Eun & Resnick 4eCHAPTER 9 Management of Economic ExposureHow to Measure Economic ExposureInternational Finance in Practice:U.S. Firms Feel the Pain of Peso’s Plunge Operating Exposure: DefinitionIllustration of Operating ExposureDeterminants of Operating ExposureManaging Operating ExposureSelecting Low-Cost Production SitesInternational Finance in Practice:The Strong Yen and Toyota’s Choice Flexible Sourcing PolicyDiversification of the MarketR&D Efforts and Product DifferentiationFinancial HedgingInternational Finance in Practice: Porsche Powers Profit with Currency PlaysCASE APPLICATION: Exchange Risk Management at MerckSummaryMINI CASE: Economic Exposure of Albion Computers PLCHow to Measure Economic Exposure1Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange ratea)Can have a significant economic consequences for U.S. firms.b)Can have a significant economic consequences for Japanese firms.c)Can have a significant economic consequences for both U.S. and Japanese firms.d)None of the aboveAnswer: c)2Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange ratea)Will tend to weaken the competitive position of import-competing U.S. car makers.b)Will tend to strengthen the competitive position of import-competing U.S. car makers.c)Will tend to strengthen the competitive position of Japanese car makers at the expense ofU.S. makers.d)None of the aboveAnswer: b)3When the Mexican peso collapsed in 1994, declining by 37 percent,a)U.S. firms that exported to Mexico and priced in peso were adversely affected.b)U.S. firms that exported to Mexico and priced in dollars were adversely affected.c)U.S. firms were unaffected by the peso collapse, since Mexico is such a small market.d)Both a) and b)Answer: d)Rationale: a) is obvious, the dollar value of revenue fell. Answer b) is less obvious, but those firm’s Mexican customers were less able to afford the imported goods.4When exchange rates change,a)U.S. firms that sell only to domestic customers will be unaffected.b)U.S. firms that sell only to domestic customers can be affected if they compete againstimports.c)U.S. firms that sell only to domestic customers will be affected, but only if they borrowin foreign currency to finance their domestic operations.d)Both a) and b)Answer: b)5When exchange rates change,a)This can alter the operating cash flow of a domestic firm.b)This can alter the competitive position of a domestic firm.c)This can alter the hom e currency values of a multinational firm’s assets and liabilities.d)All of the aboveAnswer: d)6Two recent studies have found a link between exchange rates and the stock prices of U.S.firms,a)This suggests that exchange rate changes can systematically affect the value of the firmby influencing its operating cash flows.b)This suggests that exchange rate changes can systematically affect the value of the firmby influencing the domestic currency values of its assets and liabilities.c)a) and b)d)None of the aboveAnswer: c)7Economic exposure refers to(名词解释)a)the sensitivity of realized domestic currency values of the firm’s contractual cash flowsdenominated in foreign currencies to unexpected exchange rate changesb)the extent to which the value of the firm would be affected by unanticipated changes inexchange ratec)the potential that the firm’s consolidated financial statement can be affected by changesin exchange ratesd)ex post and ex ante currency exposuresAnswer: b)8It is conventional to classify foreign currency exposures into the following types:a)economic exposure, transaction exposure, and translation exposureb)economic exposure, noneconomic exposure, and political exposurec)national exposure, international exposure, and trade exposured)conversion exposure, and exchange exposureAnswer: a)9Exposure to currency risk can be measured by the sensitivities ofa)the future home currency values of the firm’s assets and liabilitiesb)the firm’s operating cash flows to random changes in exchange ratesc)a) and b)d)none of the aboveAnswer: c)10Currency riska)is the same as currency exposureb)represents random changes in exchange ratesc)measure “what the firm has at risk”d)a) and b)Answer: b)11Suppose a U.S.