Economic Exposure

Exchange rate risk impacts on firms future cash flows that a business made
investments denominated in foreign or local currency, this represents
economic exposure. Corporate cash flows can be affected by exchange rate
movements

in

ways

that

are

not

directly

associated

with

foreign

transactions. Thus firms cannot just focus on hedging their foreign currency
payables or receivables but must also determine how all their cash flows will
be effected by exchange rate movements. For example Nike economic
exposure comes in various forms; firstly Nike is free to transaction exposure
because its numerous purchases and sale transactions are in foreign
currencies. Depreciation in one currency can be compensated by the
appreciation in other currency. Transaction exposure is a subset of economic
exposure.

Secondly,

if

Nike

received

remitted

earning

from

foreign

subsidiaries to the local currency also reflect transaction exposure &

economic exposure. Third, if exchange rate changes, the demand for Nike
shoes as compare to other shoe companies (Adidas) will be effected. Nike
can hedge some of its transaction exposure but can never hedge all of its
transaction exposure because it cannot predict all the future transactions.
So it is difficult to determine how a specific exchange rate movement will
affect the Nike demand either in upward or downward as compare to its
competitor (shoe) demand.
MNCs can manage their economic exposure but they are required to
determine economic exposure in terms of cash inflows & outflows & this
information would be later used for estimation. Restructuring can reduce the
economic exposure. Restricting involves shifting the sources of cost or
revenue to other locations in order to match cash inflows and outflows. For
Example; Madison, a US based MNC that has taken loan denominated in
Canadian dollar for the supporting operations in Canada. If Canadian dollar
appreciates against the US dollar, Madison requires more US dollars to pay

back including interest. Its revenue from sales in Canada, however increased
but the cost of purchasing the materials in Canada will increase, so the
amount of cash flows will inversely related to the strength of Canadian dollar.
And in case if the Canadian dollar is consistently strengthen, than Madison
must to ensure that expenses should be offset within revenues, for this, it
should requires restructuring.
As Madison Co. have more cash outflows than cash inflows in Canadian
dollar. Madison could create more balances by increasing its sales. It can
achieve this by increasing advertising campaigns. Moreover, it can reduce its
cost of purchasing materials by changing Canadian supplier into US based
supplier. It can also reduce its loans from Canadian Banks & prefer to taking
loans from US based financial institutions. In this way Madison total sales
increases in response to its plan to penetrate Canadian market.
If Madison increases its Canadian dollar inflows and reduces its Canadian
dollar outflows as planned, Its revenue and expenses will be effected by the
somewhat same manner but its performance will be less effected to the
movements in the Canadian dollar.
For Madison future expenses are more sensitive than the future revenue to
the possible exchange rate movements, so it reduces its economic exposure
by increasing sensitivity of revenue & decreasing sensitivity of expenses. The
firms can best evaluate a proposed restructuring operations by forecasting
for various possible exchange rate.
While restructuring operations, one must address the following questions.

Should the firm attempt to increase or reduce sales in new or existing

foreign markets?
Should the firm increases or reduces its dependency on foreign
suppliers?

Should the firm establish or eliminate production facilities in foreign

markets?
Should the firm increase or reduce level of debt denominated in foreign
currencies?