Lecture 10 - Measuring exposure to exchange rate fluctuations. After completing this chapter, students will be able to: To discuss the relevance of an MNC’s exposure to exchange rate risk; to explain how transaction exposure can be measured; to explain how economic exposure can be measured; and to explain how translation exposure can be measured. | Measuring Exposure To Exchange Rate Fluctuations 10 Lecture Chapter Objectives To discuss the relevance of an MNC’s exposure to exchange rate risk; To explain how transaction exposure can be measured; To explain how economic exposure can be measured; and To explain how translation exposure can be measured. Is Exchange Rate Risk Relevant? Purchasing Power Parity Argument Exchange rate movements will be matched by price movements. PPP does not necessarily hold. Is Exchange Rate Risk Relevant? The Investor Hedge Argument MNC shareholders can hedge against exchange rate fluctuations on their own. The investors have complete information on corporate exposure. They have the capabilities to correctly and efficiently insulate their individual exposure too. Currency Diversification Argument An MNC that is well diversified should not be affected by exchange rate movements because of offsetting effects. This is a naive presumption. Is Exchange Rate Risk Relevant? Stakeholder Diversification . | Measuring Exposure To Exchange Rate Fluctuations 10 Lecture Chapter Objectives To discuss the relevance of an MNC’s exposure to exchange rate risk; To explain how transaction exposure can be measured; To explain how economic exposure can be measured; and To explain how translation exposure can be measured. Is Exchange Rate Risk Relevant? Purchasing Power Parity Argument Exchange rate movements will be matched by price movements. PPP does not necessarily hold. Is Exchange Rate Risk Relevant? The Investor Hedge Argument MNC shareholders can hedge against exchange rate fluctuations on their own. The investors have complete information on corporate exposure. They have the capabilities to correctly and efficiently insulate their individual exposure too. Currency Diversification Argument An MNC that is well diversified should not be affected by exchange rate movements because of offsetting effects. This is a naive presumption. Is Exchange Rate Risk Relevant? Stakeholder Diversification Argument Well-diversified stakeholders will be somewhat insulated against losses experienced by an MNC due to exchange rate risk. Many MNCs are similarly affected by exchange rate movements. Is Exchange Rate Risk Relevant? Response from MNCs Many MNCs have attempted to stabilize their earnings with hedging strategies because they believe exchange rate risk is relevant. Is Exchange Rate Risk Relevant? Types of Exposure Although exchange rates cannot be forecasted with perfect accuracy, firms can at least measure their exposure to exchange rate fluctuations. Exposure to exchange rate fluctuations comes in three forms: Transaction exposure Economic exposure Translation exposure Transaction Exposure The degree to which the value of future cash transactions can be affected by exchange rate fluctuations is referred to as transaction exposure. To measure transaction exposure: estimate the net cash inflows or outflows in each currency, and measure the potential impact of the exposure to those .
