Summary International Finance
International Financial Management, Eight edition, Cheol Eun and Bruce
Resnick
Investment and International Finance Custom Edition – International Finance
part
,Index International Financial Management book
- Chapter 8
- Chapter 9
- Chapter 10
- Chapter 16
- Chapter 17
- Chapter 18
- Chapter 19
Index Investment and International Finance Custom Edition book
- Chapter 14
- Chapter 15
- Chapter 16
- Chapter 17
- Chapter 18
- Chapter 19
- Chapter 20
,CHAPTER 8 (CHAPTER 14 FROM UT FENSI BOOK) MANAGEMENT OF TRANSACTION
EXPOSURE
Types of exposure
1. Transaction exposure
2. Economic exposure
3. Translation exposure
Transaction exposure = the sensitivity of “realized” domestic currency values of the firm’s
contractual cash flow denominated in foreign currencies to unexpected exchange rate
changes
Economic exposure = the extent to which the value of the firm would be affected by
unanticipated changes in exchange rates
Translation exposure = the potential that the firm’s consolidates financial statement can be
affected by changes in exchange rates
Financial contract
1. Forward market hedge
2. Money market hedge
3. Options market hedge
4. Swap market hedge
Forward market hedge
Currency forward contract = the firm may sell (buy) its foreign currency receivables
(payables) forward to eliminate its exchange risk exposure
Gain = (F – ST) x payable
Where:
F – forward exchange rate
ST – spot rate on the maturity date
If:
F > ST – loss
F < ST – gain
F = ST – no gain or loss
Money market hedge
Step-by-step procedure of money market hedging
1. Borrow needed money (divided by the interest rate)
2. Convert currency to correct currency at the current spot exchange rate
3. Invest that money in the country of the latest currency
4. Collect the actual money you receive
5. Receive maturity value of the latest currency
, Options market hedge
Possible shortcoming of forward and money market hedges: these methods completely
eliminate exchange risk exposure
Cross-hedging = hedging a position in one asset by taking a position in another asset
Contingent exposure = a situation in which the firm may or may not be subject to exchange
exposure
Market imperfections
1. Information asymmetry
2. Differential transaction costs
3. Default costs
4. Progressive corporate taxes
Operational techniques
1. Choice of invoice currency
2. Lead/lag strategy
3. Exposure netting
Choice of invoice currency = the firm can shift, share, or diversify exchange risk by
appropriately choosing the currency of invoice
Lead/lag strategy = leading soft currency receivables and lag hard currency receivables to
avoid the loss from depreciation of the soft currency and benefit from the appreciation of
the hard currency
To lead = to pay or collect early
To lag = to pay or collect late
Exposure netting = offsetting exposure in one currency with exposure in the same or
another similar currency
Reinvoice center = a financial subsidiary, a mechanism for centralizing exposure
management functions
International Financial Management, Eight edition, Cheol Eun and Bruce
Resnick
Investment and International Finance Custom Edition – International Finance
part
,Index International Financial Management book
- Chapter 8
- Chapter 9
- Chapter 10
- Chapter 16
- Chapter 17
- Chapter 18
- Chapter 19
Index Investment and International Finance Custom Edition book
- Chapter 14
- Chapter 15
- Chapter 16
- Chapter 17
- Chapter 18
- Chapter 19
- Chapter 20
,CHAPTER 8 (CHAPTER 14 FROM UT FENSI BOOK) MANAGEMENT OF TRANSACTION
EXPOSURE
Types of exposure
1. Transaction exposure
2. Economic exposure
3. Translation exposure
Transaction exposure = the sensitivity of “realized” domestic currency values of the firm’s
contractual cash flow denominated in foreign currencies to unexpected exchange rate
changes
Economic exposure = the extent to which the value of the firm would be affected by
unanticipated changes in exchange rates
Translation exposure = the potential that the firm’s consolidates financial statement can be
affected by changes in exchange rates
Financial contract
1. Forward market hedge
2. Money market hedge
3. Options market hedge
4. Swap market hedge
Forward market hedge
Currency forward contract = the firm may sell (buy) its foreign currency receivables
(payables) forward to eliminate its exchange risk exposure
Gain = (F – ST) x payable
Where:
F – forward exchange rate
ST – spot rate on the maturity date
If:
F > ST – loss
F < ST – gain
F = ST – no gain or loss
Money market hedge
Step-by-step procedure of money market hedging
1. Borrow needed money (divided by the interest rate)
2. Convert currency to correct currency at the current spot exchange rate
3. Invest that money in the country of the latest currency
4. Collect the actual money you receive
5. Receive maturity value of the latest currency
, Options market hedge
Possible shortcoming of forward and money market hedges: these methods completely
eliminate exchange risk exposure
Cross-hedging = hedging a position in one asset by taking a position in another asset
Contingent exposure = a situation in which the firm may or may not be subject to exchange
exposure
Market imperfections
1. Information asymmetry
2. Differential transaction costs
3. Default costs
4. Progressive corporate taxes
Operational techniques
1. Choice of invoice currency
2. Lead/lag strategy
3. Exposure netting
Choice of invoice currency = the firm can shift, share, or diversify exchange risk by
appropriately choosing the currency of invoice
Lead/lag strategy = leading soft currency receivables and lag hard currency receivables to
avoid the loss from depreciation of the soft currency and benefit from the appreciation of
the hard currency
To lead = to pay or collect early
To lag = to pay or collect late
Exposure netting = offsetting exposure in one currency with exposure in the same or
another similar currency
Reinvoice center = a financial subsidiary, a mechanism for centralizing exposure
management functions
