InternationalFinancialManagement4国际财务管理课件.pptx

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1、1Chapter 4Measuring Exposure ToExchange Rate Fluctuations2Objectives This chapter distinguishes among three forms by which MNCs are exposed to exchange rate risk: (1) transaction exposure, (2) economic exposure, and (3) translation exposure. Each firm differs in degree of exposure. A firm should be

2、able to measure its degree of each type of exposure as described in this chapter. Then, it can decide how to cover that exposure using methods described in the following two chapters. The specific objectives are to:3Objectives discuss the relevance of an MNCs exposure to exchange rate risk; explain

3、how transaction exposure can be measured; explain how economic exposure can be measured; explain how translation exposure can be measured.4Is Exchange Rate Risk Relevant?Purchasing Power Parity ArgumentExchange rate movements will be matched by price movements.PPP does not necessarily hold.5Is Excha

4、nge Rate Risk Relevant?The Investor Hedge ArgumentMNC shareholders can hedge against exchange rate fluctuations on their own.The investors may not have complete information on corporate exposure. They may not have the capabilities to correctly insulate their individual exposure too.6Is Exchange Rate

5、 Risk Relevant? Currency Diversification ArgumentAn MNC that is well diversified should not be affected by exchange rate movements because of offsetting effects.This is a naive presumption.7Is Exchange Rate Risk Relevant?Stakeholder Diversification ArgumentWell diversified stakeholders will be somew

6、hat insulated against losses experienced by an MNC due to exchange rate risk.MNCs may be affected in the same way because of exchange rate risk.8Is Exchange Rate Risk Relevant?Response from MNCs Many MNCs have attempted to stabilize their earnings with hedging strategies, which confirms the view tha

7、t exchange rate risk is relevant.9Types of Exposure Although exchange rates cannot be forecasted with perfect accuracy, firms can at least measure their exposure to exchange rate fluctuations. Exposure to exchange rate fluctuations comes in three forms: Transaction exposure Economic exposure Transla

8、tion exposure10Transaction Exposure The degree to which the value of future cash transactions can be affected by exchange rate fluctuations is referred to as transaction exposure. To measure transaction exposure:project the net amount of inflows or outflows in each foreign currency, anddetermine the

9、 overall risk of exposure to those currencies.11Transaction Exposure MNCs can usually anticipate foreign cash flows for an upcoming short-term period with reasonable accuracy. After the consolidated net currency flows for the entire MNC has been determined, each net flow is converted into either a p

10、oint estimate or a range of a chosen currency, so as to standardize the exposure assessment for each currency. (Example：P248)12Transaction Exposure An MNCs overall exposure can be assessed by considering each currency position together with the currencys variability and the correlations among the cu

11、rrencies. The standard deviation statistic on historical data serves as one measure of currency variability. Note that currency variability levels may change over time.13Transaction Exposure The correlations among currency movements can be measured by their correlation coefficients, which indicate t

12、he degree to which two currencies move in relation to each other. coefficientperfect positive correlation 1.00no correlation 0.00perfect negative correlation -1.0014Transaction Exposure The point in considering correlations is to detect positions that could somewhat offset each other. For example, i

13、f currency X and Y are highly correlated, the exposures of a net X inflow and a net Y outflow will offset each other to a certain degree. Note that the correlations among currencies may change over time.15Transaction Exposure A related method, the value-at-risk (VAR) method, incorporates currency vo

14、latility and correlations to determine the potential maximum one-day loss. Historical data is used to determine the potential one-day decline in a particular currency. This decline is then applied to the net cash flows in that currency.16Transaction Exposure Example: Pitt, Inc., a U.S.-based MNC, ty

15、pically has receivables in Japanese yen. It first determines the maximum potential one-day decline in the yen that would be likely using a recent historical period such as 90 days. Pitt then applies that potential decline to its receivables to determine the potential loss in the dollar value of its

16、receivables if that decline in the yen does occur.17Transaction Exposure If Pitt has other positions in yen ( such as a Japanese subsidiary), it will also determine the potential reduction in value of those positions due to a maximum one-day decline In the yens value. By aggregating these effects, P

