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10
Measuring Exposure To
Exchange Rate Fluctuations
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Is Exchange Rate Risk Relevant?
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Is Exchange Rate Risk Relevant?
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Is Exchange Rate Risk Relevant?
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Is Exchange Rate Risk Relevant?
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Is Exchange Rate Risk Relevant?
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Online Application
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Types of Exposure
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Transaction Exposure
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Transaction Exposure
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Transaction Exposure
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Transaction Exposure
Standard Deviations of Exchange Rate Movements
Based on Monthly Data
Currency 1981-1993 1994-1998
British pound 0.0309 0.0148
Canadian dollar 0.0100 0.0110
Indian rupee 0.0219 0.0168
Japanese yen 0.0279 0.0298
New Zealand dollar 0.0289 0.0190
Swedish krona 0.0287 0.0195
Swiss franc 0.0330 0.0246
Singapore dollar 0.0111 0.0174
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Transaction Exposure
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Transaction Exposure
Correlations Among Exchange Rate Movements
£ Can$ ¥ NZ$ Sk SwF
British
pound (£) 1.00
Canadian
dollar (Can$) .181.00
Japanese
yen (¥) .45.061.00
New Zealand
dollar (NZ$) .39.20 .331.00
Swedish
krona (Sk) .62.16 .46.331.00
Swiss franc
(SwF) .63.12 .61.37 .701.00
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Transaction Exposure
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Movements of Selected Currencies
Against the Dollar
1.40
1.20 $/10 Indian rupees
$/100 ¥
1.00 $/Canadian$
$ per unit
0.80
0.60
0.40 $/Singapore$ $/5 Swedish krona
0.20 $/Chinese yuan
0.00
1981 1986 1991 1996 2001
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Transaction Exposure
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Economic Exposure
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Economic Exposure
Transactions that Impact on Transactions
Influence the Firm’s Local Currency Local Currency
Cash Inflows Appreciates Depreciates
Local sales (relative
to foreign competition Decrease Increase
in local markets)
Firm’s exports
denominated in local Decrease Increase
currency
Firm’s exports
denominated in Decrease Increase
foreign currency
Interest received from
foreign investments Decrease Increase
Transactions reflecting transaction exposure. C10 - 20
Economic Exposure
Transactions that Impact on Transactions
Influence the Firm’s Local Currency Local Currency
Cash Outflows Appreciates Depreciates
Firm’s imported
supplies denominated No Change No Change
in local currency
Firm’s imported
supplies denominated Decrease Increase
in foreign currency
Interest owed on
foreign funds Decrease Increase
borrowed
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Economic Exposure
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Economic Exposure
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Economic Exposure
PCFt = a0 + a1et + t
PCFt = % change in inflation-
adjusted cash flows measured in the firm’s
home currency over period t
et = % change in the currency
exchange rate over period t
t = random error term
a0 = intercept
a1 = slope coefficient
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Economic Exposure
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Translation Exposure
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Translation Exposure
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Translation Exposure
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Translation Exposure
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Translation Exposure
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Translation Exposure
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Online Application
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Impact of Exchange Rate Exposure
on an MNC’s Value
Transaction Exposure
Economic Exposure
m
n
E CFj , t E ER j , t
j 1
Value =
t =1 1 k t
E (CFj,t ) = expected cash flows in
currency j to be received by the U.S. parent at
the end of period t
E (ERj,t ) = expected exchange rate at
which currency j can be converted to dollars at
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Chapter Review
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Chapter Review
• Transaction Exposure
¤ Transaction Exposure to “Net” Cash Flows
¤ Transaction Exposure Based on Currency
Variability
¤ Transaction Exposure Based on Currency
Correlations
¤ Transaction Exposure Based on Value-at-
Risk
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Chapter Review
• Economic Exposure
¤ Economic Exposure to Local Currency
Appreciation & Depreciation
¤ Economic Exposure of Domestic Firms &
MNCs
¤ Measuring Economic Exposure
Sensitivity of Earnings & Cash Flows to
Exchange Rates
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Chapter Review
• Translation Exposure
¤ Does Translation Exposure Matter?
Cash Flow Perspective
Stock Price Perspective
¤ Determinants of Translation Exposure
¤ Examples of Translation Exposure
• Impact of Exchange Rate Exposure on an
MNC’s Value
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