-based MNC maintains a vacation home for employees in the British countryside and the local price of this property is always moving together with the pound price of the U.S. dollar. As a result,a)Whenever the pound depreciates against the dollar, the local currency price of thisproperty goes up by the same proportion.b)The firm is not exposed to currency risk even if the pound-dollar exchange rate fluctuatesrandomly.c)a) and b)d)none of the aboveAnswer: c)12The exposure coefficient in the regression P a b S e=+⨯+is given by:a)Cov(,)Var()P S bS =b)P a b S e=+⨯+c)a) and b)d)eAnswer: a)13The exposure coefficientCov(,)Var()P SbS=in the regression P a b S e=+⨯+is:a) A measure of how a change in the exchange rate affects the dollar value of a fi rm’sassets.b)Has a value of zero if the value of the firm’s assets is perfectly correlated with changes inthe exchange ratec)a) and b)d)none of the aboveAnswer: a)14The link between the home currency value of a firm’s assets and liabilities and exchange ra te fluctuations is:a)Asset exposureb)Operating exposurec)a) and b)d)none of the aboveAnswer: a)15The link between a firm’s future operating cash flows and exchange rate fluctuations is:a)Asset exposureb)Operating exposurec)a) and b)d)none of the aboveAnswer: b)Operating Exposure: Definition16Operating exposure can be defined as:a)the future home currency values of the firm’s assets and liabilitiesb)the extent to which the firm’s operating cash flows would be affected by random changesin exchange ratesc)the sensit ivity of realized domestic currency values of the firm’s contractual cash flowsdenominated in foreign currencies to unexpected exchange rate changesd)the potential that the firm’s consolidated financial statement can be affected by changesin exchange ratesAnswer: b)17The variability of the dollar value of an asset (invested overseas) depends on:a)the variability of the dollar value of the asset that is related to random changes in theexchange rateb)the dollar value variability that is independent of exchange rate movementsc) a and bd)none of the aboveAnswer: c)18Consider a U.S. MNC who owns a foreign asset. If the foreign currency value of the asset is inversely related to changes in the dollar-foreign currency exchange rate:a)the company has a built-in hedgeb)the dollar value variability that is independent of exchange rate movementsc) a and bd)none of the aboveAnswer: c)USE THE FOLLOWING INFORMATION TO ANSWER THE NEXT FOUR QUESTIONS A U.S. firm holds an asset in Great Britain and faces the following scenario:State 1 State 2 State 3 Probability 25% 50% 25% Spot rate $2.20/£$2.00/£$1.80/£P*£2,000 £2,500 £3,000 P $4,400 $5,000 $5,400 where,P*= Pound sterling price of the asset held by the U.S. firmP = dollar price of the same asset19The expected value of the investment in U.S. dollars is:a)$4,950b)$3,700c)$2,112.50d)none of the aboveAnswer: b)Rationale:E(P) = 0.25 × $4,400 + 0.50 × $5,000 + 0.25 × $5,400 = $4,95020The variance of the exchange rate is:a)0.00200b)0.10c)0.01d)none of the aboveAnswer: a)Rationale:E(S) = 0.25 × $2.20 + 0.50 × $2.00 + 0.25 × $1.80 = $.55 + $1 + $.45 = $2.00VAR(S) = 0.25($2.20– $2.00)2 + 0.50($2.00 – $2.00)2 + 0.25($1.80 – $2.00)2 = 0.001 + 0 + 0.001= 0.00221The “exposure” (i.e. the regression coefficient beta) is:Hint: Calculate the expression Cov(,) Var()P SSa)–25,000b)25,000c)–25d)none of the aboveAnswer: a)Rationale:Cov(P,S)= 0.25×($4,400 – $4,950) × ($2.20 – $2.00)+ 0.50× ($5,000 – $4,950) × ($2.00 – $2.00) + 0.25($5,400 – $4,950) ($1.80 – $2.00) = –27.50 + 0 –22.50= –50b= –50/0.002= –25,00022Which of the following conclusions are correct?a)most of the volatility of the dollar value of the British asset can be removed by hedgingexchange risk because b2[Var(S)] and Var(e) are 236,717 ($)2and 493,751 ($)2 respectivelyb)most of the volatility of the dollar value of the British asset can not be removed byhedging exchange risk because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2 