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POINT/COUNTER-POINT:
Should Investors Care about an MNC’s Translation Exposure?
POINT: No. The present value of an MNC’s cash flows is based on the cash flows that the parent receives.
Any impact of the exchange rates on the financial statements is not important unless cash flows are
affected. MNCs should focus their energy on assessing the exposure of their cash flows to exchange rate
movements and should not be concerned with the exposure of their financial statements to exchange rate
movements. Value is about cash flows, and investors focus on value.
COUNTER-POINT: Investors do not have sufficient financial data to derive cash flows. They commonly
use earnings as a base, and if earnings are distorted, so will be their estimates of cash flows. If they
underestimate cash flows because of how exchange rates affected the reported earnings, they may
underestimate the value of the MNC. Even if the value is corrected in the future once the market realizes
how the earnings were distorted, some investors may have sold their stock by the time the correction
occurs. Investors should be concerned about an MNC’s translation exposure. They should recognize that
the earnings of MNCs with large translation exposure may be more distorted than the earnings of MNCs
with low translation exposure.
WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support?
ANSWER: Translation exposure affects earnings, and therefore can affect the value of the firm. If it affects
the value of the MNC, translation exposure is relevant to the firm, to the investors who are affected by
changing values, and to the managers whose compensation may be affected by changing values.
Answers to End of Chapter Questions
1. Transaction versus Economic Exposure. Compare and contrast transaction exposure and economic
exposure. Why would an MNC consider examining only its “net” cash flows in each currency when
assessing its transaction exposure?
2. Assessing Transaction Exposure. Your employer, a large MNC, has asked you to assess its
transaction exposure. Its projected cash flows are as follows for the next year:
Currency Total Inflow Total Outflow
Current Exchange
Rate in U.S. Dollars
Danish krone (DK) DK50,000,000 DK40,000,000 $.15
British pound (£) £2,000,000 £1,000,000 $1.50
Assume that the movements in the Danish krone and the pound are highly correlated. Provide your
assessment as to your firm’s degree of transaction exposure (as to whether the exposure is high or
low). Substantiate your answer.
ANSWER: The net exposure to each currency in U.S. dollars is derived below:
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Measuring Exposure to Exchange Rate Fluctuations 2
Foreign Currency
Net Inflows in
Foreign Currency
Current
Exchange Rate Value of Exposure
Danish krone (DK) +DK10,000,000 $.15 $1,500,000
British pound (£) +£1,000,000 $1.50 $1,500,000
3. Factors That Affect a Firm’s Transaction Exposure. What factors affect a firm’s degree of
transaction exposure in a particular currency? For each factor, explain the desirable characteristics
that would reduce transaction exposure.
4. Currency Correlations. Kopetsky Co. has net receivables in several currencies that are highly
correlated with each other. What does this imply about the firm’s overall degree of transaction
exposure? Are currency correlations perfectly stable over time? What does your answer imply about
Kopetsky Co. or any other firm using past data on correlations as an indicator for the future?
5. Currency Effects on Cash Flows. How should appreciation of a firm’s home currency generally affect
its cash inflows? How should depreciation of a firm’s home currency generally affect its cash
outflows?
6. Transaction Exposure. Fischer Inc., exports products from Florida to Europe. It obtains supplies and
borrows funds locally. How would appreciation of the euro likely affect its net cash flows? Why?
7. Exposure of Domestic Firms. Why are the cash flows of a purely domestic firm exposed to exchange
rate fluctuations?
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Measuring Exposure to Exchange Rate Fluctuations 3
8. Measuring Economic Exposure. Memphis Co. hires you as a consultant to assess its degree of
economic exposure to exchange rate fluctuations. How would you handle this task? Be specific.
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Measuring Exposure to Exchange Rate Fluctuations 4
9. Factors That Affect a Firm’s Translation Exposure. What factors affect a firm’s degree of
translation exposure? Explain how each factor influences translation exposure.
10. Translation Exposure. Consider a period in which the U.S. dollar weakens against the euro. How will
this affect the reported earnings of a U.S.-based MNC with European subsidiaries? Consider a period
in which the U.S. dollar strengthens against most foreign currencies. How will this affect the reported
earnings of a U.S.-based MNC with subsidiaries all over the world?
