial Management of Exchange Rate
       Risk:
               Financial manager’s Role
               Structure the firm’s liabilities in such a
               way that the reduction in asset earnings is
               matched by corresponding decrease in
               cost of servicing liabilities.




24
     MANAGING OPERATING EXPOSURE

     A.   Provide local manager with
          forecasts of inflation and exchange-rate
          changes.

     B.   Identify and focus on competitive exposure.




25
     MANAGING OPERATING EXPOSURE

      C. Design the evaluation criteria
         so that operating managers neither rewarded or
         penalized for unexpected exchange-rate
         changes




26

								
To top