IFM ch-10

MEASURING MEASURING EXPOSURE EXPOSURE

TO TO EXCHANGE RATE EXCHANGE RATE FLUCTUATIONSFLUCTUATIONS

Importance of MeasuringImportance of Measuring►Exchange rates may not be

forecasted with perfect accuracy

Therefore,►Firms can at least measure their

exposure to exchange rate fluctuations.

Types of ExposureTypes of Exposure

►TRANSACTION TRANSACTION

►ECONOMICECONOMIC

►TRANSLATIONTRANSLATION

TRANSACTIOTRANSACTIONN

EXPOSUREEXPOSURE

DEFINITIONDEFINITION

““The degree to which the value of The degree to which the value of future cash transactions can be future cash transactions can be affected by exchange rate affected by exchange rate fluctuations is referred to as fluctuations is referred to as transaction exposure”.transaction exposure”.

To measure transaction To measure transaction exposureexposure

1. 1. Estimate the net cash inflows or outflows in each currency, and

2. Measure the potential impact of the exposure to those currencies.

MNCs can expect foreign cash flows for the future period with sound accuracy.

After the combined net currency flows for the entire MNC has been determined, each net flow is converted into the chosen currency.

This step helps to determine the MNCs

overall position in each currency.

1.Estimating Net Currency 1.Estimating Net Currency FlowsFlows

THE CURRENCY NET INFLOW & OUTFLOWS

THE RANGE OF NET INFLOW &

OUTFLOWS IN EACH CURRENCY


CONSOLIDATED NET CASH FLOW CONSOLIDATED NET CASH FLOW ASSESSMENTASSESSMENT

currenccurrencyy

TotalTotal

infloinfloww

TotalTotal

outflooutfloww

Net Net inflowinflow

Or Or outflowoutflow

CurrentCurrent

ExchangExchangee

RateRate

Net inflow orNet inflow or

Outflow as Outflow as measured in US measured in US dollardollar

C $C $ 2 M2 M 6 M6 M 4 M4 M $ $ 0.800.80

$ 3.2M$ 3.2MOUTFLOWOUTFLOW

EEEUROEURO

11 M 11 M 12 M12 M 1 M1 M 0.300.30 0.3M0.3MOUTFLOWOUTFLOW

JAPANJAPAN

YY300 300 MM

100 M100 M 200 M200 M 0.0050.005

1.0M1.0MINFLOWINFLOW

SWISSSWISSFRANCFRANC

1 M1 M 7 M7 M 6 M6 M 0.500.50 3.0M3.0MOUTFLOWOUTFLOW

THE RANGE OF NET INFLOWS &

OUTFLOWS IN EACH CURRENCY


ESTIMATING THE RANGE OF NET INFLOW & ESTIMATING THE RANGE OF NET INFLOW &

OUTFLOWS IN EACH CURRENCYOUTFLOWS IN EACH CURRENCY CURRENCCURRENCYY

NET NET INFLOW OR INFLOW OR OUTFLOWOUTFLOW

RANGE OF RANGE OF POSSIBLEPOSSIBLE

EXCHANGE EXCHANGE RATERATE

AT THE PERIOD AT THE PERIOD

RANGE OF POSSIBLE RANGE OF POSSIBLE NET INFLOWS OR NET INFLOWS OR OUTFLOWS IN US $ OUTFLOWS IN US $ BASED ON RANGE OF BASED ON RANGE OF POSSIBLE EX-RATESPOSSIBLE EX-RATES

C $C $ 4 M4 MINFLOWINFLOW

$.75 TO .85$.75 TO .85 $ 3 M TO 3.4 $ 3 M TO 3.4

EUROEURO 1 M1 MOUTFLOWOUTFLOW

.20 TO .50.20 TO .50 .20 M TO .50.20 M TO .50

JAPAN YJAPAN Y 200 M200 MINFLOWINFLOW

.004 .004

TOTO .0006.0006.8 M TO 1.2.8 M TO 1.2

SWISSSWISSFRANCFRANC

6 M6 MOUTFLOWOUTFLOW

.40 TO .70.40 TO .70 2.4 M TO 4.22.4 M TO 4.2

2. Measuring the Potential 2. Measuring the Potential ImpactImpact

►The net cash flows of an MNC can be The net cash flows of an MNC can be viewed as portfolio of currenciesviewed as portfolio of currencies

