Transcript I. INTRODUCTION Operating exposure management

Multinational Financial Management
Alan Shapiro
10th Edition
John Wiley & Sons, Inc.
PowerPoints by
Joseph F. Greco, Ph.D.
California State University, Fullerton
1
CHAPTER 11
Measuring and Managing
Economic Exposure
FOREIGN EXCHANGE RISK
AND ECONOMIC EXPOSURE
I.
FOREIGN EXCHANGE RISK
A. Economic exposure
focuses on the impact of currency
fluctuations on firm’s value
1.
The most important aspect of
foreign exchange risk management:
Incorporate expectations about the
risk into all basic decisions of the
firm
3
FOREIGN EXCHANGE RISK AND
ECONOMIC EXPOSURE
2. Definition:
Economic exposure = Transaction exposure
+Operating exposure
Operating exposure:
arises because currency fluctuations alter a
company’s future revenues and expenses
4
FOREIGN EXCHANGE RISK AND
ECONOMIC EXPOSURE
To measure operating exposure requires a longerterm perspective.
i.e. Cost and price competitiveness could be
affected by exchange rate changes
5
FOREIGN EXCHANGE RISK AND
ECONOMIC EXPOSURE
Operating Exposure begins:
the moment a firm starts to invest in a market
subject to foreign competition or in sourcing goods
or inputs abroad
6
FOREIGN EXCHANGE RISK AND
ECONOMIC EXPOSURE
The new investment includes:
New product development
A distribution network
Brand name development
Marketing
Foreign supply contracts
Production facilities
7
FOREIGN EXCHANGE RISK AND
ECONOMIC EXPOSURE
B.
Real Exchange Rates Changes and
Risk
Nominal v. real exchange rates:
real rate has been adjusted for
price changes.
8
FOREIGN EXCHANGE RISK AND
ECONOMIC EXPOSURE
C.
Implications
1. If nominal rates change with an equal
price change, no alteration to cash
flows
2. If real rates change, it causes relative
price changes and changes in purchasing
power
9
FOREIGN EXCHANGE RISK AND
ECONOMIC EXPOSURE
A depreciation in the real value of a
currency: makes exports and import-competing
goods more competitive
An appreciating currency makes:
imports and export-competing goods more
competitive
10
FOREIGN EXCHANGE RISK
AND ECONOMIC EXPOSURE
During an appreciation of home currencies:
Exporters face two choices:
#1 keep prices constant (but lose sales)
or
#2 adjust prices to foreign currency to
maintain market share (lose profits)
11
FOREIGN EXCHANGE RISK AND
ECONOMIC EXPOSURE
3.
SUMMARY
a.
the economic impact of a
currency change depends on the
offset by the difference in inflation
rates or the change in real exchange
rates
b.
It is the relative price changes that
ultimately determine a firm’s long-run
exposure
12
THE ECONOMIC CONSEQUENCES
OF EXCHANGE RATE CHANGES
I.
ECONOMIC CONSEQUENCES
A. The impact on Operating Exposure of a real
rate change depends upon:
Pricing flexibility and
1.
Price elasticity of demand
2.
Degree of product differentiation
3.
The Ability to shift production and
the substitution of inputs
13
If HC Appreciates
Pricing Flexibility is key
14
If HC Appreciates
Can the firm maintain its profit margins both at
home and abroad?
If price elasticity of demand is low, the more price
flexibility a firm has
i.e. Availability of good substitutes
15
If HC Appreciates
Product Differentiation
price elasticity depends on the degree of
differentiation
The greater the differentiation, the more the firm
can control its prices
e.g. Mercedes Benz autos
16
If HC Appreciates
The Ability to Shift Production and to source
inputs from other countries
e.g. The lack of ability of Japanese car
makers in the late 1980’s
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MANAGING OPERATING
EXPOSURE
I.
INTRODUCTION
Operating exposure management requires
long-term operating adjustments and the
involvement of all departments.
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MANAGING OPERATING
EXPOSURE
II.
Marketing Strategy
A. Market Selection:
use competitive advantage to carve
out market share when currency
values change
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MANAGING OPERATING
EXPOSURE
B.
Pricing strategy: Expectations are
critical
1.
2.
If HC depreciates, exporter gains
competitive advantage by increasing
unit profitability or market share
The higher price elasticity of demand,
the more currency risk the firm faces
by other product substitution
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MANAGING OPERATING
EXPOSURE
C.
Product Strategy
exchange rate changes may alter
1.
The timing of new product
introductions
2.
Product deletion
3.
Product innovations
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MANAGING OPERATING
EXPOSURE
III.
Product Management Adjustments
A.
Input mix “shop the world”
B.
C.
D.
Shift production among plants
Plant relocation
Raising productivity
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MANAGING OPERATING
EXPOSURE
IV.
Planning For Exchange-Rate Changes
A. Develop contingency plans with plausible
scenarios before the impact of a currency
change makes itself felt.
e.g.
flexible mfg systems
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MANAGING OPERATING
EXPOSURE
V. Financial Management of Exchange Rate Risk:
A. Financial manager’s Role
Structure the firm’s liabilities in such a way that the
reduction in asset earnings is matched by
corresponding decrease in cost of servicing
liabilities.
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MANAGING OPERATING
EXPOSURE
B.
Provide local manager with
forecasts of inflation and exchange-rate
changes.
C.
Identify and focus on competitive exposure.
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MANAGING OPERATING
EXPOSURE
D.
Design the evaluation criteria
so that operating managers neither rewarded
or penalized for unexpected exchange-rate
changes
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