Chapter10Measuring

Exposure

ToExchange

Rate

FluctuationsSouth-Western/Thomson

Learning

?

2003See

c10.xls

for

spreadsheets

toaccompany

this

chapter.ChapterObjectivesTo

discuss

the

relevance

of

anMNC’s

exposure

to

exchange

ratrisk;

To

explain

how

transactionexposurecan

be

measured;

To

explain

how

economic

exposurecanbe

measured;

and

To

explain

how

translation

exposurecan

be

measured.C10

-

2Is

Exchange

Rate

Risk

Relevant?Purchasing

Power

Parity

Argument·Exchange

ratemovements

will

be

matchedby

price

movements.√PPP

does

notnecessarily

hold.C10

-

3C10

-

4Is

Exchange

Rate

Risk

Relevant?The

Investor

Hedge

Argument·MNC

shareholderscan

hedge

againstexchange

rate

fluctuationson

their

own.√The

investors

maynot

have

completeinformation

on

corporateexposure.

They

may

nothave

the

capabilities

tocorrectly

insulate

theirC10

-

5Currency

Diversification

Argument·An

MNCthatis

welldiversified

shouldnotbeaffected

by

exchange

ratemovements

because

ofoffsetting

effects.√This

is

a

naivepresumption.Is

Exchange

Rate

Risk

Relevant?C10

-

6Stakeholder

Diversification

Argument·Well

diversifiedstakeholders

will

besomewhat

insulated

againstlosses

experienced

by

anMNC

due

to

exchange

raterisk.√MNCs

may

beaffected

in

the

same

waybecause

of

exchange

raterisk.Is

Exchange

Rate

Risk

Relevant?Response

from

MNCsMany

MNCs

have

attempted

tostabilize

their

earnings

with

hedgingstrategies,

which

confirms

theviewthat

exchange

rate

risk

is

relevant.Is

Exchange

Rate

Risk

Relevant?C10

-

7

For

current

and

historic

exchangerates,

as

well

as

implied

currencyvolatilities,

visit/pihome/statisticsOnline

Application11/30/01C10

-

8Implied

Vols

1

Week

1

Month

2

Month

3

Month

6

Month

12

Month

2

Year

3

YearEUR10.99.910.9

11.2

11.711.9 11.9

11.8JPY9.18.99.5

9.9

10.410.6 10.7

10.7CHF11.210.311.2

11.5

11.912.1 12.0

12.0GBP9.08.18.89.19.49.59.6

9.7CAD6.25.96.06.16.16.16.2

6.1AUD10.410.311.011.411.812.0 12.0

12.0GBPEUR8.16.97.47.78.48.7

8.6

8.5EURJPY9.39.09.710.310.811.3 11.4

11.4C10

-

9Types

of

Exposure

Although

exchange

rates

cannot

beforecasted

with

perfect

accuracy,firms

can

at

least

measure

theirexposure

to

exchange

ratefluctuations.

Exposure

to

exchange

ratefluctuationscomes

in

three

forms:TransactionEconomic¤exposure¤exposureC10

-

10Transaction

Exposure

The

degree

to

which

the

value

offuture

cash

transactions

can

beaffected

by

exchange

ratefluctuations

isreferredto

astransaction

exposure（交易風(fēng)險(xiǎn)）.To

measure

transaction

exposure:·project

the

netamount

of

inflows

oroutflows

in

each

foreigncurrency,

and·determine

theoverall

risk

of

exposure

toC10

-

11

MNCs

can

usually

anticipate

foreigncash

flows

for

an

upcoming

short-term

period

with

reasonableaccuracy.

After

the

consolidated

net

currencyflows

for

the

entire

MNC

has

beendetermined,

each

net

flow

isconverted

into

either

apointestimate

or

a

range

of

a

chosencurrency,

so

as

to

standardize

theexposure

assessment

for

eachTransaction

Exposure

An

MNC’s

overall

exposure

can

beassessed

by

considering

eachcurrency

position（頭寸）

togetherwith

the

currency’s

variability（可變性）

and

the

correlations

amongthe

currencies.

