SOLUTIONS FOR SESSION 3: FX EXPOSURE AND THE
MANAGEMENT OF FX EXPOSURE
1. Economic exposure
The Walt Disney Company built an amusement park in France that opened in 1992. How
do you think this project, EuroDisney, affected Disney’s overall operating exposure?
Explain.
ANSWER: The typical first reaction is that the Walt Disney Company’s economic
(operating) exposure may have increased, since this new park would generate revenue in
French francs (now euros), which may someday be converted to US dollars. If the French
currency weakens against the dollar, the revenue will be converted to fewer dollars.
However, keep in mind that Walt Disney was already affected by movements in the French
franc and other major currencies before this park was built. When major currencies
weaken against the dollar, foreign tourism decreases and Walt Disney’s business in the US
declines. By having a European amusement park, it may be able to offset the declining US
business during strong dollar cycles, since more European tourists may go to the Disney
park in France during these periods. Overall, the economic value of Disney may be less
exposed to exchange rate movements because of the EuroDisney amusement park.
2. Hedging a payable
Assume the following information:
90-day US interest rate = 16% (annualized)
90-day Malaysian interest rate = 12% (annuialized)
90-day forward rate of Malaysian ringgit = $.400
Spot rate of Malaysian ringgit = $.404
Assume that the Santa Barbara Company from the US will need 300,000 ringgit in 90
days. It wishes to hedge this payables position. Would it be better off using forward hedge
or money market hedge? Substantiate your answer with estimated costs for each type of
hedge.
ANSWER:
• Forward hedge: in 90 days the firm will pay out 300,000 ringgit × $.400 =
$120,000
• Money market hedge:
1. Invest 300,000/1.03 = 291,262 ringgit now in a Malaysian deposit that will
accumulate to 300,000 ringgit in 90 days.
2. This implies that the number of US dollars to be borrowed now is:
291,262 ringgit × $.404 spot = $117,670.
3. If this amount is borrowed today, the firm will need:
$117,670 × 1.04 = $122,377 to repay the loan in 90 days.
• In comparison, the firm will only pay out $120,000 in 90 days if it uses the
forward hedge. Thus, it should use the forward hedge.
MANAGEMENT OF FX EXPOSURE
1. Economic exposure
The Walt Disney Company built an amusement park in France that opened in 1992. How
do you think this project, EuroDisney, affected Disney’s overall operating exposure?
Explain.
ANSWER: The typical first reaction is that the Walt Disney Company’s economic
(operating) exposure may have increased, since this new park would generate revenue in
French francs (now euros), which may someday be converted to US dollars. If the French
currency weakens against the dollar, the revenue will be converted to fewer dollars.
However, keep in mind that Walt Disney was already affected by movements in the French
franc and other major currencies before this park was built. When major currencies
weaken against the dollar, foreign tourism decreases and Walt Disney’s business in the US
declines. By having a European amusement park, it may be able to offset the declining US
business during strong dollar cycles, since more European tourists may go to the Disney
park in France during these periods. Overall, the economic value of Disney may be less
exposed to exchange rate movements because of the EuroDisney amusement park.
2. Hedging a payable
Assume the following information:
90-day US interest rate = 16% (annualized)
90-day Malaysian interest rate = 12% (annuialized)
90-day forward rate of Malaysian ringgit = $.400
Spot rate of Malaysian ringgit = $.404
Assume that the Santa Barbara Company from the US will need 300,000 ringgit in 90
days. It wishes to hedge this payables position. Would it be better off using forward hedge
or money market hedge? Substantiate your answer with estimated costs for each type of
hedge.
ANSWER:
• Forward hedge: in 90 days the firm will pay out 300,000 ringgit × $.400 =
$120,000
• Money market hedge:
1. Invest 300,000/1.03 = 291,262 ringgit now in a Malaysian deposit that will
accumulate to 300,000 ringgit in 90 days.
2. This implies that the number of US dollars to be borrowed now is:
291,262 ringgit × $.404 spot = $117,670.
3. If this amount is borrowed today, the firm will need:
$117,670 × 1.04 = $122,377 to repay the loan in 90 days.
• In comparison, the firm will only pay out $120,000 in 90 days if it uses the
forward hedge. Thus, it should use the forward hedge.