11. Transaction Exposure. Aggie Co. produces chemicals. It is a major exporter to Europe, where its
main competition is from other U.S. exporters. All of these companies invoice the products in U.S.
dollars. Is Aggie’s transaction exposure likely to be significantly affected if the euro strengthens or
weakens? Explain. If the euro weakens for several years, can you think of any change that might
occur in the global chemicals market?
12. Economic Exposure. Longhorn Co. produces hospital equipment. Most of its revenues are in the
United States. About half of its expenses require outflows in Philippine pesos (to pay for Philippine
materials). Most of Longhorn’s competition is from U.S. firms that have no international business at
all. How will Longhorn Co. be affected if the peso strengthens?
13. Economic Exposure. Lubbock, Inc., produces furniture and has no international business. Its major
competitors import most of their furniture from Brazil and then sell it out of retail stores in the United
States. How will Lubbock, Inc., be affected if Brazil’s currency (the real) strengthens over time?
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Measuring Exposure to Exchange Rate Fluctuations 5
14. Economic Exposure. Sooner Co. is a U.S. wholesale company that imports expensive high-quality luggage
and sells it to retail stores around the United States. Its main competitors also import high-quality luggage
and sell it to retail stores. None of these competitors hedge their exposure to exchange rate movements.
Why might Sooner’s market share be more volatile over time if it hedges its exposure?
15. PPP and Economic Exposure. Boulder, Inc., exports chairs to Europe (invoiced in U.S. dollars) and
competes against local European companies. If purchasing power parity exists, why would Boulder
not benefit from a stronger euro?
16. Measuring Changes in Economic Exposure. Toyota Motor Corp. measures the sensitivity of its
exports to the yen exchange rate (relative to the U.S. dollar). Explain how regression analysis could be
used for such a task. Identify the expected sign of the regression coefficient if Toyota primarily exports
to the United States. If Toyota established plants in the United States, how might the regression
coefficient on the exchange rate variable change?
17. Impact of Exchange Rates on Earnings. Cieplak, Inc., is a U.S.-based MNC that has expanded into
Asia. Its U.S. parent exports to some Asian countries, with its exports denominated in the Asian
currencies. It also has a large subsidiary in Malaysia that serves that market. Offer at least two reasons
related to exposure to exchange rates why Cieplak's earnings were reduced during the Asian crisis.
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Measuring Exposure to Exchange Rate Fluctuations 6
Advanced Questions
18. Speculating Based on Exposure. Periodically, there are rumors that China will weaken its currency
(the yuan) against the U.S. dollar and many European currencies. This causes investors to sell stocks in
Asian countries such as Japan, Taiwan, and Singapore. Offer an intuitive explanation for such an
effect. What types of Asian firms would be affected the most?
19. Comparing Transaction and Economic Exposure. Erie Co. has most of its business in the U.S.,
except that it exports to Belgium. Its exports were invoiced in euros (Belgium’s currency) last year. It
has no other economic exposure to exchange rate risk. Its main competition when selling to Belgium’s
customers is a company in Belgium that sells similar products, denominated in euros. Starting today,
Erie Co. plans to adjust its pricing strategy to invoice its exports in U.S. dollars instead of euros. Based
on the new strategy, will Erie Co. be subject to economic exposure to exchange rate risk in the future?
Briefly explain.
20. Using Regression Analysis to Measure Exposure.
a. How can a U.S. company use regression analysis to assess its economic exposure to fluctuations
in the British pound?
b. In using regression analysis to assess the sensitivity of cash flows to exchange rate movements,
what is the purpose of breaking the database into subperiods?
c. Assume the regression coefficient based on assessing economic exposure was much higher in the
second sub period than in the first sub period. What does this tell you about the firm’s degree of
economic exposure over time? Why might such results occur?
21. Transaction Exposure. Vegas Corp. is a U.S. firm that exports most of its products to Canada. It
historically invoiced its products in Canadian dollars to accommodate the importers. However, it was
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Measuring Exposure to Exchange Rate Fluctuations 7
adversely affected when the Canadian dollar weakened against the U.S. dollar. Since Vegas did not
hedge, its Canadian dollar receivables were converted into a relatively small amount of U.S. dollars.
