International Banking

1
International Banking and Trade Finance
Chpt 12
2
Managing Economic Exposure and Translation
Exposure

• Chapter 12

3
Exchange Rate Exposure

• Reminder There are 3 forms by which a MNC is
  exposed to exchange rate fluctuations
• 1. Transaction exposure
• 2. Economic Exposure - Chapter 12
• 3. Translation Exposure

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• Economic Exposure
• is essentially the fact that the cash flows of
  the MNCs are sensitive to exchange rate movements
• if the exchange rate goes up, or down, usually
  this is caused by economic circumstances in the
  particular country - this is why we call it
  Economic Exposure

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Managing Economic Exposure

• Economic exposure
• any impact of exchange rate fluctuations on
  future cash flows
• affect cash flows in manner not associated with
  currency transactions
• an MNC would examine how all cash flow is
  affected by exchange rate movement

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• Transaction Exposure
• is the fact that you have to make conversions of
  the currency into foreign currency for some parts
  of the intl business
• Economic Exposure
• is the fact that once you make that conversion -
  the currency could go up or down - and give you
  advantages or disadvantages

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Sometimes Hedging is not relevant

• Corporate cash flows can sometimes be effected
  by exchange rate movements in ways not directly
  associated with foreign exchange transactions
• Thus firms cannot JUST focus on hedging - they
  have to determine how cash flows will be affected

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Managing Economic Exposure

• Example British Laker Airlines
• What happened?
• Revenues generated in pounds
• large amount of expenses in dollars
• when dollar strengthens, expenses creep up
• bank loan also denominated in dollars

Laker went bankrupt
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Managing Economic Exposure

• Assessing economic exposure
• examine sensitivity of revenues and costs to
  exchange rate fluctuation
• an imbalance between costs and revenues creates
  higher exposure level
• determine sensitivity of earnings to exposure

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Restructuring
Page 378

• You can increase advertising costs and hope to
  increase sales
• you can borrow money from one country, to pay
  back loans in another

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Economic Exposure
Measuring exposure for US MNC Y

• US firm with subsidiary in Japan
• most revenue raised in the US dollars
• most costs occur in Japanese yen
• most borrowing occurs in Japan
• a currency imbalance exists between costs and
  revenues
• Income statement becomes sensitive to currency
  fluctuations

12
Economic Exposure
Measuring exposure for US MNC Y

• Income statement becomes sensitive to currency
  fluctuations
• effect of currency imbalance among costs and
  revenues

Net earnings
Costs
Revenues
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Economic Exposure
Measuring exposure for US MNC Y

• Impact if yen were to strengthen
• increases MNC Ys production costs
• increases MNC Ys interest expenses
• decreases net earnings

Costs
Net earnings
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Economic Exposure
Measuring exposure for US MNC Y

• Response to a strong yen over time
• MNC Y may change emphasis of the two sites
• increase Japanese revenue
• shift costs to US
• attempt to reduce effect of currency imbalance

15
Analysis with Computer Spreadsheets

• Allows you to understand the results of different
  scenarios because you can plug in the different
  exchange rate changes - and see the subsequent
  results

Page 380
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When Deciding to Restructure

• One must address the following questions

Each of these 4 questions is important because
they reflect a different part of the firms
income statement
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When Deciding to Restructure

• One must address the following questions
• Should the firm attempt to increase or decrease
  sales
• Should the firm increase or decrease its
  dependency on foreign suppliers

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When Deciding to Restructure

• the following questions, , , ,
• Should the firm establish or eliminate production
  facilities
• Should the firm increase or reduce its level of
  debt denominated in foreign currencies

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• By making cars in the U.S.A., they pay for parts
  in dollars, and sell the cars for dollars, and
  pay employees in dollars,
• so if dollars change in respect to Yen, it
  doesnt mean much cause very little has to be
  paid for in Yen, and very little goes back to
  Japan in Yen

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Summary

• Economic exposure
• balances sensitivity of revenues and expenses to
  exchange rate fluctuations