The

standard

deviation

statistic

onhistorical

data

serves

as

onemeasure

of

currency

variability.Note

thatcurrency

variability

levelsmay

change

over

time.Transaction

ExposureC10

-

12British

pound0.03090.0148Canadian

dollar0.01000.0110Indian

rupee0.02190.0168Japanese

yen0.02790.0298New

Zealand

dollar0.02890.0190Swedish

krona

0.02870.0195Swiss

franc

0.0330Singapore

dollar0.02460.01110.0174Transaction

ExposureStandard

Deviations

of

Exchange

Rate

MovementsBased

on

Monthly

DataCurrency

1981-1993

1994-1998C10

-

13C10

-

14

The

correlations

among

currencymovements

can

be

measured

bytheir

correlation

coefficients,

whichindicatethe

degreeto

which

twocurrencies

move

in

relation

to

eachother.coefficientperfect

positivecorrelation

1.00noTransaction

ExposureSwFBritishpound

(￡)1.00Canadiandollar

(Can$)Japaneseyen

(￥)

.45.06

1.00New

Zealanddollar

(NZ$)Swedishkrona

(Sk)

.62Swiss

franc(SwF)

.63.181.00.39.20.331.00.16.46.331.00.12.61.37.701.00Transaction

ExposureCorrelations

Among

Exchange

Rate

Movements￡

Can$

￥

NZ$

SkC10

-

15

The

point

in

consideringcorrelations

is

to

detect

positionsthat

could

somewhat

offset

eachother.

Forexample,

if

currencies

X

and

Yare

highly

correlated,

the

exposuresof

a

net

X

inflow

and

a

net

Y

outflowwill

offset

each

other

to

a

certaindegree.Note

that

the

corrrelations

amongTransaction

ExposureC10

-

16Movements

of

Selected

CurrenciesAgainst

the

Dollar$/100

￥C10

-

17$/10

Indian

rupees$/Canadian$$

per

unit$/Singapore$$/5

Swedish

krona$/Chinese

yuan

A

related

method,

the

value-at-risk(VAR)

method,

incorporatescurrency

volatility

and

correlationsto

determine

the

potential

maximumone-day

loss.

Historical

data

is

used

to

determinethe

potential

one-day

decline

in

aparticular

currency.

This

decline

isthen

applied

to

the

net

cash

flows

inthat

currency.Transaction

ExposureC10

-

18C10

-

19Economic

Exposure

Economic

exposure

refers

to

thedegree

to

which

a

firm’spresentvalue

of

future

cash

flows

can

beinfluenced

by

exchange

ratefluctuations.

Cash

flows

that

do

not

requireconversion

of

currencies

do

notreflect

transaction

exposure.

Yet,these

cash

flows

may

also

beinfluenced

significantly

by

exchangerate

movements.Economic

ExposureTransactions

thatCash

InflowsInfluence

the

Firm’sLocal

CurrencyAppreciatesLocal

CurrencyDepreciatesLocal

sales

(relativeto

foreign

competitionin

local

markets)Firm’s

exportsdenominated

in

localcurrencyFirm’s

exportsdenominated

inforeign

currencyInterest

received

fromforeign

investmentsTransactions

reflecting

transaction

exposure.C10

-

20DecreaseDecreaseDecreaseDecreaseIncreaseIncreaseIncreaseIncreaseImpact

on

TransactionsEconomic

ExposureTransactions

thatCash

OutflowsInfluence

the

Firm’sLocal

CurrencyAppreciatesLocal

CurrencyDepreciatesImpact

on

TransactionsTransactions

reflecting

transaction

exposure.C10

-

21Firm’s

importedsupplies

denominatedin

local

currencyFirm’s

importedsupplies

denominatedin

foreign

currencyInterest

owed

onforeign

fundsborrowedNo

ChangeDecreaseDecreaseNo

ChangeIncreaseIncrease

Even

purely

domestic

firms

may

beaffected

by

economic

exposure

ifthere

is

foreign

competition

withinthe

local

markets.