After a few more years of continual concern about possible exchange rate movements, Vegas called its
customers and requested that they pay for future orders with U.S. dollars instead of Canadian dollars.
At this time, the Canadian dollar was valued at $.81. The customers decided to oblige, since the
number of Canadian dollars to be converted into U.S. dollars when importing the goods from Vegas
was still slightly smaller than the number of Canadian dollars that would be needed to buy the product
from a Canadian manufacturer. Based on this situation, has transaction exposure changed for Vegas
Corp.? Has economic exposure changed? Explain.
22. Measuring Economic Exposure. Using the following cost and revenue information shown for
DeKalb, Inc., determine how the costs, revenue, and cash flow would be affected by three possible
exchange rate scenarios for the New Zealand dollar (NZ$): (1) NZ$ = $.50, (2) NZ$ = $.55, and (3)
NZ$ = $.60. (Assume U.S. sales will be unaffected by the exchange rate.) Assume that NZ$ earnings
will be remitted to the U.S. parent at the end of the period. Ignore possible tax effects.
23. Changes in Economic Exposure. Walt Disney World built an amusement park in France that opened
in 1992. How do you think this project has affected Disney’s economic exposure to exchange rate
movements? Think carefully before you give your final answer. There is more than one way in which
Disney’s cash flows may be affected. Explain.
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Measuring Exposure to Exchange Rate Fluctuations 8
24. Lagged Effects of Exchange Rate Movements. Cornhusker Co. is an exporter of products to
Singapore. It wants to know how its stock price is affected by changes in the Singapore dollar’s
exchange rate. It believes that the impact may occur with a lag of one to three quarters. How could
regression analysis be used to assess the impact?
25. Potential Effects if the United Kingdom Adopted the Euro. The U.K. still has its own currency, the
pound. The pound’s interest rate has historically been higher than the euros interest rate. The U.K. has
considered adopting the euro as its currency. There have been many arguments about whether it should
do so.
Use your knowledge and intuition to discuss the likely effects if the United Kingdom adopts the euro.
For each of the 10 statements below, insert either INCREASE or DECREASE and complete the
statement by adding a clear short explanation (perhaps one to three sentences) of why the U.K.’s
adoption of the euro would have that effect.
To help you narrow your focus, follow these guidelines. Assume that the pound is more volatile than
the euro. Do not base your answer on whether the pound would have been stronger than the euro in the
future. Also, do not base your answer on an unusual change in economic growth in the U.K. or in the
euro zone if the euro is adopted.
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Measuring Exposure to Exchange Rate Fluctuations 9
26. Invoicing Policy to Reduce Exposure. Celtic Co. is a U.S. firm that exports its products to England.
It faces competition from many firms in England. Its price to customers in England has generally been
lower than those of the competitors, primarily because the British pound has been strong. It has priced
its exports in pounds, and then converts the pound receivables into dollars. All of its expenses are in the
U.S. and are paid with dollars. It is concerned about its economic exposure. It considers a change in its
pricing policy, in which it will price its products in dollars instead of pounds. Offer your opinion on
why this will or will not significantly reduce its economic exposure.
27. Exposure to Cash Flows. Raton Co. is a U.S. company that has net inflows of 100 million Swiss
francs and net outflows of 100 million British pounds. The present exchange rate of the Swiss franc is
about $.70 while the present exchange rate of the pound is $1.90. Raton Co. has not hedged these
positions. The Swiss franc and British pound are highly correlated in their movements against the
dollar. Explain whether Raton will be favorably or adversely affected if the dollar weakens against
foreign currencies over time.
28. Assessing Exchange Rate Risk. Washington Co. and Vermont Co. have no domestic business. They
have a similar dollar equivalent amount of international exporting business. Washington Co. exports all
of its products to Canada. Vermont Co. exports its products to Poland and Mexico, with about half of
its business in each of these 2 countries. Each firm receives the currency of the country where it sends
its exports. You obtain the end-of-month spot exchange rates of the currencies mentioned above during
the end of each of the last 6 months.