►The exposure of the portfolio can be The exposure of the portfolio can be measured by St. deviationmeasured by St. deviation

►To find how the value deviate from the To find how the value deviate from the expectedexpected

Currency VariabilityCurrency Variability►The St. Deviation measures the degree

of movement for each currency

►Some currencies fluctuate much more than others

►The variability of a currency will not necessarily remain constant from one period to another.

CURRENCY VARIABILITYCURRENCY VARIABILITY((STANDARD DEVIATIONSTANDARD DEVIATION))

CURRENCCURRENCYY

1995-1995-20052005

1995-1995-19971997

1998-1998-20002000

2001-2001-20032003

2004-2004-20052005

MXP 1.525% 1.2% 1.5% 1.8% 1.6%

GBP 2.47 1.31 1.96 2.31 3.42

EUR 3.09 1.05 3.88 2.46 3.90

JPY 0.99 0.73 0.69 1.27 0.99

CurrencyCurrency CorrelationCorrelation►The correlations among currency The correlations among currency

movements can be measured by their movements can be measured by their correlation coefficientscorrelation coefficients

► It indicates the degree to which two It indicates the degree to which two currencies move in relation to each othercurrencies move in relation to each other

Perfect positive correlationPerfect positive correlation

► (correlation coefficients)= (correlation coefficients)= 1.001.00Perfect negative correlationPerfect negative correlation

► (correlation coefficients)= (correlation coefficients)= - - 1.001.00

CURRENCY CORRELATIONCURRENCY CORRELATIONCURRENCY PAIR

1995-1997

1998-2000

2001-2003

2004-2005

USD GBPCADJPY

.15

.55

.67

.33

.66

.50

.23

.77

.69

-.15.88.65

GBP USDCADJPY

.15

.45

.35

.33

.87

.67

.23

.45

.34

-.15.87.39

CAD USDGBPJPY

.55

.45

.40

.25

.45

.67

JPY USDGBPCAD

.67

.35

.40

CORRELATIONCORRELATION

XX

%CHANGE%CHANGE YY

ZZ

TIME PERIODTIME PERIOD

Impact of Cash Flow and Impact of Cash Flow and Correlations on an MNCs Correlations on an MNCs

ExposureExposure

If the MNCs Expected Cash Flow Situation is:

And the Currencies are:

The MNCs Exposure is Relatively:

Pg: 305

Assessing transaction Assessing transaction exposureexposure

currency Total inflows Total outflows Current ex-rate in $

Danish krone(DK)

DK 50,000,000

DK 40,000,000

$ 0.15

GBP GBP 2,000,000

GBP 1,000,000

$ 1.50

Assume that the Movements in the Danish krone and 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)

The Net exposure to each The Net exposure to each currency in USD is derived currency in USD is derived

belowbelowForeign currency

Net inflows in foreign Currency

Current Ex-Rate

Value of Exposure

DK +DK 10,000,000

$ 0.15 $ 1,500,000

GBP +GBP 1,000,000

$ 1.50 $ 1,500,000

ECONOMIC ECONOMIC

EXPOSUREEXPOSURE

Definition Definition ““The degree to which a firm’s present The degree to which a firm’s present value of future cash flows can be value of future cash flows can be influenced by exchange rate fluctuations”.influenced by exchange rate fluctuations”.

Some of these affected cash flows do not Some of these affected cash flows do not require currency conversion.require currency conversion.

Even a purely domestic firm may be Even a purely domestic firm may be affected by economic exposure if it faces affected by economic exposure if it faces foreign competition in its local markets.foreign competition in its local markets.

