Reference no: EM13798331

Part 1

1. Transaction versus Economic Exposure. Compare and contrast transaction exposure and economic exposure. Why would an MNC consider examining only its "net" cash flows in each currency when assessing its transaction exposure?

2. Currency Effects on Cash Flows. How should appreciation of a firm's home currency generally affect its cash inflows? How should depreciation of a firm's home currency generally affect its cash outflows?

3. Measuring Changes in Economic Exposure. Toyota Motor Corp. measures the sensitivity of its exports to the yen exchange rate (relative to the U.S. dollar). Explain how regression analysis could be used for such a task. Identify the expected sign of the regression coefficient if Toyota primarily exports to the United States. If Toyota established plants in the United States, how might the regression coefficient on the exchange rate variable change?

4. Transaction Exposure. Vegas Corp. is a U.S. firm that exports most of its products to Canada. It historically invoiced its products in Canadian dollars to accommodate the importers. However, it was adversely affected when the Canadian dollar weakened against the U.S. dollar. Since Vegas did not hedge, its Canadian dollar receivables were converted into a relatively small amount of U.S. dollars. After a few more years of continual concern about possible exchange rate movements, Vegas called its customers and requested that they pay for future orders with U.S. dollars instead of Canadian dollars. At this time, the Canadian dollar was valued at $.81. The customers decided to oblige, since the number of Canadian dollars to be converted into U.S. dollars when importing the goods from Vegas was still slightly smaller than the number of Canadian dollars that would be needed to buy the product from a Canadian manufacturer. Based on this situation, has transaction exposure changed for Vegas Corp.? Has economic exposure changed? Explain.

Part 2

1. Hedging with Forward Contracts. Explain how a U.S. corporation could hedge net receivables in Malaysian ringgit with a forward contract.

Explain how a U.S. corporation could hedge payables in Canadian dollars with a forward contract.

2. Potential Effects if the United Kingdom Adopted the Euro. The U.K. still has its own currency, the pound. The pound's interest rate has historically been higher than the euros interest rate. The U.K. has considered adopting the euro as its currency. There have been many arguments about whether it should do so.

Use your knowledge and intuition to discuss the likely effects if the United Kingdom adopts the euro. For each of the 10 statements below, insert either INCREASE or DECREASE and complete the statement by adding a clear short explanation (perhaps one to three sentences) of why the U.K.'s adoption of the euro would have that effect.

To help you narrow your focus, follow these guidelines. Assume that the pound is more volatile than the euro. Do not base your answer on whether the pound would have been stronger than the euro in the future. Also, do not base your answer on an unusual change in economic growth in the U.K. or in the euro zone if the euro is adopted.

Part 3

1. Exchange Rate Effects on Earnings. Explain how a U.S.-based MNC's consolidated earnings are affected when foreign currencies depreciate.

2. Comparing Degrees of Translation Exposure. Nelson Co. is a U.S. firm with annual export sales to Singapore of about S$800 million. Its main competitor is Mez Co., also based in the United States, with a subsidiary in Singapore that generates about S$800 million in annual sales. Any earnings generated by the subsidiary are reinvested to support its operations. Based on the information provided, which firm is subject to a higher degree of translation exposure? Explain.

3. Assessing Economic Exposure. Alaska Inc. plans to create and finance a subsidiary in Mexico that produces computer components at a low cost and exports them to other countries. It has no other international business. The subsidiary will produce computers and export them to Caribbean islands and will invoice the products in U.S. dollars. The values of the currencies in the islands are expected to remain very stable against the dollar. The subsidiary will pay wages, rent, and other operating costs in Mexican pesos. The subsidiary will remit earnings monthly to the parent.

a. Would Alaska's cash flows be favorably or unfavorably affected if the Mexican peso depreciates over time?

b. Assume that Alaska considers partial financing of this subsidiary with peso loans from Mexican banks instead of providing all the financing with its own funds. Would this alternative form of financing increase, decrease, or have no effect on the degree to which Alaska is exposed to exchange rate movements of the peso?

4. Hedging Continual Exposure. Consider this common real-world dilemma by many firms that rely on exporting. Clearlake Inc. produces its products in its factory in Texas, and exports most of the products to Mexico each month. The exports are denominated in pesos. Clearlake Inc. recognizes that hedging on a monthly basis does not really protect against long-term movements in exchange rates. It also recognizes that it could eliminate its transaction exposure by denominating the exports in dollars, but that it still would have economic exposure (because Mexican consumers would reduce demand if the peso weakened). Clearlake Inc. does not know how many pesos it will receive in the future, so it would have difficulty even if a long-term hedging method were available. How can Clearlake realistically deal with this dilemma and reduce its exposure over the long-term? [There is no perfect solution, but in the real world, there rarely are perfect solutions.]