Operating Exposure

Operating Exposure

Operating Exposure

Operating exposure (economic exposure) measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates

Measuring the operating exposure of a firm requires forecasting and analyzing all the firm’s future individual transaction exposures together with the future exposures of all the firm’s competitors and potential competitors worldwide

Attributes of operating exposure

Operating exposure is far more important for the long-run health of a business

Operating exposure is subjective, because it depends on estimates of future cash flow changes over an arbitrary time horizon

Planning for operating exposure depends on the interaction of strategies in finance, marketing, purchasing, and production

Only unexpected changes in exchange rates, or an inefficient foreign exchange market, should cause market value to change

Measuring the impact of operating exposure

Short run

Medium run:

Equilibrium case

Disequilibrium case

Long run

Strategic Management of Operating Exposure

Management can diversify the firm’s operating and financing base.

A firm’s operationscan be diversified internationally

A firm’s financing sources can be diversifiedinternationally

Proactive Management of Operating Exposure

The four most commonly employed proactive policies are:

Matching currency cash flows

One way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)

Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms

In addition, the company could engage in currency switching, in which the company would pay foreign suppliers with Canadian dollars

Currency Clauses: Risk-Sharing:

An alternate method for managing a long-term cash flow exposure between firms is risk sharing

This is a contractual arrangement in which the buyer and seller agree to “share” or split currency movement impacts on payments between them

This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements

Back-to-Back Loans:

A back-to-back loan, also referred to as a parallel loan or credit swap, occurs when two business firms in separate countries arrange to borrow each other’s currency for a specific period of time

At an agreed terminal date they return the borrowed currencies

Such a swap creates a covered hedge against exchange loss, since each company, on its own books, borrows the same currency it repays

Currency Swaps:

A currency swap resembles a back-to-back loan except that it does not appear on a firm’s balance sheet

In a currency swap, a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time