Transactions that reflect transaction exposure

Economic Exposure to Exchange Rate Economic Exposure to Exchange Rate FluctuationsFluctuations

Firm’s exports denominated Decrease Increasein foreign currency

Interest owed on foreign funds Decrease Increaseborrowed

Transactions that Influence the Firm’s Cash Inflows

Local Currency Appreciates

Local Currency Depreciates

Local sales (relative to foreign Decrease Increasecompetition in local markets)Firm’s exports denominated Decrease Increasein local currency

Interest received from foreign Decrease Increaseinvestments

Firm’s imported supplies No change No changedenominated in local currency

Transactions that Influence the Firm’s Cash Outflows

Firm’s imported supplies Decrease Increasedenominated in foreign currency

FORMS OF ECONOMIC EXPOSURE TO EXCHANGE RATE FLUCTUATION

VARIABLES THAT INFLUENCE THE VARIABLES THAT INFLUENCE THE

LOCAL CURRENCY LOCAL CURRENCY INFLOWSINFLOWSIMPACT OF LOCAL IMPACT OF LOCAL CURRENCYCURRENCY

APPRECIATIONAPPRECIATION

IMPACT OF LOCAL IMPACT OF LOCAL CURRENCYCURRENCY

DEPPRECIATIONDEPPRECIATION

LOCAL SALES LOCAL SALES (RELATIVE TO FOREIGN COMPETITION IN (RELATIVE TO FOREIGN COMPETITION IN LOCAL MARKETS)LOCAL MARKETS)

FIRM’S EXPORTS FIRM’S EXPORTS DENOMINATED IN LOCAL CURRENCYDENOMINATED IN LOCAL CURRENCY

FIRM’S EXPORTS FIRM’S EXPORTS DENOMINATED IN FOREIGN CURRENCYDENOMINATED IN FOREIGN CURRENCY

INTEREST RECEIVED FROM FOREIGN INVESTMENTSINTEREST RECEIVED FROM FOREIGN INVESTMENTS

VARIABLES THAT INFLUENCE THE VARIABLES THAT INFLUENCE THE

LOCAL CURRENCY LOCAL CURRENCY OUTFLOWSOUTFLOWSFIRM’S IMPORTED SUPPLIES FIRM’S IMPORTED SUPPLIES (DENOMITED IN LOCAL (DENOMITED IN LOCAL CURRENCY)CURRENCY)

NO CHANGENO CHANGE NO CHANGENO CHANGE

FIRM’S IMPORTED SUPPLIES FIRM’S IMPORTED SUPPLIES (DENOMITED IN FOREIGN (DENOMITED IN FOREIGN CURRFENCY)CURRFENCY)

INTEREST OWED ON FOREIGN FUNDS BORROWEDINTEREST OWED ON FOREIGN FUNDS BORROWED

INFLOWSINFLOWS

VARIABLES THAT VARIABLES THAT INFLUENCE THE LOCAL INFLUENCE THE LOCAL

CURRENCY CURRENCY

Local currency APPRECIATION

LOCAL SALES LOCAL SALES (RELATIVE TO FOREIGN COMPETITION (RELATIVE TO FOREIGN COMPETITION

IN LOCAL MARKETS)IN LOCAL MARKETS)

