International Financial Management e–
Solution Manual | Complete Chapter
Answers and Case Solutions
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? - answers Transaction exposure is due only to international
transactions by a firm. Economic exposure includes any form by which the firm's cash
flow will be affected. Foreign competition may increase due to currency fluctuations.
This could affect the firm's cash flow, but did not affect the value of any ongoing
transactions. Thus, it represents a form of economic exposure but not transaction
exposure. Transaction exposure is a subset of economic exposure. Consideration of all
cash flows in a particular currency is not necessary when some inflows and outflows
offset each other. Only net cash flows are necessary.
Your employer, a large MNC, has asked you to assess its transaction exposure. Its
projected cash flows are as follows for the next year:
Currency
Total Inflow: DK50,000,000 £2,000,000
Total Outflow: DK40,000,000 £1,000,000
Exchange Rate: DK - $.15 BP - $.10
Assume that the movements in the Danish krone and the pound are highly correlated.
Provide your assessment as to your firm's degree of transaction exposure (as to
whether the exposure is high or low). Substantiate your answer. - answers Danish krone
(DK) +DK10,000,000 $.15 $1,500,000
British pound (£) +£1,000,000 $1.50 $1,500,000
What factors affect a firm's degree of transaction exposure in a particular currency? For
each factor, explain the desirable characteristics that would reduce transaction
exposure - answers Currency variability—low level is desirable. Currency correlations—
low level is desirable for currencies that are net inflows, while a high level is desirable
for pairs of currencies in which one currency shows future net inflows while the other
currency shows future net outflows
Kopetsky Co. has net receivables in several currencies that are highly correlated with
each other. What does this imply about the firm's overall degree of transaction
exposure? Are currency correlations perfectly stable over time? What does your answer
imply about Kopetsky Co. or any other firm using past data on correlations as an
indicator for the future? - answers Its exposure is high since all currencies move in
tandem—no offsetting effect is likely. If one of these currencies depreciates
substantially against the firm's local currency, all others will as well, and this reduces the
,value of these net receivables. No! Thus, past correlations will not serve as perfect
forecasts of future correlations. Firms can not presume that past correlations will be
perfectly accurate forecasts of future correlations. Yet, historical data may still be useful
if the general ranking of correlations is somewhat stable.
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? -
answers Appreciation of the firm's home currency reduces inflows since the foreign
demand for the firm's goods is reduced and foreign competition is increased.
Depreciation of the firm's home currency should increase inflows since it will likely
increase foreign demand for the firm's goods and reduce foreign competition.
Fischer Inc., exports products from Florida to Europe. It obtains supplies and borrows
funds locally. How would appreciation of the euro likely affect its net cash flows? Why? -
answers Fischer Inc. should benefit from the appreciation of the euro, because it should
experience a strong demand for its products when the euro has more purchasing power
(can obtain dollars at a low price).
Why are the cash flows of a purely domestic firm exposed to exchange rate
fluctuations? - answers If the firm competes with foreign firms that also sell in a given
market, the consumers may switch to foreign products if the local currency strengthens.
Memphis Co. hires you as a consultant to assess its degree of economic exposure to
exchange rate fluctuations. How would you handle this task? Be specific. - answers
Regression analysis can be used to determine the rela¬tion¬ship between the firm's
value and exchange rate fluctua¬tions. Stock returns can be used as a proxy for the
change in the firm's value. The time period can be segmented into two subperiods so
that regression analysis can be run for each subperiod. The sign and magnitude of the
regression coeffic¬ient will imply how the firm's value is influenced by each currency.
Also, the coefficients can be compared among subperiods for each currency to
determine how the impact of a currency is changing over time.
What factors affect a firm's degree of translation exposure? Explain how each factor
influences translation exposure. - answers The greater the percentage of business
conducted by subsidiaries, the greater is the translation exposure. The greater the
variability of each relevant foreign currency relative to the headquarters' home
(reporting) currency, the greater is the translation exposure. The type of accounting
method employed can also affect translation exposure.
