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1、Chapter 10Transaction Exposure 2013 Pearson Education, Inc. All rights reserved. 10-2 Transaction ExposureForeign exchange exposure is a measure of the potential for a firms profitability, net cash flow, and market value to change because of a change in exchange rates.An important task of the financ
2、ial manager is to measure foreign exchange exposure and to manage it so as to maximize the profitability, net cash flow, and market value of the firm.The effect on a firm when foreign exchange rates change can be measured in several ways.Exhibit 10.1 shows schematically the three main types of forei
3、gn exchange exposure: transaction, translation, and operating. 2013 Pearson Education, Inc. All rights reserved. 10-3 Exhibit 10.1 Corporate Foreign Exchange Exposure 2013 Pearson Education, Inc. All rights reserved. 10-4 Types of Foreign Exchange ExposureTransaction exposure measures changes in the
4、 value of outstanding financial obligations incurred prior to a change in exchange rates but not due to be settled until after the exchange rates change.Thus, this type of exposure deals with changes in cash flows the result from existing contractual obligations. 2013 Pearson Education, Inc. All rig
5、hts reserved. 10-5 Types of Foreign Exchange ExposureOperating exposure, also called economic exposure, competitive exposure, or strategic exposure, measures the change in the present value of the firm resulting from any change in future operating cash flows of the firm caused by an unexpected chang
6、e in exchange rates. 2013 Pearson Education, Inc. All rights reserved. 10-6 Types of Foreign Exchange ExposureTransaction exposure and operating exposure exist because of unexpected changes in future cash flows. The difference between the two is that transaction exposure is concerned with future cas
7、h flows already contracted for, while operating exposure focuses on expected (not yet contracted for) future cash flows that might change because a change in exchange rates has altered international competitiveness. 2013 Pearson Education, Inc. All rights reserved. 10-7 Types of Foreign Exchange Exp
8、osureTranslation exposure, also called accounting exposure, is the potential for accounting-derived changes in owners equity to occur because of the need to “translate” foreign currency financial statements of foreign subsidiaries into a single reporting currency to prepare worldwide consolidated fi
9、nancial statements. 2013 Pearson Education, Inc. All rights reserved. 10-8 Why Hedge?MNEs possess a multitude of cash flows that are sensitive to changes in exchange rates, interest rates, and commodity prices.These three financial price risks are the subject of the growing field of financial risk m
10、anagement.Many firms attempt to manage their currency exposures through hedging. 2013 Pearson Education, Inc. All rights reserved. 10-9 Why Hedge?Hedging is the taking of a position, acquiring either a cash flow, an asset, or a contract (including a forward contract) that will rise (fall) in value a
11、nd offset a fall (rise) in the value of an existing position.While hedging can protect the owner of an asset from a loss, it also eliminates any gain from an increase in the value of the asset hedged against. 2013 Pearson Education, Inc. All rights reserved. 10-10 Why Hedge?The value of a firm, acco
12、rding to financial theory, is the net present value of all expected future cash flows.The fact that these cash flows are expected emphasizes that nothing about the future is certain.Currency risk is defined roughly as the variance in expected cash flows arising from unexpected exchange rate changes.
13、A firm that hedges these exposures reduces some of the variance in the value of its future expected cash flows.Exhibit 10.2 illustrates the distribution of expected net cash flows of the individual firm. 2013 Pearson Education, Inc. All rights reserved. 10-11 Exhibit 10.2 Hedgings Impact on the Expe
14、cted Cash Flows of the Firm 2013 Pearson Education, Inc. All rights reserved. 10-12 Why Hedge?However, is a reduction in the variability of cash flows sufficient reason for currency risk management? Opponents of hedging state (among other things):Shareholders are much more capable of diversifying cu
15、rrency risk than the management of the firmCurrency risk management does not increase the expected cash flows of the firmManagement often conducts hedging activities that benefit management at the expense of the shareholders (agency conflict)Managers cannot outguess the market 2013 Pearson Education
16、, Inc. All rights reserved. 10-13 Why Hedge?Proponents of hedging cite:Reduction in risk in future cash flows improves the planning capability of the firmReduction of risk in future cash flows reduces the likelihood that the firms cash flows will fall below a necessary minimum (the point of financia
17、l distress)Management has a comparative advantage over the individual shareholder in knowing the actual currency risk of the firmManagement is in better position to take advantage of disequilibrium conditions in the market 2013 Pearson Education, Inc. All rights reserved. 10-14 Measurement of Transa
18、ction ExposureTransaction exposure measures gains or losses that arise from the settlement of existing financial obligations whose terms are stated in a foreign currency.The most common example of transaction exposure arises when a firm has a receivable or payable denominated in a foreign currency.