respectivelyc)most of the volatility of the dollar value of the British asset can NOT be removed byhedging exchange risk because b2[Var(S)] and Var(e) are 1,250,000 ($)2 and –1,122,500 ($)2 respectivelyd)most of the volatility of the dollar value of the British asset can be removed by hedgingexchange risk because b2[Var(S)] and Var(e) are 1,250,000 ($)2and –1,122,500 ($)2 respectivelyAnswer: c)Rationale:E(P) = 0.25 × $4,400 + 0.50 × $5,000 + 0.25 × $5,400= $4,950Var(P) = 0.25($4,400 – $4,950)2 + 0.50($5000 – $4,950)2 + 0.25($5,400 – $4,950)2 = 75,625 + 1,250 + 50,625= 127,500 ($)2From the results to earlier questions we have the values:V(S) = 0.002b= –25,000Therefore, using the Equation 9.2, we obtainV(P) = b2 Var(S) + Var(e)127,500 = (–25,000)2 × 0.002 + Var(e)Var(e) = 127,500 – 1,250,000= –1,122,500 ($)2The expression “b2 Var(S)” represents the volatility of the dollar value of the asset that is related to random changes in the exchange rate. The expression “Var(e)” is the volatility in the dollar value of the asset that is independent of exchange rate movements. Notice that there’s a built in hedge in this example, when the exchange rate is down, the £-denominated value of the asset is up and vice-versa.USE THE FOLLOWING INFORMATION TO ANSWER THE NEXT FOUR QUESTIONS A U.S. firm holds an asset in Israel and faces the following scenario:State 1 State 2 State 3 Probability 25% 50% 25% Spot rate $0.30/IS $0.20/IS $0.15/IS P*IS2,000 IS5,000 IS3,000 P $3,000 $2,500 $750 where,P*= Israeli shekel (IS) price of the asset held by the U.S. firmP= dollar price of the same asset23The expected value of the investment in U.S. dollars is:a)$2,083.33b)$2,187.50c)$6,250.00d)$6,562.50Answer: b)Rationale:E(P) = 0.25 × $3,000 + 0.50 × $2,500 + 0.25 × $750= $2,187.5024The variance of the exchange rate is:a)0.001968b)0.002968c)0.003968d)0.004968Answer: b)Rationale:E(S) = 0.25 × $0.30 + 0.50 × $0.20 + 0.25 × $0.15= $0.0750 + $0.1000 + $0.0375= $0.2125VAR(S) = 0.25($0.30 – $0.2125)2 + 0.50($0.20 – $0.2125)2 + 0.25($0.15 – $0.2125)2= 0.001914 + 0.000078 + 0.000976= 0.00296825The “exposure” (i.e. the regression coefficient beta) is:Hint: Calculate the expression Cov(,) Var()P SSa)128.98b)1,289.80c)12,898.00d)none of the aboveAnswer: c)Rationale: Cov(P,S) = 0.25×($3,000.00 – $2,187.50) × ($0.30 – $0.2125)+ 0.50× ($2,500.00 – $2,187.50) × ($0.20 – $0.2125) + 0.25($750.00 – $2,187.50)($0.15 – $0.2125) = 17.7734 – 1.9531 + 22.4609 = 38.2813b= Cov(,)Var()P SS= 38.2813/0.002968 = 12,89826Which of the following conclusions are correct?a)most of the volatility of the dollar value of the Israeli asset can be removed by hedgingexchange risk because b2[Var(S)] and Var(e) are 236,717 ($)2and 493,751 ($)2respectivelyb)most of the volatility of the dollar value of the Israeli asset can not be removed byhedging exchange risk because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2respectivelyc)most of the volatility of the dollar value of the Israeli asset can not be removed byhedging exchange risk because b2[Var(S)] and Var(e) are 493,751 ($)2 and 236,717 ($)2,respectivelyd)most of the volatility of the dollar value of the Israeli asset can be removed by hedgingexchange risk because b2[Var(S)] and Var(e) are 493,751 ($)2and 236,717 ($)2respectivelyAnswer: d)Rationale:Var(P) = 0.25($3,000.00 – $2,187.50)2 + 0.50($2,500.00 – $2,187.50)2 + 0.25($750.00 – $2,187.50)2 = 165,039 + 48,828 + 516,601= 730,468 ($)2From the results to earlier questions we have the values:V(S) = 0.002968b= 12,898Therefore, using the Equation 9.2, we obtainV(P) = b2 Var(S) + Var(e)730,468 = (12,898)2 × 0.002968 + Var(e)Var(e) = 730,468 – 493,751= 236,717 ($)2The expression “b2 Var(S)” represents the volatility of the dollar value of the asset that is related to random changes in the exchange rate. The expression “Var(e)” is the volatility in the dollar value of the asset that is independent of exchange rate movements.Illustration of Operating Exposure27Consider a U.S.