17、itt can determine how its value could be affected by a maximum one-day loss in the value of the yen. By repeating this process, the company can determine how its value could be affected by a maximum loss in the yen over a different time horizon, such as a 7-day or 30-day horizon.18Transaction Exposu

18、re If MNCs are exposed to more than one currency, they may apply the VAR method to a currency portfolio.19Economic Exposure Economic exposure refers to the degree to which a firms present value of future cash flows can be influenced by exchange rate fluctuations. Cash flows that do not require conve

19、rsion of currencies do not reflect transaction exposure. Yet, these cash flows may also be influenced significantly by exchange rate movements.20Economic Exposure Even purely domestic firms may be affected by economic exposure if there is foreign competition within the local markets. MNCs are likely

20、 to be much more exposed to exchange rate fluctuations. The impact varies across MNCs according to their individual operating characteristics and net currency positions.21Economic Exposure One measure of economic exposure involves classifying the firms cash flows into income statement items, and the

21、n reviewing how the earnings forecast in the income statement changes in response to alternative exchange rate scenarios.22Economic Exposure Example: Madison, Inc., is a U.S.-based MNC that conduct a portion of its business in Canada. Its U.S. sales are denominated in U.S. dollars, while its Canadia

22、n sales are denominated in Canadian dollars. Its pro forma income statement for next year is shown in the following exhibit. The income statement items are segmented into those for the United States and for Canada. Assume that Madison desires to assess how its income statement items would be affecte

23、d by three possible exchange rates scenarios for the Canadian dollar over the period of concern: (1) $.75, (2)$.80, (3) $.85. These scenarios are separately analyzed in the exhibit.23Economic Exposure Impact of Possible Exchange Rate Movements on Earnings of Madison, Inc. (in Millions) Exchange Rate

24、 Scenario C$ = $.75 C$ = $.80 C$ = $.85 Sales: (1) U.S. $300.00 $304.00 $307.00 (2) Canadian C$4 = 3.00 C$4 = 3.20 C$4 = 3.40 (3) Total $303.00 $307.20 $310.40 Cost of goods sold: (4) U.S. $ 50.00 $ 50.00 $50.00 (5) Canadian C$200 = 150.00 C$200= 160.00 C$200 = 170.00 (6) Total $200.00 $210.00 $220.

25、00 (7) Gross Profit $103.00 $ 97.20 $ 90.40 Operating expenses: (8) U.S.: Fixed $ 30.00 $ 30.00 $ 30.00 (9) U.S. Variable(10% of total sales) 30.30 30.72 31.04 (10) Total 60.30 60.72 61.04 (11) EBIT $ 42.70 $ 36.48 $ 29.36 Interest expense: (12) U.S. $ 3.00 $ 3.00 $ 3.00 (13) Canadian C$ 10 = 7.50 C

26、$10 = 8.00 C$ 10 = 8.50 (14) Total $ 10.50 $ 11.00 $ 11.50 (15) EBT $ 32.20 $ 25.48 $ 17.8624Economic Exposure Conclusion: Madison, Inc., would be adversely affected by a strong Canadian dollar. *In general, firms with more foreign costs than revenues will be unfavorably affected by stronger foreign

27、 currencies.25Economic Exposure Another method of assessing a firms economic exposure involves applying regression analysis to historical cash flow and exchange rate data.26Economic ExposurePCFt = a0 + a1et + tPCFt= % change in inflation-adjusted cash flows measured in the firms home currency over p

28、eriod t et= % change in the currency exchange rate over period t t= random error term a0= intercept a1= slope coefficient27Economic Exposure The regression model may be revised to handle multiple currencies by including them as additional independent variables, or by using a currency index (composit

29、e). By changing the dependent variable, the impact of exchange rates on the firms value (as measured by its stock price), earnings, exports, sales, etc. may also be assessed.28Translation Exposure The exposure of the MNCs consolidated financial statements to exchange rate fluctuations is known as tr

30、anslation exposure. In particular, subsidiary earnings translated into the reporting currency on the consolidated income statement are subject to changing exchange rates.29Translation ExposureDoes Translation Exposure Matter? Cash Flow Perspective * Translating financial statements for consolidated

31、reporting purposes does not by itself affect an MNCs cash flows. * However, a weak foreign currency today may result in a forecast of a weak exchange rate at the time subsidiary earnings are actually remitted.30Translation ExposureDoes Translation Exposure Matter? Stock Price Perspective - Since an