19、Exhibit 10.3 demonstrates how this exposure comes about. 2013 Pearson Education, Inc. All rights reserved. 10-15 Exhibit 10.3 The Life Span of Transaction Exposure 2013 Pearson Education, Inc. All rights reserved. 10-16 Measurement of Transaction ExposureForeign exchange transaction exposure can be
20、managed by contractual, operating, and financial hedges.The main contractual hedges employ the forward, money, futures, and options markets.Operating and financial hedges employ the use of risk-sharing agreements, leads and lags in payment terms, swaps, and other strategies. 2013 Pearson Education,
21、Inc. All rights reserved. 10-17 Measurement of Transaction ExposureThe term natural hedge refers to an off-setting operating cash flow, a payable arising from the conduct of business.A financial hedge refers to either an off-setting debt obligation (such as a loan) or some type of financial derivati
22、ve such as an interest rate swap.Care should be taken to distinguish operating hedges from financing hedges. 2013 Pearson Education, Inc. All rights reserved. 10-18 Tridents Transaction ExposureWith reference to Tridents Transaction Exposure, the CFO, Maria Gonzalez, has four alternatives:Remain unh
23、edged;hedge in the forward market;hedge in the money market; orhedge in the options market.These choices apply to an account receivable and/or an account payable.See Exhibit 10.4 2013 Pearson Education, Inc. All rights reserved. 10-19 Exhibit 10.4 Tridents Transaction Exposure 2013 Pearson Education
24、, Inc. All rights reserved. 10-20 Tridents Transaction ExposureA forward hedge involves a forward (or futures) contract and a source of funds to fulfill the contract.In some situations, funds to fulfill the forward exchange contract are not already available or due to be received later, but must be
25、purchased in the spot market at some future date.This type of hedge is “open” or “uncovered” and involves considerable risk because the hedge must take a chance on the uncertain future spot rate to fulfill the forward contract.The purchase of such funds at a later date is referred to as covering. 20
26、13 Pearson Education, Inc. All rights reserved. 10-21 Tridents Transaction ExposureA money market hedge also involves a contract and a source of funds to fulfill that contract.In this instance, the contract is a loan agreement.The firm seeking the money market hedge borrows in one currency and excha
27、nges the proceeds for another currency.Funds to fulfill the contract to repay the loan may be generated from business operations, in which case the money market hedge is covered.Alternatively, funds to repay the loan may be purchased in the foreign exchange spot market when the loan matures (uncover
28、ed or open money market hedge). 2013 Pearson Education, Inc. All rights reserved. 10-22 Tridents Transaction ExposureHedging with options allows for participation in any upside potential associated with the position while limiting downside risk.The choice of option strike prices is a very important
29、aspect of utilizing options as option premiums, and payoff patterns will differ accordingly.Exhibit 10.5 shows the value of Tridents 1,000,000 account receivable over a range of possible ending spot exchange rates and hedging alternatives.Exhibit 10.6 shows alternatives for an account payable 2013 P
30、earson Education, Inc. All rights reserved. 10-23 Exhibit 10.5 Valuation of Cash Flows Under Hedging Alternatives for Trident with Option 2013 Pearson Education, Inc. All rights reserved. 10-24 Exhibit 10.6 Valuation of Hedging Alternatives for an Account Payable 2013 Pearson Education, Inc. All rig
31、hts reserved. 10-25 Risk Management in PracticeThe treasury function of most private firms, the group typically responsible for transaction exposure management, is usually considered a cost center.The treasury function is not expected to add profit to the firms bottom line.Currency risk managers are
32、 expected to err on the conservative side when managing the firms money. 2013 Pearson Education, Inc. All rights reserved. 10-26 Risk Management in PracticeFirms must decide which exposures to hedge:Many firms do not allow the hedging of quotation exposure or backlog exposure as a matter of policyMa
33、ny firms feel that until the transaction exists on the accounting books of the firm, the probability of the exposure actually occurring is considered to be less than 100%An increasing number of firms, however, are actively hedging not only backlog exposures, but also selectively hedging quotation an
34、d anticipated exposures.Anticipated exposures are transactions for which there are at present no contracts or agreements between parties 2013 Pearson Education, Inc. All rights reserved. 10-27 Risk Management in PracticeAs might be expected, transaction exposure management programs are generally div
35、ided along an “option-line,” those that use options and those that do not.Firms that do not use currency options rely almost exclusively on forward contracts and money market hedges. 2013 Pearson Education, Inc. All rights reserved. 10-28 Risk Management in PracticeMany MNEs have established rather
36、rigid transaction exposure risk management policies that mandate proportional hedging.These contracts generally require the use of forward contract hedges on a percentage of existing transaction exposures.The remaining portion of the exposure is then selectively hedged on the basis of the firms risk tolerance, view of exchange rate movements, and confidence level.
