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PART V. AN OPERATIONAL MEASURE OF EXCHANGE RISK

PART V. AN OPERATIONAL MEASURE OF EXCHANGE RISK

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AN OPERATIONAL MEASURE OF

EXCHANGE RISK

B. REGRESSION EQUATION

-approach based on the operational

definition of the exchange risk faced by a

parent or one of its affiliates:

-a company faces exchange risk to the

extent that variations in the dollar value

of the unit’s cash flows are correlated

with variations in the nominal exchange

rate

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AN OPERATIONAL MEASURE OF

EXCHANGE RISK



CFt a  EXCH t  ut

where CFt =

CFt - CFt-1 and

CFt is the dollar

value of total affiliate(parent)cash

flows in period t

EXCHt =

EXCHt - EXCHt-1 equals the

average

nominal exchange rate during period t

u = a random error term

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AN OPERATIONAL MEASURE OF

EXCHANGE RISK

1. Output measures:

a. Beta coefficient (

measures the association

of

changes in cash flows

to

exchange rate

changes.

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AN OPERATIONAL MEASURE OF

EXCHANGE RISK

b.



the higher the percentage

change of cash flow to

changes in exchange rates,

the greater the economic

exposure (higher beta

values).



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AN OPERATIONAL MEASURE OF

EXCHANGE RISK

VI. SUMMARY:

A. The focus of the accounting

profession on the balance sheet

impact of currency changes has led

to ignoring the important

impact

on future cash flows.



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AN OPERATIONAL MEASURE OF

EXCHANGE RISK

B.



For firms incurring costs and selling

products in foreign countries,

the net

effect of currency

changes may be less

important in

the long run.



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AN OPERATIONAL MEASURE OF

EXCHANGE RISK

C.



To measure exposure properly, you

must focus on inflation-adjusted or

real

exchange rates instead of

nominal or

actual exchange

rates.



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AN OPERATIONAL MEASURE OF

EXCHANGE RISK

D. It is difficult in practice to

determine

what the actual

economic impact of a

currency

change will be.



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PART VI. MANAGING OPERATING

EXPOSURE

I. INTRODUCTION

Operating exposure management

requires

long-term operating adjustments.

A. Real v. Nominal Changes

1. Relative price changes

leads to marketing and/or

production revisions

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MANAGING OPERATING EXPOSURE

B. Proactive Marketing and Production

Initiatives

1. Marketing:

market selection

product strategy

pricing strategy

promotional strategy

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MANAGING OPERATING EXPOSURE

B. Proactive Marketing and Production

Initiatives (con’t)

2. Production:

product sourcing

input mix

plant location

raising productivity

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PART V. AN OPERATIONAL MEASURE OF EXCHANGE RISK

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