Page 178 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 10: Management of Operating/Economic Exposure

10.5 Summary Notes

Economic exposure is the risk that a variation in the rate will affect the company’s
competitive position in the market and hence its profits.

Economic exposure can be managed by balancing the sensitivity of revenue and expenses
to exchange rate fluctuations.

Transaction exposure differs from economic exposure in that the former is essentially
objective while the later is subjective as it depends on estimated future cash flows for an
arbitrary time horizon.
The various techniques for mechanizing economic exposure are leading and lagging,
currency swap, credit swap, parallel financing and by diversification of the firm’s operating
base strategy and financing base strategy.
Economic exposure can be managed by a combination of marketing and production
initiatives. However a lot depends on the corporate philosophy of a company specifically
its attitude towards risk.
Thus, it is necessary to formulate a strategy to deal with economic exposure as without a
clearly defined strategy it may become difficult to make the right decisions.

10.6 Keywords

Call Option: Call option gives the buyer the right, but not the duty, to purchase an underlying
asset, reference rate or index at a particular price before a specified date.
Currency Future: Currency future is the price of a particular currency for settlement at a specified
future date.

Currency Swap: It is referred to a simple swap of currencies between two firms in two countries.
A currency swap stays off the books because it does not involve interest, gains, or losses.
Interest Rate Swap: An interest rate swap is a contractual agreement entered into between two
counterparties under which each agrees to make periodic payment to the other for an agreed
period of time based upon a national amount of principal.
Leading and Lagging: It is a technique that manipulates accounts receivable and accounts payable
to take advantage of exchange rate fluctuations.
Money Market Hedge: Money market hedge involves simultaneous borrowing and lending
activities in two different currencies to lock in the home currency value of a future foreign
currency cash flow.

Netting: Netting is a technique of optimizing cash flow movements with the joint efforts of
subsidiaries.
Put Option: Put option gives the buyer the ability, but not the obligation, to sell an underlying
asset, reference rate, or index at a particular price to a specified date.

10.7 Review Questions

1. How does inflation affect a country’s currency value? Is it a good idea to borrow or obtain
financing in a country with high inflation?

2. What are leading and lagging and how should they be employed with regard to payment
and collection?

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