1. Managing Economic Exposure and Translation Exposure
C H A P T E R 12
Managing Economic Exposure and Translation Exposure

2. Chapter Overview A. Economic Exposure
B. A Case Study in Hedging Economic Exposure
C. Hedging Exposure to Fixed Assets
D. Managing Translation Exposure

3. Chapter 12 Objectives This chapter will:
A. Explain how an MNC’s economic exposure can be hedged
B. Explain how an MNC’s translation exposure can be hedged

4. A. Economic Exposure
1. Use of the Income Statement to Assess Economic Exposure
2. How Restructuring Can Reduce Economic Exposure
a. Expediting the Analysis with Computer Spreadsheets

5. A. Economic Exposure
12.3
Economic Exposure Based on the Original and Proposed Operating Structures

6. A. Economic Exposure 3. Issues Involved in the Restructuring Decision
• Should the firm attempt to increase or reduce sales in new or existing foreign markets?
• Should the firm increase or reduce its dependency on foreign suppliers?
• Should the firm establish or eliminate production facilities in foreign markets?
• Should the firm increase or reduce its level of debt denominated in foreign currencies?

7. B. A Case Study in Hedging Economic Exposure
1. Savor Co.’s Dilemma
2. Assessment of Economic Exposure
3. Assessment of Each Unit’s Exposure
4. Identifying the Source of the Unit’s Exposure

8. B. A Case Study in Hedging Economic Exposure
5. Possible Strategies to Hedge Economic Exposure
a. Pricing Policy
b. Hedging with Forward Contracts
c. Purchasing Foreign Supplies
d. Financing with Foreign Funds
e. Revising Operations of other Units

9. B. A Case Study in Hedging Economic Exposure
6. Savor’s Hedging Solutions
7. Limitations of Savor’s Optimal Hedging Strategy

10. C. Hedging Exposure to Fixed Assets
When an MNC has fixed assets (such as buildings or machinery) in a foreign country, the dollar cash flows to be received from the ultimate sale of the assets is subject to exchange
rate risk.

11. D. Managing Translation Exposure
1. Use of Forward Contracts to Hedge Translation Exposure
a. use forward contracts or futures contracts to hedge translation exposure
b. sell the currency forward that their foreign subsidiaries receive as earnings
c. Result: create a cash outflow in the currency to offset the earnings received in that currency

12. D. Managing Translation Exposure
2. Limitations of Hedging Translation Exposure
a. Inaccurate Earnings Forecasts
b. Inadequate Forward Contracts for Some Currencies
c. Accounting Distortions
d. Increased Transaction Exposure