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1、,Measuring Exposure ToExchange Rate Fluctuations,10,Chapter,South-Western/Thomson Learning 2003,See c10.xls for spreadsheets to accompany this chapter.,Chapter Objectives,To discuss the relevance of an MNCs exposure to exchange rate risk;To explain how transaction exposure can be measured;To explain
2、 how economic exposure can be measured;andTo explain how translation exposure can be measured.,Is Exchange Rate Risk Relevant?,Purchasing Power Parity ArgumentExchange rate movements will be matched by price movements.PPP does not necessarily hold.,Is Exchange Rate Risk Relevant?,The Investor Hedge
3、ArgumentMNC shareholders can hedge against exchange rate fluctuations on their own.The investors may not have complete information on corporate exposure.They may not have the capabilities to correctly insulate their individual exposure too.,Currency Diversification ArgumentAn MNC that is well divers
4、ified should not be affected by exchange rate movements because of offsetting effects.This is a naive presumption.,Is Exchange Rate Risk Relevant?,Stakeholder Diversification ArgumentWell diversified stakeholders will be somewhat insulated against losses experienced by an MNC due to exchange rate ri
5、sk.MNCs may be affected in the same way because of exchange rate risk.,Is Exchange Rate Risk Relevant?,Response from MNCsMany MNCs have attempted to stabilize their earnings with hedging strategies,which confirms the view that exchange rate risk is relevant.,Is Exchange Rate Risk Relevant?,For curre
6、nt and historic exchange rates,as well as implied currency volatilities,visit http:/www.ny.frb.org/pihome/statistics/.,Online Application,11/30/01Implied Vols 1 Week 1 Month 2 Month 3 Month 6 Month 12 Month 2 Year 3 Year EUR 10.9 9.9 10.9 11.2 11.7 11.9 11.9 11.8 JPY 9.1 8.9 9.5 9.9 10.4 10.6 10.7 1
7、0.7 CHF 11.2 10.3 11.2 11.5 11.9 12.1 12.0 12.0 GBP 9.0 8.1 8.8 9.1 9.4 9.5 9.6 9.7 CAD 6.2 5.9 6.0 6.1 6.1 6.1 6.2 6.1 AUD 10.4 10.3 11.0 11.4 11.8 12.0 12.0 12.0 GBPEUR 8.1 6.9 7.4 7.7 8.4 8.7 8.6 8.5 EURJPY 9.3 9.0 9.7 10.3 10.8 11.3 11.4 11.4,Types of Exposure,Although exchange rates cannot be f
8、orecasted with perfect accuracy,firms can at least measure their exposure to exchange rate fluctuations.Exposure to exchange rate fluctuations comes in three forms:Transaction exposureEconomic exposureTranslation exposure,Transaction Exposure,The degree to which the value of future cash transactions
9、 can be affected by exchange rate fluctuations is referred to as transaction exposure（交易风险）.To measure transaction exposure:project the net amount of inflows or outflows in each foreign currency,anddetermine the overall risk of exposure to those currencies.,MNCs can usually anticipate foreign cash f
10、lows for an upcoming short-term period with reasonable accuracy.After the consolidated net currency flows for the entire MNC has been determined,each net flow is converted into either a point estimate or a range of a chosen currency,so as to standardize the exposure assessment for each currency.,Tra
11、nsaction Exposure,An MNCs overall exposure can be assessed by considering each currency position（头寸）together with the currencys variability（可变性）and the correlations among the currencies.The standard deviation statistic on historical data serves as one measure of currency variability.Note that curren
12、cy variability levels may change over time.,Transaction Exposure,Currency 1981-1993 1994-1998British pound0.03090.0148Canadian dollar0.01000.0110Indian rupee0.02190.0168Japanese yen0.02790.0298New Zealand dollar0.02890.0190Swedish krona0.02870.0195Swiss franc0.03300.0246Singapore dollar0.01110.0174,
13、Transaction Exposure,Standard Deviations of Exchange Rate MovementsBased on Monthly Data,The correlations among currency movements can be measured by their correlation coefficients,which indicate the degree to which two currencies move in relation to each other.coefficientperfect positive correlatio
14、n1.00no correlation0.00perfect negative correlation-1.00,Transaction Exposure,Can$NZ$Sk SwFBritishpound()1.00Canadiandollar(Can$).181.00Japaneseyen().45.061.00New Zealanddollar(NZ$).39.20.331.00Swedishkrona(Sk).62.16.46.331.00Swiss franc(SwF).63.12.61.37.701.00,Transaction Exposure,Correlations Amon
15、g Exchange Rate Movements,The point in considering correlations is to detect positions that could somewhat offset each other.For example,if currencies X and Y are highly correlated,the exposures of a net X inflow and a net Y outflow will offset each other to a certain degree.Note that the corrrelati
16、ons among currencies may change over time.,Transaction Exposure,Movements of Selected CurrenciesAgainst the Dollar,A related method,the value-at-risk(VAR)method,incorporates currency volatility and correlations to determine the potential maximum one-day loss.Historical data is used to determine the
