Foreign Exposure

Exchange rate changes can affect an MNC’s cash flows which in turn affect its performance and firm value. MNCs measure their exposure to exchange risk so they can decide how to hedge that risk.

Transaction exposure is the exposure of an MNC’s contractual transactions to exchange rate movements. Economic exposure is any exposure of an MNC’s cash flows to exchange rate movements. Translation exposure is the exposure of an MNC’s consolidated financial statements to exchange rate movements.

In this assignment, explore ways the MNCs manage each exposure outlined in the module.

Part 1

In Part 1 of the project, write an essay that includes the discussions on the following questions:How do you define transaction exposure? Explain the differences between transaction exposure and economic exposure in detail.MNCs can hedge transaction exposure with forward contracts or money market instruments. Explain the differences in these two approaches.What advantages does a currency options contract have as a hedging tool compared with a forward contract?Should a firm hedge? Explain.

Part 2

In Part 2 of the project, analyze the following case studies.Assume that you rent an apartment in London. As a U.S. resident, you are concerned with the dollar value of the rent. If the British economy booms in the future, the rent will increase to £2,000, and one British pound will be worth $1.42. If the British economy slows down, on the other hand, the rent will fall to £1,500, but the pound will be stronger, i.e., $1.52/£. You feel that the British economy will experience a boom with a 60% probability and a recession with a 40% probability.What is your exposure coefficient, b (include your calculations)? What does the value imply?Based on your b, how can you hedge your exchange risk exposure? Explain.At this time, sporting goods exporter Sports Exports receives payments in British pounds for the monthly exports it sends to the United Kingdom. Although all of its receivables are denominated in pounds, it has no payables in pounds or any other foreign currency. Sports Exports wants to assess the firm’s exposure to exchange rate risk.Does the company face transaction, economic, or translation exposure? Explain.If the company changes the pricing policy so that the importer must pay in dollars (no more pound-to-dollar conversions), does it eliminate any of exposure you listed in part a)? Explain.

Your submission should be at least four pages total for both parts plus a reference page for Part 1 in Microsoft Word, APA formatted, and with correct grammar.


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