Consider a period in which the U.S. dollar weakens against the euro. How will this affect
the reported earnings of a U.S. based MNC with European subsidiaries? Consider a
period in which the U.S. dollar strengthens against most foreign currencies. How will
this affect the reported earnings of a U.S.-based MNC with subsidiaries all over the
world? - answers The consolidated earnings will be increased due to the strength of the
subsidiaries' local currency (the euro). The consolidated earnings will be reduced due to
the weakness of the subsidiaries' local currencies.
,Aggie Co. produces chemicals. It is a major exporter to Europe, where its main
competition is from other U.S. exporters. All of these companies invoice the products in
U.S. dollars. Is Aggie's transaction exposure likely to be significantly affected if the euro
strengthens or weakens? Explain. If the euro weakens for several years, can you think
of any change that might occur in the global chemicals market? - answers If the euro
strengthens, European customers can purchase Aggie's goods with fewer euros. Since
Aggie's competitors also invoice their exports in dollars, Aggie Company will not gain a
competitive advantage. Nevertheless, the overall demand for the product could increase
because the chemicals are now less expensive to European customers. If the euro
weakens, European customers will need to pay more euros to purchase Aggie's goods.
Since Aggie's competitors also invoice their exports in dollars, Aggie Company may not
necessarily lose some of its market share. However, the overall European demand for
chemicals could decline because the prices paid for them have increased. If the euro
remained weak for several years, some companies in Europe may begin to produce the
chemicals, so that customers could avoid purchasing dollars with weak euros. That is,
the U.S. exporters could be priced out of the European market over time if the euro
continually weakened.
Longhorn Co. produces hospital equipment. Most of its revenues are in the United
States. About half of its expenses require outflows in Philippine pesos (to pay for
Philippine materials). Most of Longhorn's competition is from U.S. firms that have no
international business at all. How will Longhorn Co. be affected if the peso strengthens?
- answers If the peso strengthens, Longhorn will incur higher expenses when paying for
the Philippine materials. Because its competition is not affected in a similar manner,
Longhorn Company is at a competitive disadvantage when the peso strengthens.
Lubbock, Inc., produces furniture and has no international business. Its major
competitors import most of their furniture from Brazil and then sell it out of retail stores
in the United States. How will Lubbock, Inc., be affected if Brazil's currency (the real)
strengthens over time? - answers If the Brazilian real strengthens, U.S. retail stores will
likely have to pay higher prices for the furniture from Brazil, and may pass some or all of
the higher cost on to customers. Consequently, some customers may shift to furniture
produced by Lubbock Inc. Thus, Lubbock Inc. is expected to be favorably affected by a
strong Brazilian real.
Sooner Co. is a U.S. wholesale company that imports expensive high quality luggage
and sells it to retail stores around the United States. Its main competitors also import
high quality luggage and sell it to retail stores. None of these competitors hedge their
exposure to exchange rate movements. Why might Sooner's market share be more
volatile over time if it hedges its exposure? - answers If Sooner Company hedged its
imports, then it would have an advantage over the competition when the dollar
weakened (since its competitors would pay higher prices for the luggage), and could
possibly gain market share or would have a higher profit margin. It would be at a
disadvantage relative to the competition when the dollar strengthened and may lose
market share or be forced to accept a lower profit margin. When Sooner Company does
, not hedge, the amount paid for imports would depend on exchange rate movements,
but this is also true for all of its competitors. Thus, Sooner is more likely to retain its
existing market share.
Boulder, Inc., exports chairs to Europe (invoiced in U.S. dollars) and competes against
local European companies. If purchasing power parity exists, why would Boulder not
benefit from a stronger euro? - answers If purchasing power parity exists, a stronger
euro would occur only because the U.S. inflation is higher than European inflation.
