1. Operating Exposure Long-term risk affecting firm value Managing operating exposure December 18, 20151Operating Exposure

2. Operating exposure  exposure to changes in the PV of the firm  Net Cashflows come from the Income Statement December 18, 20152Operating Exposure

3. Income Statement Revenues (Cost of goods sold) (Operating costs) (Capital cost allowances) Incidental income Incidental expenses (Taxes) Net Income December 18, 20153Operating Exposure

4. Profit variables COGS Labour Costs Input prices Operating Costs Overhead Administrative costs December 18, 20154Operating Exposure

5. Equilibrium case  exchange rates accommodate changes in relative inflation relatively low inflation countries  exchange rate appreciates to accommodate relative inflation  transaction exposure can be hedged volatility December 18, 20155Operating Exposure

6. Disequilibrium case  potential changes in real exchange rates assume real exchange rate appreciates Canadian dollar buys more in real terms  transactions exposure is hedged typically 90 days forward  Continuing exposure beyond 90 days cannot be hedged revenues will decrease (Canadian exports) (and) costs will decrease (Canadian imports) December 18, 20156Operating Exposure

7. Causes of disequilibrium  governmental intrusion in normal goods market activity tariffs quotas subsidies  governmental capital restrictions movement of capital out of the country exchange market restrictions December 18, 20157Operating Exposure

8. Tariffs PePe QeQe December 18, 20158Operating Exposure

9. Tariffs  marginal cost curve the supply curve equilibrium where marginal cost equals marginal revenue  marginal costs curve shifts outward new equilibrium higher import prices renders them non- competitive December 18, 20159Operating Exposure

10. Quotas PePe QeQe December 18, 201510Operating Exposure

11. Quotas  government mandates limit to supply creates a vertical supply curve well short expected market equilibrium  higher prices for imported products new equilibrium higher import prices renders them non- competitive December 18, 201511Operating Exposure

12. Subsidies PePe QeQe December 18, 201512Operating Exposure

13. Subsidies  Government gives cost advantage direct subsidy  grants  seed money indirect subsidy  tax breaks/incentives  lowers marginal costs to domestic firm more competitive relative to foreign competition December 18, 201513Operating Exposure

14. Regulatory intrusion  restrict products for non-compliance labour laws environmental laws safety laws  create bureaucratic barriers licensing customs declarations official delays December 18, 201514Operating Exposure

15. Monetary policy affects  monetary policy, high relative inflation exchange rate depreciation high volatility  higher costs of hedging  exchange rate policy, high relative inflation frequent exchange market intervention  attempts to peg  frequent devaluations  capital controls December 18, 201515Operating Exposure

16. Fiscal policy affects  high deficits financing costs increase country risk  higher interest rates  exchange rate depreciation  increased exchange rate volatility adds to normally high debt load  higher taxes  higher political risk December 18, 201516Operating Exposure

17. Managing Operating exposure - diversification  diversifying operations multicountry sales multicountry production outsourcing  diversifying financing reduce WACC December 18, 201517Operating Exposure

18. Managing operating exposure - changing operating procedures  leads/lags  risk sharing  Re-invoicing centers this is really transaction exposure  matching currency flows loan in foreign currency seek inputs invoiced in foreign currency  swaps December 18, 201518Operating Exposure

19. Operating exposure real exchange rate changes  domestic firms with domestic market international competition  real exchange rate changes affect competitiveness  Canadian firms used to undervalued dollars exporters don’t have to compete hard assume cd appreciates in real terms  Canadian exports become more expensive  foreign imports become less expensive December 18, 201519Operating Exposure