End of Month Canadian Dollar Mexican Peso Polish Zloty
1 $0.8142 $.09334 $.29914
2 0.8176 .09437 .29829
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Measuring Exposure to Exchange Rate Fluctuations 10
3 0.8395 .09241 .30187
4 0.8542 .09263 .3088
5 0.8501 .09251 .30274
6 0.8556 .09448 .30312
You want to assess the data in a logical manner to determine which firm has a higher degree of exchange
rate risk. Show your work and write your conclusion. [HINT: The percentage change in the portfolio of
currencies is a weighted average of the percentage change in each currency in the portfolio.]
Standard
deviation
Maximum expected loss = 1.65
x Std. Dev.
Canadian $ .0123 2.03%
Mexican peso .0157 2.59%
Polish zloty .0160 2.64%
Portfolio .0100 1.65%
29. Exposure to Pegged Currency System. Assume that the Mexican peso and the Brazilian currency
(called the “real”) have depreciated against the dollar recently, due to the high inflation rates in those
countries. Assume that inflation in these two countries is expected to continue and that it will have a
major effect on these currencies if they are still allowed to float. Assume that the government of Brazil
decides to peg its currency to the dollar and will definitely maintain the peg for the next year. Milez Co.
is based in Mexico. Its main business is to export supplies from Mexico to Brazil. It invoices its
supplies in Mexican pesos. Its main competition is from firms in Brazil that produce similar supplies
and sell them locally. How will the sales volume of Milez Co.be affected (if at all) by the Brazilian
government’s actions? Explain.
30. Assessing Currency Volatility. Zemart is a U.S. firm that plans to establish international business in
which it will export to Mexico (these exports will be denominated in pesos) and to Canada (these
exports will be denominated in Canadian dollars) once a month and will therefore receive payments
once a month. It is concerned about exchange rate risk. It wants to compare the standard deviation of
exchange rate movements of these 2 currencies against the dollar on a monthly basis. For this reason, it
asks you to
a. estimate the standard deviation of the monthly movements in the Canadian dollar against the U.S.
dollar over the last 12 months
b. estimate the standard deviation of the monthly movements in the Mexican peso against the U.S.
dollar over the last 12 months.
c. Determine which currency is less volatile
You can use the oanda.com web site (or any legitimate web site that has currency data) to obtain the
end of month direct exchange rate of the peso and the Canadian dollar in order to do your analysis.
Show your work. You can use a calculator or a spreadsheet (like excel) to do the actual computations.
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Measuring Exposure to Exchange Rate Fluctuations 11
31. Exposure of Net Cash Flows. Each of the following U.S. firms is expected to generate $40 million in
net cash flows (after including the estimated cash flows from international sales if there are any) over
the next year. Ignore any tax effects. Each firm has the same level of expected earnings. None of the
firms have taken any positions in exchange rate derivatives to hedge their exchange rate risk. All
payments for the international trade by each firm will occur one year from today.
Sunrise Co. has ordered imports from Austria, and its imports are invoiced in euros. The dollar value
of the payables (based on today’s exchange rate) from its imports during this year is $10 million. It has
no international sales.
Copans Co. has ordered imports from Mexico, and its imports are invoiced in U.S. dollars. The dollar
value of the payables from its imports during this year is $15 million. It has no international sales.
Yamato Co. ordered imports from Italy, and its imports are invoiced in euros. The dollar value of the
payables (based on today’s exchange rate) from its imports during this year is $12 million. In addition,
Yamato exports to Portugal and its exports are denominated in euros. The dollar value of the
receivables (based on today’s exchange rate) from its exports during this year is $8 million.
Glades Co. ordered imports from Belgium, and these imports are invoiced in euros. The dollar value of
the payables (based on today’s exchange rate) from its imports during this year is $7 million.
Glades also ordered imports from Luxembourg and these imports are denominated in dollars. The
dollar value of these payables is $30 million. Glades has no international sales.
Based on this information, which firm is exposed to the most exchange rate risk? Explain.
ANSWER:
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