measuring exposure to exchange rate fluctuations.pptxVIP

N9: Measuring Exposure to Exchange Rate Fluctuations Measuring Exposure to Exchange Rate Fluctuations This section will discuss: A. The relevance of an MNC’s exposure to exchange rate risk; and B. Explain how transaction exposure can be measured C. Explain how economic exposure can be measured D. Explain how translation exposure can be measured Objectives Relevance of Exchange Rate Risk Investor Hedge Argument: exchange rate risk is irrelevant because investors can hedge exchange rate risk on their own. Currency Diversification Argument: if U.S.-based MNC is well diversified across numerous currencies, its value will not be affected by exchange rate risk Stakeholder Diversification Argument: if stakeholders are well diversified, they will be somewhat insulated against losses due to MNC exchange rate risk. Forms of Exchange Rate Exposure Transaction exposure Estimating “Net” Cash Flows in Each Currency Exposure of an MNC’s Portfolio Transaction Exposure Based on Value-at-Risk Economic exposure Economic Exposure to Local Currency Appreciation Economic Exposure to Local Currency Depreciation Economic Exposure of Domestic Firms Measuring Economic Exposure 3. Translation exposure Does Translation Exposure Matter? Determinants of Translation Exposure Examples of Translation Exposure Forms of Exchange Rate Exposure Transaction ExposureDefinition: sensitivity of the firm’s contractual transactions in foreign currencies to exchange rate movements.To assess transaction exposure, the MNC must:1. Estimate “net” cash flows in each currency2. Measure potential impact of the currency exposure  Exposure of an MNC’s Portfolio Affected by: Measurement of currency variability Currency variability over time Measurement of currency correlations Applying currency correlations to net cash flows Currency correlations over time Measurement of currency variability Standard Deviation of Exchange Rate Movements Based on Quarterly Exchange Rates, 2007–2012 Shifts in S