CONSUMERS OF PAKISTAN WILL START CONSUMERS OF PAKISTAN WILL START BUYING FOREIGN PRODUCTSBUYING FOREIGN PRODUCTS

BECAUSEBECAUSE HOME CURRENCY HAS BECAME HOME CURRENCY HAS BECAME STRONGERSTRONGER

THEREFORE THEREFORE

LOCAL SALES WILL DECLINELOCAL SALES WILL DECLINEAND AS A RESULT THE INFLOW WILL AND AS A RESULT THE INFLOW WILL

DECLINEDECLINE

If APPRECIATIONIn Local currency

FIRM’S EXPORTSFIRM’S EXPORTS DENOMINATED IN LOCAL CURRENCYDENOMINATED IN LOCAL CURRENCY

FOR THE FOREIGNERS IMPORTS BECAME FOR THE FOREIGNERS IMPORTS BECAME EXPENSIVE EXPENSIVE

BECAUSE PAKISTANI CURRENCY HAS BECAUSE PAKISTANI CURRENCY HAS STRENGTHEN STRENGTHEN

SO FOREIGN IMPORTERS WILL STOP SO FOREIGN IMPORTERS WILL STOP BUYING PAKISTANI PRODUCTSBUYING PAKISTANI PRODUCTS

THEREFORE THE EXPORTS WILL DECLINETHEREFORE THE EXPORTS WILL DECLINE

AND AS A RESULT INFLOWS WILL AND AS A RESULT INFLOWS WILL

DECLINEDECLINE


FIRM’S EXPORTSFIRM’S EXPORTS DENOMINATED IN FOREIGN CURRENCYDENOMINATED IN FOREIGN CURRENCY

► WHEN PAKISTANI EXPORTER CONVERTS FOREIGN CURRENCY RECEIVED FROM EXPORTS IT WILL GET A FEW UNITS OF PAK RS

BECAUSEBECAUSE HOME CURRENCY HAS HOME CURRENCY HAS APPRECIATED APPRECIATED

►THE LOCAL CURRENCY INFLOWS THE LOCAL CURRENCY INFLOWS WILLWILL DECLINEDECLINE

►Therefore EXPORTS WILL Therefore EXPORTS WILL DECLINE DECLINE


INTEREST INTEREST RECEIVEDRECEIVED

FROM FOREIGN INVESTMENTSFROM FOREIGN INVESTMENTS► WHEN PAKISTANI INVESTOR CONVERTS

FOREIGN CURRENCY RECEIVED AS INTEREST OR DIVIDENDS

IT WILL GET A FEW UNITS OF PAK RS IT WILL GET A FEW UNITS OF PAK RS

BECAUSEBECAUSE HOME CURRENCY HAS HOME CURRENCY HAS APPRECIATEDAPPRECIATED

INTEREST RECEIVED will INTEREST RECEIVED will DECLINEDECLINE

LOCAL CURRENCY INFLOWS WILLLOCAL CURRENCY INFLOWS WILL DECREASEDECREASE


OUTFLOWSOUTFLOWS


CURRENCYCURRENCY

APPRECIATION

THERE WILL BE NO EFFECTTHERE WILL BE NO EFFECT

BECAUSEBECAUSE

PAKISTANI RS APPRECIATION WILL PAKISTANI RS APPRECIATION WILL NOT EVEN INCREASE NOT EVEN INCREASE OROR DECREASE DECREASE THE OUTFLOW THE OUTFLOW

HENCE THE OUTFLOW WILL REMAIN HENCE THE OUTFLOW WILL REMAIN SAME SAME

FIRM’S IMPORTED SUPPLIES

(DENOMITED IN LOCAL CURRENCY)If APPRECIATIONIn Local currency

FIRM’S IMPORTED FIRM’S IMPORTED SUPPLIESSUPPLIES

(DENOMITED IN FOREIGN (DENOMITED IN FOREIGN CURRFENCY)CURRFENCY)

MNC HAS TO PAY LESS MONEY FOR IMPORTSMNC HAS TO PAY LESS MONEY FOR IMPORTS

BECAUSEBECAUSE

PAK RS HAS STRENGTHEN PAK RS HAS STRENGTHEN IT WILL TAKE FEW UNITS OF PAK RS IT WILL TAKE FEW UNITS OF PAK RS

ANDAND

RECEIVE MORE UNITS OF FOREIGN CURRENCYRECEIVE MORE UNITS OF FOREIGN CURRENCY

HENCE THE PAK RS OUTFLOW WILL HENCE THE PAK RS OUTFLOW WILL

DECLINEDECLINE


INTEREST OWEDINTEREST OWED (ON FOREIGN FUNDS BORROWED)(ON FOREIGN FUNDS BORROWED)

