1. International Business (MB 40)
Exchange Rate Risk
International Business (MB 40)

2. Outline Meaning of Exchange Rate Risk Types of Exchange Rate Risks
Transaction Exposure
Translation Exposure
Economic Exposure
Management of Exchange Rate Risk
Management of Transaction Exposure
Management of Economic Exposure

3. Meaning of Exchange Rate Risk
Risk of fluctuating value of a currency over time
Impacts dollar value of foreign currency cash inflows and foreign currency cash outflows
If we have foreign currency cash inflows, we face risk of foreign currency depreciating against domestic currency
If we have foreign currency cash outflows, we face risk of foreign currency appreciating against domestic currency

4. Types of Exchange Rate Exposures
Transaction Exposure
Only companies engaged in global business and doing transactions in foreign currency face this risk
Arises due foreign currency transactions of a firm
Arises from the possibility of incurring future exchange gains/losses on transactions already entered into and denominated in a foreign currency.

5. Translation Exposure
The exposure of the MNC’s consolidated financial statements to exchange rate fluctuations
If the assets/liabilities are translated at something other than the historical exchange rates, the Balance Sheet will be affected by fluctuations in currency values over time

6. Economic Exposure structure of markets for a firm’s product
The extent to which the economic value of a company can decline because of exchange rate changes
Decline can be due to a decline in the level of expected cash flows or an increase in the riskiness of these cash flows
Overall effect of exchange rate changes in competitive relationships between alternative foreign locations
Extent of exposure depends on
structure of markets for a firm’s product
Price elasticity of demand for the product
Availability of close substitutes for the product
Even pure domestic firms may face economic exposure

7. Management of Transaction Exposure
Foreign currency cash outflows
Risk: Foreign currency may become more expensive/appreciate against domestic currency
Strategy: Buy foreign currency futures, forwards, or call options
Foreign currency cash inflows
Risk: Foreign currency may become more cheap/depreciate against domestic currency
Strategy: Sell foreign currency futures, forwards, or buy put options

8. Management of Economic Exposure
Marketing Initiatives
Market Selection
Pricing Strategy
Product Strategy
Promotion Strategy
Production Initiatives
Product sourcing and input mix
Plant location
Raise Productivity
Financial Initiatives

9. Marketing Initiatives
Shall we pull out of a market that has been rendered unprofitable due to competition or shall we differentiate the product and concentrate on specific customers only?
Shall we emphasize market share or profit margin in response to weak domestic currency?
Shall we add/drop a product to our product line in response to exchange rate changes?
Where to advertise?

10. Production Initiatives
Outsource your inputs/raw materials/components in response to strong domestic currency
Change input mix to reduce cost in response to strong domestic currency
Shift production to weak currency area in response to strong domestic currency
Raise productivity by cutting costs—produce the same number of units at a lower cost or produce more units at the same cost

11. Financial Initiatives
Equate the sensitivity of costs and revenues to exchange rate changes