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Management of Economic Exposure - Coggle Diagram
Management of Economic Exposure
How to Measure Economic Exposure
b = Cov(P,S)/Var(S)
Measuring Asset Exposure (Continued)
Channels of Economic Exposure
P = a + b×S + e
Measurement of Currency Exposure
How to Measure Economic Exposure
Hedging Asset Exposure
Operating Exposure: Definition
Many managers do not fully understand the effect of volatile
exchange rates on operating cash flows
Operating exposure is the extent to which the firm’s operatingcash flows will be affected by random changes in the exchange rates
In many cases, operating exposure may account for a larger portion of the firm’s total exposure than contractual exposure
Illustration of Operating Exposure
Consider the possible effect of a depreciation of the pound on the projected dollar operating cash flow of Albion Computers.
Assume the pound may depreciate from $1.60 to $1.40 per pound The dollar operating cash flow may change following a pound depreciation due to:
◦ Conversion effect
◦ Competitive effect
Consider the following cases with varying degree of realism:
CASE 3:
•All the variables change.
CASE 1
•No variables change, except the price of the imported input.
CASE 2:
•The selling price as well as the price of the imported input changes, with no other changes.
Managing Operating Exposure
Operating exposure cannot be readily determined from the firm’s accounting statements, unlike transaction exposure. A firm’s operating exposure is determined by:
A firm is usually subject to high degrees of operating exposure when either its cost or its price is sensitive to exchange rate changes. The extent to which a firm is subject to operating exposure depends on the firm’s ability to stabilize cash flows in the face of exchange rate changes
Facing exchange rate changes, a firm may choose one of the following three pricing strategies:
Determinants of Operating Exposure
Objective of managing operating exposure is to stabilize cash flows in the fact of fluctuating exchange rates Firms may use the following strategies for managing operating exposure:
Flexible sourcing policy
Diversification of the market
Selecting low-cost production sites
Product differentiation and R&D efforts
Financial hedging