Thus, the European demand for Boulder's chairs may not be affected much since the
inflated prices of U.S. made chairs would have offset the European consumer's ability to
obtain cheaper dollars. The European consumer's purchasing power of European chairs
versus U.S. chairs is not affected by the change in the euro's value.
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? - answers The dependent
variable is a percentage change (from one period to the next) in Toyota's export volume
to the U.S. The independent variables are (1) the percentage change in the yen's value
with respect to the dollar, (2) a measure of the strength of the U.S. economy, and (3)
any other factors that could affect the volume of Toyota's exports. The regression
coefficient related to the exchange rate variable (as defined here) would be negative,
since a decrease in the yen's value is likely to cause an increase in the U.S. demand for
Toyotas built in Japan. If Toyota established plants in the U.S., dealers do not need to
purchase Toyotas in Japan. Thus, the demand for Toyotas is less sensitive to the
exchange rate, which should cause the regression coefficient for the exchange rate
variable to decrease.
Cieplak, Inc., is a U.S.-based MNC that has expanded into Asia. Its U.S. parent exports
to some Asian countries, with its exports denominated in the Asian currencies. It also
has a large subsidiary in Malaysia that serves that market. Offer at least two reasons
related to exposure to exchange rates why Cieplak's earnings were reduced during the
Asian crisis. - answers First, its receivables from its exports were converted to fewer
dollars due to the depreciation of the Asian currencies. Second, any funds remitted by
the Malaysian subsidiary converted to fewer dollars for the parent. Third, the earnings
generated by the Malaysian subsidiary were translated to fewer dollars on the
consolidated income statement (translation exposure) even if it did not remit any
earnings to the parent.
Erie Co. has most of its business in the U.S.,
except that it exports to Belgium. Its exports were invoiced in euros (Belgium's currency)
last year. It has no other economic exposure to exchange rate risk. Its main competition
when selling to Belgium's customers is a company in Belgium that sells similar products,
denominated in euros. Starting today, Erie Co. plans to adjust its pricing strategy to
invoice its exports in U.S. dollars instead of euros. Based on the new strategy, will Erie
Solution Manual | Complete Chapter
Answers and Case Solutions
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? - answers Transaction exposure is due only to international
transactions by a firm. Economic exposure includes any form by which the firm's cash
flow will be affected. Foreign competition may increase due to currency fluctuations.
This could affect the firm's cash flow, but did not affect the value of any ongoing
transactions. Thus, it represents a form of economic exposure but not transaction
exposure. Transaction exposure is a subset of economic exposure. Consideration of all
cash flows in a particular currency is not necessary when some inflows and outflows
offset each other. Only net cash flows are necessary.
Your employer, a large MNC, has asked you to assess its transaction exposure. Its
projected cash flows are as follows for the next year:
Currency
Total Inflow: DK50,000,000 £2,000,000
Total Outflow: DK40,000,000 £1,000,000
Exchange Rate: DK - $.15 BP - $.10
Assume that the movements in the Danish krone and the pound are highly correlated.
Provide your assessment as to your firm's degree of transaction exposure (as to
whether the exposure is high or low). Substantiate your answer. - answers Danish krone
(DK) +DK10,000,000 $.15 $1,500,000
British pound (£) +£1,000,000 $1.50 $1,500,000
What factors affect a firm's degree of transaction exposure in a particular currency? For
each factor, explain the desirable characteristics that would reduce transaction
exposure - answers Currency variability—low level is desirable. Currency correlations—
low level is desirable for currencies that are net inflows, while a high level is desirable
for pairs of currencies in which one currency shows future net inflows while the other
currency shows future net outflows
Kopetsky Co. has net receivables in several currencies that are highly correlated with
each other. What does this imply about the firm's overall degree of transaction
exposure? Are currency correlations perfectly stable over time? What does your answer
imply about Kopetsky Co. or any other firm using past data on correlations as an
indicator for the future? - answers Its exposure is high since all currencies move in
tandem—no offsetting effect is likely. If one of these currencies depreciates
substantially against the firm's local currency, all others will as well, and this reduces the
,value of these net receivables. No! Thus, past correlations will not serve as perfect
forecasts of future correlations. Firms can not presume that past correlations will be
perfectly accurate forecasts of future correlations. Yet, historical data may still be useful
if the general ranking of correlations is somewhat stable.