-based MNC with a wholly-owned Italian subsidiary. Following a depreciation of the dollar against the euro, which of the following conclusions are correct?a)The cash flow in euro could be altered due an alteration in the firm’s competitive positionin the marketplace.b) A given operating cash flow in euro will be converted to a higher U.S. dollar cash flow.c)Answers a) and b)d)None of the aboveAnswer: c)28Consider a U.S.-based MNC with a wholly-owned Italian subsidiary. Following a depreciation of the dollar against the euro, which of the following describes the competitive effect of the depreciation?a)The cash flow in euro could be altered due an alteration in the firm’s competitive positionin the marketplace.b) A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow.c)Answers a) and b)d)None of the aboveAnswer: a)29Consider a U.S.-based MNC with a wholly-owned German subsidiary. Following a depreciation of the dollar against the euro, which of the following describes the conversion effect of the depreciation?a)The cash flow in euro could be altered due an alteration in the firm’s competitive positionin the marketplace.b) A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow.c)Answers a) and b)d)None of the aboveAnswer: b)30Consider a U.S.-based MNC with a wholly-owned French subsidiary. Following a depreciation of the dollar against the euro, which of the following best describes the mechanism of any effect of the depreciation?a)The change in the cash flow in euro due an alteration in the firm’s competitive position inthe mar ketplace is in part a function of the elasticity of demand for the firm’s product.b) A given operating cash flow in euro will be translated to a higher U.S. dollar cash flowregardless of the firm’s hedging program.c)Answers a) and b)d)None of the aboveAnswer: a)Determinants of Operating Exposure31Consider a U.S.-based MNC with a wholly-owned European subsidiary selling a product sourced in euro and priced in euro with inelastic demand. Following a depreciation of the dollar against the euro, which of the following is the most true?a)Since they have inelastic demand, the U.S. firm can just pass through the impact of theexchange rate changeb)Since they have elastic demand, the U.S. firm cannot just pass through the impact of theexchange rate changec)Since the exchange rate movement was favorable to the U.S. firm, there is no impact onthe firm’s positiond)None of the aboveAnswer: d)32 A firm’s operating exposure is:a)defined as the extent to which the firm’s operating cash flows would be affected by therandom changes in exchange ratesb)determined by the structure of the markets in which the firm sources its inputs, such aslabor and materials, and sells its productsc)determined by the firm’s ability to mitigate the effect of exchange rate changes byadjusting its markets, product mix, and sourcingd)all of the aboveAnswer: d)33Generally speaking, a firm is subject to high degrees of operating exposure:a)When its costs are sensitive to exchange rate changesb)When its prices are sensitive to exchange rate changesc)When either its cost or its price is sensitive to exchange rate changesd)none of the aboveAnswer: c)34Generally speaking, when both a firm’s costs and its price is sensitive to exchange rate changesa)The firm is not subject to high degrees of operating exposure:b)The firm is subject to high degrees of operating exposure:c)The firm should hedged)none of the aboveAnswer: a)35The firm may not be subject to high degrees of operating exposure:a)When changes in real exchange rates are exactly offset by the inflation differential.b)When changes in nominal exchange rates are exactly matched by the inflationdifferential.c)When changes in nominal exchange rates are exactly offset by the inflation differential.d)None of the aboveAnswer: c)36The firm may not be able to pass through changes in the exchange rate:a)In industries with low product differentiation.b)In industries with high price elasticities.c)Both a) and b).d)None of the aboveAnswer: c)Managing Operating Exposure37What is the objective of managing operating exposure?a)Stabilize cash flows in the face of fluctuating