MNC HAS TO PAY LESS MONEY FOR INTEREST MNC HAS TO PAY LESS MONEY FOR INTEREST

BECAUSEBECAUSE

PAK RS HAS STRENGTHENPAK RS HAS STRENGTHEN YOU WILL TAKE FEW UNITS OF PAK RS YOU WILL TAKE FEW UNITS OF PAK RS

ANDAND

RECEIVE MORE UNITS OF FOREIGN CURRENCYRECEIVE MORE UNITS OF FOREIGN CURRENCY

HENCE THE PAK RS OUTFLOW WILL HENCE THE PAK RS OUTFLOW WILL

DECLINEDECLINE

INFLOWSINFLOWS


CURRENCY CURRENCY

DEPRECIATION

LOCAL SALESLOCAL SALES (RELATIVE TO FOREIGN COMPETITION IN (RELATIVE TO FOREIGN COMPETITION IN

LOCAL MARKETS)LOCAL MARKETS)

. CONSUMERS OF PAKISTAN WILL START BUYING . CONSUMERS OF PAKISTAN WILL START BUYING LOCAL PRODUCTSLOCAL PRODUCTS

BECAUSEBECAUSE HOME CURRENCY HAS BECAME HOME CURRENCY HAS BECAME WEAKERWEAKER

THEREFORE LOCAL SALES WILL THEREFORE LOCAL SALES WILL INCREASEINCREASE

AND AS A RESULT THE INFLOW WILL AND AS A RESULT THE INFLOW WILL

INCREASEINCREASE

If DEPRECIATIONIn Local currency

FIRM’S EXPORTSFIRM’S EXPORTS DENOMINATED IN LOCAL CURRENCYDENOMINATED IN LOCAL CURRENCY

FOR THE FOREIGNERS IMPORTS BECAME CHEAPER FOR THE FOREIGNERS IMPORTS BECAME CHEAPER

BECAUSEBECAUSE PAKISTANI CURRENCY HAS WEAKENED PAKISTANI CURRENCY HAS WEAKENED

SO FOREIGN IMPORTERS WILL START BUYING SO FOREIGN IMPORTERS WILL START BUYING MORE PAKISTANI PRODUCTSMORE PAKISTANI PRODUCTS

THEREFORE THE EXPORTS WILL THEREFORE THE EXPORTS WILL INCREASEINCREASE

AND AS A RESULT INFLOWS WILL AND AS A RESULT INFLOWS WILL INCREASEINCREASE


FIRM’S EXPORTS FIRM’S EXPORTS DENOMINATED IN FOREIGN CURRENCYDENOMINATED IN FOREIGN CURRENCY

WHEN PAKISTANI EXPORTER CONVERTS WHEN PAKISTANI EXPORTER CONVERTS FOREIGN CURRENCY RECEIVED FROM EXPORTS FOREIGN CURRENCY RECEIVED FROM EXPORTS IT WILL GET MORE UNITS OF PAK RS IT WILL GET MORE UNITS OF PAK RS

BECAUSEBECAUSE FOREIGN CURRENCY HAS STRENGTHEN FOREIGN CURRENCY HAS STRENGTHEN

EXPORTS WILL EXPORTS WILL REMAIN SAMEREMAIN SAME

BUT THE LOCAL CURRENCY INFLOWS WILL BUT THE LOCAL CURRENCY INFLOWS WILL

INCREASEINCREASE


INTEREST RECEIVEDINTEREST RECEIVED

FROM FOREIGN INVESTMENTSFROM FOREIGN INVESTMENTS

WHEN PAKISTANI INVESTORS CONVERT WHEN PAKISTANI INVESTORS CONVERT FOREIGN CURRENCY RECEIVED AS INTEREST FOREIGN CURRENCY RECEIVED AS INTEREST OR DIVIDENDS IT WILL GET OR DIVIDENDS IT WILL GET MOREMORE UNITS OF UNITS OF PAK RS PAK RS