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? -
answers Appreciation of the firm's home currency reduces inflows since the foreign
demand for the firm's goods is reduced and foreign competition is increased.
Depreciation of the firm's home currency should increase inflows since it will likely
increase foreign demand for the firm's goods and reduce foreign competition.
Fischer Inc., exports products from Florida to Europe. It obtains supplies and borrows
funds locally. How would appreciation of the euro likely affect its net cash flows? Why? -
answers Fischer Inc. should benefit from the appreciation of the euro, because it should
experience a strong demand for its products when the euro has more purchasing power
(can obtain dollars at a low price).
Why are the cash flows of a purely domestic firm exposed to exchange rate
fluctuations? - answers If the firm competes with foreign firms that also sell in a given
market, the consumers may switch to foreign products if the local currency strengthens.
Memphis Co. hires you as a consultant to assess its degree of economic exposure to
exchange rate fluctuations. How would you handle this task? Be specific. - answers
Regression analysis can be used to determine the rela¬tion¬ship between the firm's
value and exchange rate fluctua¬tions. Stock returns can be used as a proxy for the
change in the firm's value. The time period can be segmented into two subperiods so
that regression analysis can be run for each subperiod. The sign and magnitude of the
regression coeffic¬ient will imply how the firm's value is influenced by each currency.
Also, the coefficients can be compared among subperiods for each currency to
determine how the impact of a currency is changing over time.
What factors affect a firm's degree of translation exposure? Explain how each factor
influences translation exposure. - answers The greater the percentage of business
conducted by subsidiaries, the greater is the translation exposure. The greater the
variability of each relevant foreign currency relative to the headquarters' home
(reporting) currency, the greater is the translation exposure. The type of accounting
method employed can also affect translation exposure.
Consider a period in which the U.S. dollar weakens against the euro. How will this affect
the reported earnings of a U.S. based MNC with European subsidiaries? Consider a
period in which the U.S. dollar strengthens against most foreign currencies. How will
this affect the reported earnings of a U.S.-based MNC with subsidiaries all over the
world? - answers The consolidated earnings will be increased due to the strength of the
subsidiaries' local currency (the euro). The consolidated earnings will be reduced due to
the weakness of the subsidiaries' local currencies.
,Aggie Co. produces chemicals. It is a major exporter to Europe, where its main
competition is from other U.S. exporters. All of these companies invoice the products in
U.S. dollars. Is Aggie's transaction exposure likely to be significantly affected if the euro
strengthens or weakens? Explain. If the euro weakens for several years, can you think
of any change that might occur in the global chemicals market? - answers If the euro
strengthens, European customers can purchase Aggie's goods with fewer euros. Since
Aggie's competitors also invoice their exports in dollars, Aggie Company will not gain a
competitive advantage. Nevertheless, the overall demand for the product could increase
because the chemicals are now less expensive to European customers. If the euro
weakens, European customers will need to pay more euros to purchase Aggie's goods.
Since Aggie's competitors also invoice their exports in dollars, Aggie Company may not
necessarily lose some of its market share. However, the overall European demand for
chemicals could decline because the prices paid for them have increased. If the euro
remained weak for several years, some companies in Europe may begin to produce the
chemicals, so that customers could avoid purchasing dollars with weak euros. That is,
the U.S. exporters could be priced out of the European market over time if the euro
continually weakened.
Longhorn Co. produces hospital equipment. Most of its revenues are in the United
States. About half of its expenses require outflows in Philippine pesos (to pay for
Philippine materials). Most of Longhorn's competition is from U.S. firms that have no
international business at all. How will Longhorn Co. be affected if the peso strengthens?
