The impact of a change in the exchange rate on

the value of the firm.

How does the change in exchange rate affect the
long term cash flows of a company?
How do you predict it?
How do you measure it?
Planning for Economic Exposure is a total
management responsibility: Interaction of
finance, marketing, purchasing and production
functions will help development of the strategies
to manage Economic Exposure.
No change in terms of parent currency
Volume increases because the product
becomes cheaper other things remaining
constant
Price becomes lower-other things remaining
constant.
A combination is more likely. What will be
the overall impact?
Introduction of a product- delayed, rushed?
Accessing a new market-delayed, rushed?
Sourcing
Diversifying operation
Preference for setting up subsidiaries with negative
(low) correlation in growth.
Sourcing issues for critical material
Sourcing financing
Parent country or host country?
How do you minimize exposure
Matching currency cash flows:
You expect the subsidiary to generate a certain
amount of cash flows per month (local currency). If you
used local financing for initial investment, then
payment obligation will be in local currency and your
exposure will be reduced.
Source required material for global operation from the
subsidiarys country. Subsidiarys inflow can be
matched with the required outflow. Net amount
remains exposed. (Natural hedge)
Enter into agreements with suppliers who will accept
subsidiary currency for payment.

How do you minimize exposure
Risk Sharing (long-term buyer-supplier
relationship):
Suppose you have a 5 year supply contract. Present
cost 5,000,000 of local currency per year. You have
projected exchange rate for 5 years based on
inflation expectation data. Identify a band for
future exchange rates. If actual exchange rate is
outside the band, the loss of the losing party is
shared half by the gaining party.
4. British Firms Dutch Subsidiary
borrows Euros from Dutch Parent
1. British firm wishes
to invest in Dutch
Subsidiary
2. British firm identifies
a Dutch firm wishing to
invest in a British
Subsidiary
British
Parent Firm
Dutch
Parent Firm
Dutch
Firms
British
Subsidiary
British
Firms
Dutch
Subsidiary
3. British Firm loans British Pounds
directly to Dutch firms British
Subsidiary




Sales to US Debt in Yen




Sales to Japan Debt in US $


Japanese Corporation
US Corporation
Assets Liabilities
Inflow In
US $
Assets Liabilities
Inflow in
Yen
Swap
Dealer
Pay Dollars
Receive Yen
Pay Yen
Receive
Dollars
Leading: Pay sooner to avoid an appreciation
Lagging: Delay payment to take advantage of
a devaluation.

There are usually limits on how far you can
lead and lag

Intra-company
Intercompany
A separate Corporate subsidiary that serves
as a middleman
Paper work through the reinvoicing center. Actual
flow of goods normal.
Benefits:
Exposure Netting
Guaranteeing Exchange Rates for Future Orders
Managing Intra-Subsidiary cash flows
Subsidiary W to pay $38,000 to Subsidiary X
by the end of September
Subsidiary X to pay Subsidiary Y $49,000 by
September 22
Subsidiary Y to pay Subsidiary W $62,000 by
September 28
Subsidiary X to pay Subsidiary Z $55,000 by
September 25
Subsidiary Z to pay Subsidiary Y $70,000 by
September 20
Receiving SubsidiaryW X Y Z
Paying
Subsidiary Total
w 38000 38000
x 49000 55000 104000
y 62000 62000
z 70000 70000
Total 62000 38000 119000 55000 274000
Pay Receive Net
w 38000 62000 24000
x 104000 38000 -66000
y 62000 119000 57000
z 70000 55000 -15000
Total 274000