Page 169 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes 10.2 Measuring Economic Exposure

The degree of economic exposure to exchange rate fluctuations is significantly higher for a firm
involved in international business than for a purely domestic firm. Assessing the economic
exposure of an MNC is difficult due to the complex interaction of funds that flow into, out of and
within the MNC. Yet, economic exposure is crucial to operations of the firm in the long-run. If
an MNC has subsidiaries around the world, each subsidiary will be affected differently by
fluctuations in currencies. Thus, attempts by the MNC to measure its economic exposure would
be extremely complex.
One method of measuring an MNC’s economic exposure is to classify the cash flows into different
items on the income statement and predict movement of each item in the income statement
based on a forecast of exchange rates. This will help in developing an alternative exchange rate
scenario and the forecasts for the income statement items can be revised. By assessing how the
earnings forecast in the income statement has changed in response to alternative exchange rate
scenarios, the firm can assess the influence of currency movements on earnings and cash flows.

10.2.1 Managing Economic Exposure

The following are some of the proactive marketing and production strategies which a firm can
pursue in response to anticipated or actual real exchange rate changes.
Marketing Initiatives

Marketing initiatives include the following:
Market Selection: Major strategy considerations for an exporter are the markets in which
to sell, i.e., market selection. It is also necessary to consider the issue of market segmentation
with individual countries. A firm that sells differentiated products to more affluent
customers may not be harmed as much by a foreign currency devaluation as will a mass
marketer. On the other hand, following a depreciation of the home currency, a firm that
sells primarily to the upper income group may now find itself able to penetrate mass
markets abroad.
Pricing Strategy Market Share versus Profit Margin: In the wake of the rising dollar, a US
firm selling overseas or competing at home against foreign imports faces a Hobson’s
choice: does it keep its dollar price constant to preserve its profit margin and thereby lose
sales volume or does it cut its dollar price to maintain market share and, thereby, suffer a
reduced profit margin? Conversely, does the firm use a weaker dollar to regain lost
ground or does it use the weak dollar to raise prices and recoup losses incurred from the
strong dollar?
To begin the analysis, a firm selling overseas should follow the standard economic
proposition of setting the price that maximises dollar profits (by equating marginal
revenues and marginal costs). In making this decision, however, profits should be translated
using the forward exchange rate that reflects the true expected dollar value of the receipts
upon collection.
Following appreciation of the dollar, which is equivalent to foreign currency devaluation,
a firm selling overseas should consider opportunities to increase the foreign currency
prices of its products. The problem, of course, is that local producers now will have a
competitive cost advantage, limiting an exporter’s ability to recoup dollar profits by
raising foreign currency selling prices.
Promotional Strategy: Promotional strategy should take into account anticipated exchange
rate changes. A key issue in any marketing programme is the size of the promotional
budget.

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