MNCs

are

likely

to

be

much

moreexposed

to

exchange

ratefluctuations.

The

impact

variesacross

MNCs

according

to

theirindividual

operating

characteristicsand

net

currency

positions.C10

-

22Economic

ExposureC10

-

23

One

measure

of

economic

exposureinvolves

classifying

the

firm’scash

flows

into

income

statementitems,

and

then

reviewing

how

theearnings

forecast

in

the

incomestatementchanges

in

response

toalternative

exchange

rate

scenarios.

In

general,

firms

with

more

foreigncosts

than

revenues

will

beunfavorably

affected

by

strongerforeign

currencies.Economic

Exposure

Another

method

of

assessing

afirm’s

economic

exposure

involvesapplying

regression

analysis

tohistorical

cash

flow

and

exchangerate

data.C10

-

24Economic

ExposurePCFt

=

a0

+

a1et

+C10

-

25tPCFt

= %

change

in

inflation-adjusted

cash

flows

measured

in

the

firm’shome

currency

over

period

tet

= %

change

in

the

currency

exchangerate

over

period

tt=a0

=a1

=random

error

term（隨機(jī)誤差）intercept

（截距）slope

coefficient（斜率相關(guān)系數(shù)）Economic

ExposureC10

-

26

The

regression

model

may

berevised

to

handle

multiplecurrencies

by

including

them

asadditional

independent

variables,

orby

using

a

currencyindex(composite).

By

changing

the

dependent

variable,theimpact

of

exchange

rates

on

thefirm’s

value

(as

measured

by

itsstock

price),

earnings,

exports,sales,

etc.

may

also

be

assessed.Economic

ExposureTranslation

ExposureC10

-

27

The

exposure

of

the

MNC’sconsolidated

financial

statements

toexchange

rate

fluctuations

is

knownas

translation

exposure.

In

particular,

subsidiary

earningstranslated

into

the

reportingcurrency

on

the

consolidated

income

statement

are

subject

tochanging

exchange

rates.Translation

ExposureC10

-

28Does

Translation

Exposure

Matter?

Cash

Flow

Perspective

-

Translatingfinancial

statements

forconsolidated

reporting

purposesdoes

not

by

itself

affect

an

MNC’scash

flows.

However,

a

weak

foreign

currencytoday

may

result

in

a

forecast

of

aweak

exchange

rate

at

the

timesubsidiary

earnings

are

actuallyTranslation

ExposureC10

-

29Does

Translation

Exposure

Matter?

Stock

Price

Perspective

-

Since

anMNC’s

translation

exposure

affectsits

consolidated

earnings

and

manyinvestors

tendtouseearnings

whenvaluing

firms,

the

MNC’s

valuationmay

be

affected.C10

-

30

In

general,

translation

exposure

isrelevant

because·some

MNCsubsidiaries

may

want

toremit

their

earnings

to

theirparents

now,·the

prevailingexchange

rates

may

beused

to

forecast

theexpected

cash

flows

thatwill

result

from

futureTranslation

ExposureC10

-

31

An

MNC’s

degree

of

translationexposure

is

dependent

on:·the

proportion

ofits

business

conducted

byits

foreign

subsidiaries,·the

locations

of

itsforeign

subsidiaries,

and·the

accountingmethod

that

it

uses.Translation

ExposureC10

-

32

According

to

World

ResearchAdvisory

estimates,

the

translatedearnings

of

U.S.-based

MNCs

inaggregate

were

reduced

by

$20billion

in

the

third

quarter

of

1998alone

simply

because

of

thedepreciation

of

Asian

currenciesagainst

the

dollar.

In

2000,

the

weakness

of

the

euroalso

caused

several

U.S.-basedMNCs

to

report

lower

earnings

thanTranslation

ExposureC10

-

33

The

annual

reports

for

many

MNCsmay

be

found

at.

Reviewsome

annual

reports

and

see

if

youcan

find

any

comments

thatdescribe

the

MNCs’

transaction,economic,

or

translation

exposures.Online

ApplicationC10

-

34I