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Economic Exposure

Economic Exposure. Changes in the exchange rate can affect the competitiveness of both MNCs and purely “domestic” businesses. How Changing FX Rates can Affect Firm Value.

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Economic Exposure

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  1. Economic Exposure Changes in the exchange rate can affect the competitiveness of both MNCs and purely “domestic” businesses.

  2. How Changing FX Rates can Affect Firm Value

  3. This study measures industry stock market performance against over-all market performance and the US$ fx rate for USA firms.

  4. Statistical Review * We are going to want to measure the sensitivity of business performance to changes in the exchange rate. * These coefficients are also known as “betas”.

  5. Asset Exposure (acct. receivable)

  6. Example of Economic (Asset Exposure) Case 1: When UK£ gets stronger, internationally, local UK£ prices go up. Case 2: When UK£ gets stronger, internationally, local UK£ prices go fall. Case 3: When UK£ gets stronger, internationally, local UK£ prices stay same.

  7. Example (cont.): How the Betas Were Calculated.

  8. Imperfect Forward Hedging • Only when there is no local price risk (Case 3) is perfect forward hedging possible. • To continue with example • Assume forward rate F( ) is $1.50/£. • Sell £ forward: contract size equal to beta (Case 1: £1,700; Case 3: £1,000). • Win/Lose forward contract size x $(F – S).

  9. Example (cont.): Imperfect Benefits of Forward Hedge Only when FX risk is the ONLY risk can a currency hedge reduce ALL the risk!

  10. Operating Exposure

  11. Operating Exposure: Example • USA computer company with UK subsidiary “Albion”. • Albion makes and sells computers in the UK. • Albion imports computer chips from Intel (USA) for $512 (currently £320, part of variable costs). • Current sport rate $1.60/£. • Tax rate in UK = 50%.

  12. Current Projections for Albion Computers

  13. Example (cont.) • Now, suppose sterling falls in value from $1.60/£ to $1.40/£. (*Computer chips now cost £366 each). • Competitive Effect: Weaker pound may effect Albion’s competitive position. • Conversion Effect: A given £ cash flow will be worth less in $ to the USA parent .

  14. Example (cont.): CASE 1. Nothing changes except the price of the imported computer chips. * Albion is assumed NOT to be able to raise prices due to UK competition.

  15. Example (cont.): CASE 2. Albion is able to raise the price of its computers in response to the increase in the price of the imported computer chips.

  16. Example (cont.): CASE 3. Albion is able to raise the price of its computers in response to the increase in the price of the imported computer chips and local input prices, but loses some customers.

  17. Example (cont.): Summary of the Three Cases

  18. Determinants of Operating Exposure

  19. Managing Operating Exposure

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