- answers If the peso strengthens, Longhorn will incur higher expenses when paying for
the Philippine materials. Because its competition is not affected in a similar manner,
Longhorn Company is at a competitive disadvantage when the peso strengthens.
Lubbock, Inc., produces furniture and has no international business. Its major
competitors import most of their furniture from Brazil and then sell it out of retail stores
in the United States. How will Lubbock, Inc., be affected if Brazil's currency (the real)
strengthens over time? - answers If the Brazilian real strengthens, U.S. retail stores will
likely have to pay higher prices for the furniture from Brazil, and may pass some or all of
the higher cost on to customers. Consequently, some customers may shift to furniture
produced by Lubbock Inc. Thus, Lubbock Inc. is expected to be favorably affected by a
strong Brazilian real.
Sooner Co. is a U.S. wholesale company that imports expensive high quality luggage
and sells it to retail stores around the United States. Its main competitors also import
high quality luggage and sell it to retail stores. None of these competitors hedge their
exposure to exchange rate movements. Why might Sooner's market share be more
volatile over time if it hedges its exposure? - answers If Sooner Company hedged its
imports, then it would have an advantage over the competition when the dollar
weakened (since its competitors would pay higher prices for the luggage), and could
possibly gain market share or would have a higher profit margin. It would be at a
disadvantage relative to the competition when the dollar strengthened and may lose
market share or be forced to accept a lower profit margin. When Sooner Company does
, not hedge, the amount paid for imports would depend on exchange rate movements,
but this is also true for all of its competitors. Thus, Sooner is more likely to retain its
existing market share.
Boulder, Inc., exports chairs to Europe (invoiced in U.S. dollars) and competes against
local European companies. If purchasing power parity exists, why would Boulder not
benefit from a stronger euro? - answers If purchasing power parity exists, a stronger
euro would occur only because the U.S. inflation is higher than European inflation.
Thus, the European demand for Boulder's chairs may not be affected much since the
inflated prices of U.S. made chairs would have offset the European consumer's ability to
obtain cheaper dollars. The European consumer's purchasing power of European chairs
versus U.S. chairs is not affected by the change in the euro's value.
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? - answers The dependent
variable is a percentage change (from one period to the next) in Toyota's export volume
to the U.S. The independent variables are (1) the percentage change in the yen's value
with respect to the dollar, (2) a measure of the strength of the U.S. economy, and (3)
any other factors that could affect the volume of Toyota's exports. The regression
coefficient related to the exchange rate variable (as defined here) would be negative,
since a decrease in the yen's value is likely to cause an increase in the U.S. demand for
Toyotas built in Japan. If Toyota established plants in the U.S., dealers do not need to
purchase Toyotas in Japan. Thus, the demand for Toyotas is less sensitive to the
exchange rate, which should cause the regression coefficient for the exchange rate
variable to decrease.
Cieplak, Inc., is a U.S.-based MNC that has expanded into Asia. Its U.S. parent exports
to some Asian countries, with its exports denominated in the Asian currencies. It also
has a large subsidiary in Malaysia that serves that market. Offer at least two reasons
related to exposure to exchange rates why Cieplak's earnings were reduced during the
Asian crisis. - answers First, its receivables from its exports were converted to fewer
dollars due to the depreciation of the Asian currencies. Second, any funds remitted by
the Malaysian subsidiary converted to fewer dollars for the parent. Third, the earnings
generated by the Malaysian subsidiary were translated to fewer dollars on the
consolidated income statement (translation exposure) even if it did not remit any
earnings to the parent.
Erie Co. has most of its business in the U.S.,
except that it exports to Belgium. Its exports were invoiced in euros (Belgium's currency)
last year. It has no other economic exposure to exchange rate risk. Its main competition
when selling to Belgium's customers is a company in Belgium that sells similar products,
denominated in euros. Starting today, Erie Co. plans to adjust its pricing strategy to
invoice its exports in U.S. dollars instead of euros. Based on the new strategy, will Erie