BECAUSEBECAUSE FOREIGN CURRENCY HAS BECOME FOREIGN CURRENCY HAS BECOME STRONGERSTRONGER

AMOUNT OF INTEREST IN FOREIGN CURRENCY AMOUNT OF INTEREST IN FOREIGN CURRENCY WILL WILL NOT CHANGENOT CHANGE

BUT THE LOCAL CURRENCY INFLOWS WILL BUT THE LOCAL CURRENCY INFLOWS WILL

INCREASEINCREASE


OUTFLOWSOUTFLOWS


CURRENCY CURRENCY

DEPRECIATION

FIRM’S IMPORTED SUPPLIESFIRM’S IMPORTED SUPPLIES

(DENOMITED IN LOCAL CURRENCY)(DENOMITED IN LOCAL CURRENCY)THERE WILL BE NO EFFECTTHERE WILL BE NO EFFECT

BECAUSE PAKISTANI RS DEPRECIATION BECAUSE PAKISTANI RS DEPRECIATION WILL NOT EVENWILL NOT EVEN

INCREASE OR DECREASE THE OUTFLOWS INCREASE OR DECREASE THE OUTFLOWS

HENCE THE OUTFLOWS WILL REMAIN HENCE THE OUTFLOWS WILL REMAIN SAMESAME


FIRM’S IMPORTED SUPPLIESFIRM’S IMPORTED SUPPLIES (DENOMITED IN FOREIGN CURRFENCY)(DENOMITED IN FOREIGN CURRFENCY)

NOW YOU WILL PAY NOW YOU WILL PAY MOREMORE MONEY FOR IMPORTS MONEY FOR IMPORTS

BECAUSEBECAUSE PAK RS HAS WEAKENED PAK RS HAS WEAKENED

YOU WILL TAKE YOU WILL TAKE MOREMORE UNITS OF PAK RS UNITS OF PAK RS

ANDAND

RECEIVE RECEIVE LESSLESS UNITS OF FOREIGN CURRENCY UNITS OF FOREIGN CURRENCY

HENCE THE PAK RS OUTFLOWS WILL HENCE THE PAK RS OUTFLOWS WILL

INCREASEINCREASE


INTEREST OWEDINTEREST OWED ON FOREIGN FUNDS BORROWEDON FOREIGN FUNDS BORROWED

NOW YOU WILL NOW YOU WILL PAY MORE PAY MORE MONEY IN INTERESTMONEY IN INTEREST

((INTEREST REMAINS THE SAMEINTEREST REMAINS THE SAME))BECAUSEBECAUSE PAK RS HAS WEAKENED PAK RS HAS WEAKENED YOU WILL TAKE YOU WILL TAKE MOREMORE UNITS OF PAK RS UNITS OF PAK RS

ANDAND

RECEIVE RECEIVE LESSLESS UNITS OF FOREIGN CURRENCY UNITS OF FOREIGN CURRENCY

HENCE THE PAK RS OUTFLOW WILL HENCE THE PAK RS OUTFLOW WILL INCREASEINCREASE


INDIRECT ECONOMIC INDIRECT ECONOMIC EXPOSUREEXPOSURE

Eg: FIRM’S IMPORTED SUPPLIESEg: FIRM’S IMPORTED SUPPLIES (DENOMITED IN LOCAL CURRFENCY)(DENOMITED IN LOCAL CURRFENCY)