32、MNCs translation exposure affects its consolidated earnings and many investors tend to use earnings when valuing firms, the MNCs valuation may be affected.31Translation Exposure In general, translation exposure is relevant becausesome MNC subsidiaries may want to remit their earnings to their parent

33、s now,the prevailing exchange rates may be used to forecast the expected cash flows that will result from future remittances, andconsolidated earnings are used by many investors to value MNCs.32Translation Exposure An MNCs degree of translation exposure is dependent on:the proportion of its business

34、 conducted by its foreign subsidiaries,The locations of its foreign subsidiaries, andthe accounting method that it uses.33Questions and Applications 1. Your employer, a large MNC, has asked you to assess its transaction exposure. Its projected cash flows are as follows for the next year: Currency To

35、tal inflow Total outflow Current Exchange Rate in U.S. Dollars Danish (DK) 50,000,000 40,000,000 $.15 krone British ( ) 2,000,000 1,000,000 $1.50 pound Assume that the movements in the Danish krone and the pound are highly correlated . Provide your assessment as to your firms degree of transaction e

36、xposure (as to whether the exposure is high or low). Substantiate your answer.34Questions and Applications 2. Fisher Inc., Export products from Florida to Europe. It obtains its supplies and borrows funds locally. How would appreciation of the euro likely affect its net cash flows? Why? 3. Walt Disn

37、ey World build an amusement park in France that opened in 1992. How do you think this project has affected Disneys overall economic exposure to exchange rate movements? Explain.35Questions and Applications 4. Lubbock, Inc., produces furniture and has no international business. Its major competitors

38、import most of their furniture from Brazil and then sell it out of retail stores in the United States. How will Lubbock be affected if Brazils currency (the real ) strengthens over time?36Questions and Applications 5. Cieplak, Inc., is a U.S.-based MNC that has expanded into Asia. Its U.S. parent ex

39、ports to some Asian countries, with its exports denominated in the Asian currencies. It also has a large subsidiary in Malaysia that serves that market. Offer at least two reasons related to exposure to exchange rates why Cieplaks earnings were reduced during the Asian Crisis.37Questions and Applica

40、tions 6. Vegas Corp. is a U.S. Firm that exports most of its products to Canada. It historically invoiced its products in Canadian dollars to accommodate the importers. However, it was adversely affected when the Canadian dollar weakened against the U.S. dollar. Since Vegas did not hedge, its Canadi

41、an dollar receivables were converted into a relatively small amount of U.S. dollars. After a few more year of continual concern about possible exchange rate movements, Vegas called38Questions and Applications its customers and requested that they pay for future orders with U.S. dollars instead of Ca

42、nadian dollars. At this time, the Canadian dollar was valued at $.81. The customers decided to oblige, since the number of Canadian dollars to be converted into U.S. dollars when importing the goods from Vegas was still slightly smaller than the number of Canadian dollars that would be needed to buy

43、 the product from a Canadian manufacturer. Based on this situation, has transaction exposure changed for Vegas Corp.? Has economic exposure changed? Explain.39Questions and Applications 7. Decko Co. is a U.S. firm with a Chinese subsidiary that produces cell phones in China and sells them in Japan.

44、This subsidiary pays its wages and its rent in Chinese yuan. The cell phones sold to Japan are denominated in Japanese yen. Assume that Decko Co. expects that the Chinese yuan will continue to be stable against the dollar. The subsidiarys main goal is to generate profits for itself and it reinvests

45、the profits. It does not plan to remit any funds to the U.S. parent.40Questions and Applicationsa. Assume that the Japanese yen strengthens against the U.S. dollar over time. How would this be expected to affect the profits earned by the Chinese subsidiary?b. If Decko Co. had established its subsidi

46、ary in Tokyo, Japan instead of China, would its subsidiarys profits be more exposed or less exposed to exchange rate risk?c. Why do you think that Decko Co. established the subsidiary in China instead of Japan? Assume no major country risk barriers.d. If the Chinese subsidiary needs to borrow money to finance its expansion and wants to reduce its exchange rate risk, should it borrow U.S. dollars, Chinese yuan, or Japanese yen?