17、potential one-day decline in a particular currency.This decline is then applied to the net cash flows in that currency.,Transaction Exposure,Economic Exposure,Economic exposure refers to the degree to which a firms present value of future cash flows can be influenced by exchange rate fluctuations.Ca
18、sh flows that do not require conversion of currencies do not reflect transaction exposure.Yet,these cash flows may also be influenced significantly by exchange rate movements.,Economic Exposure,Economic Exposure,Even purely domestic firms may be affected by economic exposure if there is foreign comp
19、etition within the local markets.MNCs are likely to be much more exposed to exchange rate fluctuations.The impact varies across MNCs according to their individual operating characteristics and net currency positions.,Economic Exposure,One measure of economic exposure involves classifying the firms c
20、ash flows into income statement items,and then reviewing how the earnings forecast in the income statement changes in response to alternative exchange rate scenarios.In general,firms with more foreign costs than revenues will be unfavorably affected by stronger foreign currencies.,Economic Exposure,
21、Another method of assessing a firms economic exposure involves applying regression analysis to historical cash flow and exchange rate data.,Economic Exposure,PCFt=a0+a1et+tPCFt=%change in inflation-adjusted cash flows measured in the firms home currency over period tet=%change in the currency exchan
22、ge rate over period tt=random error term（随机误差）a0=intercept（截距）a1=slope coefficient（斜率相关系数）,Economic Exposure,The regression model may be revised to handle multiple currencies by including them as additional independent variables,or by using a currency index(composite).By changing the dependent varia
23、ble,the impact of exchange rates on the firms value(as measured by its stock price),earnings,exports,sales,etc.may also be assessed.,Economic Exposure,Translation Exposure,The exposure of the MNCs consolidated financial statements to exchange rate fluctuations is known as translation exposure.In par
24、ticular,subsidiary earnings translated into the reporting currency on the consolidated income statement are subject to changing exchange rates.,Translation Exposure,Does Translation Exposure Matter?Cash Flow Perspective-Translating financial statements for consolidated reporting purposes does not by
25、 itself affect an MNCs cash flows.However,a weak foreign currency today may result in a forecast of a weak exchange rate at the time subsidiary earnings are actually remitted.,Translation Exposure,Stock Price Perspective-Since an MNCs translation exposure affects its consolidated earnings and many i
26、nvestors tend to use earnings when valuing firms,the MNCs valuation may be affected.,Does Translation Exposure Matter?,In general,translation exposure is relevant becausesome MNC subsidiaries may want to remit their earnings to their parents now,the prevailing exchange rates may be used to forecast
27、the expected cash flows that will result from future remittances,andconsolidated earnings are used by many investors to value MNCs.,Translation Exposure,An MNCs degree of translation exposure is dependent on:the proportion of its business conducted by its foreign subsidiaries,the locations of its fo
28、reign subsidiaries,andthe accounting method that it uses.,Translation Exposure,According to World Research Advisory estimates,the translated earnings of U.S.-based MNCs in aggregate were reduced by$20 billion in the third quarter of 1998 alone simply because of the depreciation of Asian currencies a
29、gainst the dollar.In 2000,the weakness of the euro also caused several U.S.-based MNCs to report lower earnings than expected.,Translation Exposure,The annual reports for many MNCs may be found at http:/.Review some annual reports and see if you can find any comments that describe the MNCs transacti
30、on,economic,or translation exposures.,Online Application,Impact of Exchange Rate Exposureon an MNCs Value,Is Exchange Rate Risk Relevant?Purchasing Power Parity ArgumentThe Investor Hedge ArgumentCurrency Diversification ArgumentStakeholder Diversification ArgumentResponse from MNCsTypes of Exposure
31、Transaction,Economic,and Translation Exposures,Chapter Review,Chapter Review,Transaction ExposureTransaction Exposure to“Net”Cash FlowsTransaction Exposure Based on Currency VariabilityTransaction Exposure Based on Currency CorrelationsTransaction Exposure Based on Value-at-Risk,Chapter Review,Econo
32、mic ExposureEconomic Exposure to Local Currency Appreciation&DepreciationEconomic Exposure of Domestic Firms&MNCsMeasuring Economic ExposureSensitivity of Earnings&Cash Flows to Exchange Rates,Chapter Review,Translation ExposureDoes Translation Exposure Matter?Cash Flow PerspectiveStock Price PerspectiveDeterminants of Translation ExposureExamples of Translation ExposureImpact of Exchange Rate Exposure on an MNCs Value,