THERE WILL BE THERE WILL BE NO AFFECT NO AFFECT ON THE ON THE OUTFLOWSOUTFLOWS

BECAUSE PAK RS HAS WEAKENEDBECAUSE PAK RS HAS WEAKENED

BUT BUT THE US EXPORTER IS AFFECTEDTHE US EXPORTER IS AFFECTED

US EXPORTER WILL RECEIVE LESS UNITS OF US EXPORTER WILL RECEIVE LESS UNITS OF PAK RS PAK RS

THEREFORETHEREFORE

IT WILL CHARGE MORE MONEY NEXT TIME IT WILL CHARGE MORE MONEY NEXT TIME

ECONOMIC EXPOSURE OF ECONOMIC EXPOSURE OF DOMESTIC FIRMDOMESTIC FIRM

► FIRM SELLING ITS PRODUCT IN LOCAL MARKET WILL BE AFFECTED

► IF THERE IS FOREIGN PRODUCT IN THE MARKET

► WHEN THE LOCAL CURRENCY APPRECIATES

► THE FOREIGN PRODUCT WILL BECOME CHEAP

► CUSTOMERS WILL SHIFT TO BUY MORE FOREIGN PRODUCTS

ECONOMIC EXPOSURE OF ECONOMIC EXPOSURE OF MNCMNC

►GENERAL MOTORS Co. USED TO SELL GENERAL MOTORS Co. USED TO SELL SOFTWARE PRODUCTS TO MEXICOSOFTWARE PRODUCTS TO MEXICO

►MXP DEPRECIATED BY 40%MXP DEPRECIATED BY 40%

AS A RESULTAS A RESULT►SOFTWARE DEMAND DECLINEDSOFTWARE DEMAND DECLINED

World Example

EVALUATION OF MNC’S SENSITIVITY EVALUATION OF MNC’S SENSITIVITY

TO EXCHANGE RATETO EXCHANGE RATE

► Regression Analysis could help to determine Regression Analysis could help to determine whether a particular policy has : whether a particular policy has :

ReducedReduced OrOr

IncreasedIncreased► MNC s exposureMNC s exposure

a a REGRESSION ANALISISREGRESSION ANALISIS

rrss = = aaoo + + aa11 PAK-PAK-SISI + + aa22 EEWhere:Where:

rrs s = % = % change in the stock price of the company change in the stock price of the company

PAK-SIPAK-SI = % = % change in Pak stock Index change in Pak stock Index

EE == % % change in foreign currency change in foreign currency

Regression coefficients :Regression coefficients :

aaoo== ConstantConstant

aa11= % = % change in company value sensitivity to % change in PAK- change in company value sensitivity to % change in PAK-ISIS

aa22== % % change in company value sensitivity to % change in E change in company value sensitivity to % change in E

aa SENSETIVITY OF A COMPANY’S STOCK VALUE TO SENSETIVITY OF A COMPANY’S STOCK VALUE TO

CURRENCY MOVEMENTS BASED ON REGRESSION CURRENCY MOVEMENTS BASED ON REGRESSION

ANALYSISANALYSIS CURRENCYCURRENCY REGRESSION COEFFICIENT REGRESSION COEFFICIENT

aa22

EARLIER SUBPERIODEARLIER SUBPERIOD

REGRESSION COEFFICIENT REGRESSION COEFFICIENT

aa22

MORE RECENT SUBPERIODMORE RECENT SUBPERIOD

CANADIAN $CANADIAN $ -0.81-0.81 -0.06-0.06

FRENCH FRENCH FRANCFRANC 0.050.05 0.050.05

EURO CEURO C -0.73-0.73 -0.01-0.01

JAPAN YJAPAN Y -0.26-0.26 -0.27-0.27

b b REGRESSION ANALISISREGRESSION ANALISIS rrss = = bboo + + bb11 PAK-PAK-SISI + + bb2 2 CADCAD ++ bb3 3 USDUSD + + bb4 4 GBPGBP ++ bb5 5 EUREUR

Where:Where:

rrs s = % = % change in the stock price of the company change in the stock price of the company

PAK-SIPAK-SI = % = % change in Pak stock Index change in Pak stock Index

CADCAD , , USDUSD , , GBPGBP , , EUREUR = % = % change in foreign currency change in foreign currency


bboo== ConstantConstant

bb11= % = % change in company value sensitive to % change in PAK-IS change in company value sensitive to % change in PAK-IS

bb22== % % change in company value sensitive to % change in Foreign currency change in company value sensitive to % change in Foreign currency

bb SENSETIVITY OF A COUNTRY’S STOCK VALUE TO SENSETIVITY OF A COUNTRY’S STOCK VALUE TO

COUNTRY ECONOMIES BASED ON REGRESSION COUNTRY ECONOMIES BASED ON REGRESSION ANALYSISANALYSIS

STOCK INDEX OF STOCK INDEX OF ::


EARLIER SUBPERIODEARLIER SUBPERIOD


MORE RECENT SUBPERIODMORE RECENT SUBPERIOD

CANADACANADA 0.50.5 0.70.7

FRANCEFRANCE 0.10.1 0.10.1

GERMANYGERMANY 0.90.9 1.41.4

JAPAN JAPAN 0.30.3 0.80.8

To assess how the MNC is influenced To assess how the MNC is influenced by economic conditions of foreign by economic conditions of foreign

countriescountries► The result will indicate a Company’s economic

exposure due to the change in the economic conditions of each country.

