Chapter 12
Managing Economic Exposure and Translation Exposure
Lecture Outline
Managing Economic Exposure
Assessing Economic Exposure
Restructuring to Reduce Economic Exposure
Issues Involved in the Restructuring Decision
A Case on Hedging Economic Exposure
Savor Co.’s Dilemma
Assessment of Economic Exposure
Assessment of Each Unit’s Exposure
Identifying the Source of the Unit’s Exposure
Possible Strategies to Hedge Economic Exposure
Savor’s Hedging Strategy
Limitations of Savor’s Hedging Strategy
Hedging Exposure to Fixed Assets
Managing Translation Exposure
Using Forward Contracts to Hedge Translation Exposure
Limitations of Hedging Translation Exposure
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Managing Economic Exposure and Translation Exposure 2
Chapter Theme
This chapter shows how an MNC can restructure its operations to reduce economic exposure. Such a
strategy is related to the firm’s long-run operations, unlike transaction exposure.
This chapter also briefly describes how translation exposure can be reduced. Yet, the limitations of
hedging translation exposure should receive as much attention as the hedging strategy itself.
Topics to Stimulate Class Discussion
1. Describe the economic exposure of a specific local small business in your city.
2. Even if you believe translation exposure is relevant, is it worthwhile to hedge it? Explain.
3. Compare the degree of translation exposure between a small firm whose foreign subsidiary generates
50% of its business versus a huge exporting company with no subsidiaries.
POINT/COUNTER-POINT:
Can an MNC Reduce the Impact of Translation Exposure by
Communicating?
POINT: Yes. Investors commonly use earnings to derive an MNC’s expected future cash flows. Investors
do not necessarily recognize how an MNC’s translation exposure could distort their estimates of the
MNC’s future cash flows. Therefore, the MNC could clearly communicate in its annual report and
elsewhere how the earnings were affected by translation gains and losses in any period. If investors have
this information, they will not overreact to earnings changes that are primarily attributed to translation
exposure.
COUNTER-POINT: No. Investors focus on the bottom line and should ignore to any communication
regarding the translation exposure. Moreover, they may believe that translation exposure should be
accounted for anyway. If foreign earnings are reduced because of a weak currency, the earnings may
continue to be weak if the currency remains weak.
WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support?
Offer your own opinion on this issue.
ANSWER: Both points have some merit. Some investors may believe that the bottom line earnings are
the key, which implies that there should not be an adjustment for translation exposure. This supports the
counter-point. However, an MNC should provide investors with much detail about translation exposure,
and let investors use the information as they wish. Some investors may adjust the cash flow estimates
once they are aware of the translation exposure. Their valuation could be affected by information
pertaining to the translation exposure, because they may want to remove any earnings effects due to
translation exposure. MNCs can not dictate the valuation processes used by investors, but they can
facilitate the processes by providing all the information about translation exposure that may be desired by
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Managing Economic Exposure and Translation Exposure 3
some investors. Many MNCs do not provide much information, which forces investors to try to guess at
the degree of translation exposure.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.