exchange rates.b)Selecting low cost production sites.c)Increase the variability of cash flows in the face of fluctuating exchange rates.d)Both a) and c).Answer: a)38Managing operating exposure:a)Is a short-term tactical issue.b)Is a long-term issue, like selecting a site for a factory.c)Is relatively unimportant, since most MNCs have a built-in hedge.d)None of the aboveAnswer: b)39Which of the following can a company use to manage operating exposure?a)Selecting low-cost production sites, diversifying the market.b)Low cost production sites, but not financial hedging.c)Pursuing a flexible sourcing policy, product differentiation, R& D effortsd)Both a) and c).Answer: d)Selecting Low-Cost Production Sites40When the domestic currency is strong or expected to become stronga)This could erode the competitive position of the firm’s exportsb)This could erode the competitive position of the firm’s import competitionc)The firm should consider locating production facilities in a foreign country where costsare lowd)a) and c)Answer: d)41 A foreign country could provide low cost production sitesa)Because the factors of production are underpricedb)Because the currency is undervaluedc)Because the locals like to give away their land labor and capital to foreignersd)a) and b)Answer: d)42While maintaining multiple production sites does provide a firm valuable options,a) A firm may miss out on economies of scopeb) A firm may miss out on economies of scalec) A firm may find that exchange rate changes can fully offset the advantage of multiplemanufacturing sitesd)a) and b)Answer: b)International Finance in Practice: The Strong Yen and Toyota’s Choice43Developing multiple production sites in a variety of countries,a)Can create an excess capacity problemb)Can lead to underutilization of domestic plantsc)Can lead to domestic job lossesd)All of the above,Answer: d)Flexible Sourcing Policy44 A firm that is committed to keeping manufacturing facilities in only the home country (andnot developing multiple production sites in a variety of countries) cana)Not mitigate the effects of exchange rate changes.b)Lessen the effect of exchange rate changes by sourcing from where input costs are low.c)Focus on selling commodity products with product differentiationd)Pursue a strategy of increasing its products price elasticity of demand.Answer: b)Diversification of the Market45 A firm that is committed to keeping manufacturing facilities in only the home country (andnot developing multiple production sites in a variety of countries) cana)Lessen the effect of exchange rate changes by pursuing a strategy of diversifying themarkets in which the firm’s produc ts are sold.b)Not mitigate the effects of exchange rate changes.c)Lessen the effect of exchange rate changes by pursuing a strategy of selling commodityproducts without product differentiation.d)Pursue a strategy of increasing its products price elasticity of demand.Answer: a)R&D Efforts and Product DifferentiationFinancial Hedging46It can be argued that, while financial hedging can be used to stabilize a firm’s cash flows,a)It is not a substitute for long-term operational hedging.b)It is therefore a substitute for long-term operational hedging.c)It is inferior to money market hedging.d)None of the above.Answer: a)47Investments in R&Da)Are usually a waste of time and money.b)Can allow the firm to maintain and strengthen its competitive position.c)Can allow the firm to cut costs and enhance productivity.d)b) and c).Answer: d)48The demand for unique products tends to bea)Highly elastic.b)Highly inelastic.c)Both a) and b)d)None of the above.Answer: b)49a)Unhedged, hedged.b)Hedged, unhedged.c)Normal, abnormald)None of the above.Answer: a)Rationale: figure 9-1250If the stock market of a foreign country is consistently up when the dollar value of the currency is down,a)There may not be a great deal of exchange rate risk for a U.S.-based investor.b)There will be a great deal of exchange rate risk for a U.S.-based investor.c)Then investors can ignore diversification.d)None of the above.Answer: a)。