► There are several possibilities :

GNP NI But these variables do not indicate anticipated

future conditions of economy

So the best measure is the foreign country’s stock index

CC REGRESSION ANALISIS REGRESSION ANALISIS

rrss = = ccoo + + cc11 HIHI + + cc22 FIFIWhere:Where:

rrs s = = Return of the company’s stockReturn of the company’s stock

HIHI = = the return on the home stock Indexthe return on the home stock Index

FIFI = = the return on the foreign stock Indexthe return on the foreign stock Index


ccoo== ConstantConstant

cc11= % = % change in company value sensitive to % change in home-IS change in company value sensitive to % change in home-IS

cc22== % % change in company value sensitive to % change in foreign-IS change in company value sensitive to % change in foreign-IS

TRANSLATION

EXPOSURE

DEFINITIONDEFINITION“The exposure of the MNC s consolidated

financial statements to exchange rate fluctuation is known as accounting or translation exposure”

►The risk that the company equities, assets, liabilities or income will change in value as a result of exchange rate changes.

►This occurs when a firm denominates its equities, assets, liabilities or income in a foreign currency

►In many cases this exposure will be recorded in the financial statement as an exchange rate gain (or loss)

► The MNC s where great business is conducted in foreign subsidiaries

ThenHigher will be the chance of translation

exposure

► The MNC s where foreign business is in the shape of exports

ThenLess will be the chance of translation

exposure

FOUR METHODS OF FOUR METHODS OF TRANSLATIONTRANSLATION

A. Current/Noncurrent MethodB. Monetary/Nonmonetary Method

C. Temporal Method D. Current Rate Method

A. Current/Noncurrent Method

1.Current accounts use current exchange rate

for conversion.

2. Income statement accounts use average exchange rate for the period.

B. Monetary/Nonmonetary Method

1. Monetary accounts use current rate

Includes:- cash- accounts receivable- accounts payable- long term debt

B. Monetary/Nonmonetary Method

2. Nonmonetary accounts use historical ratesIncludes: Inventory

fixed assetslong term investments

3. Income statement accounts use average exchange rate

--- for the period.

C. Temporal Method

1. Similar to monetary/nonmonetary

method.2. Uses current method for inventory.

D. Current Rate Method all statements use current

exchange rate for conversions

EXCHANGE RATES USED IN VARIOUS EXCHANGE RATES USED IN VARIOUS TRANSLATION METHODS TRANSLATION METHODS (C=(C=currentcurrent , ,

H=H=historicalhistorical))

ACCOUNTS TITLESACCOUNTS TITLES CURRENTNON- CURRENT

TEMPORAL MONETARYNON-MONETARY

CURRENT

CASH CURRENT CASH CURRENT RECEIVABLES & RECEIVABLES &

PAYBLESPAYBLES

CC CC CC CC

INVENTORYINVENTORY CC C or HC or H HH CC

FIXED ASSENTS LONG-TERMFIXED ASSENTS LONG-TERM HH HH HH CC

RECEIVABLES & PAYABLESRECEIVABLES & PAYABLES HH CC CC CC

65

FASB 52 FASB 52 (STATEMENT OF (STATEMENT OF FINANCIAL ACCOUNTING STANDARDS FINANCIAL ACCOUNTING STANDARDS

NO. 52)NO. 52)Many of the important consolidated accounting rules for US based MNCs are based on FASB 52

66

STATEMENT OF FINANCIAL STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 52ACCOUNTING STANDARDS NO. 52

Balance sheet translation uses current rate method.

67

STATEMENT OF FINANCIAL ACCOUNTING STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 52STANDARDS NO. 52

Income statement uses1. Weighted average rate

during period or

2. The rate in effect when revenue and expensesincurred.

68


Translation Gains or Losses

1. Recorded in separate equity

account on balance sheet.

2. Known as cumulative

translation adjustment

account.

69


Functional currency

For foreign subsidiary it is the

currency used in the primary economic

environment in which it operates.

70


2. Reporting currency the currency the parent firm uses to prepare its financial

statements.

Documents

IFM ch-10