Facultad de Ciencias Económicas y Administrativas
Javier Correa C.
Jorge Duque C.
Quito, 26 de enero de 2010
Operating exposure is the degree to which exchange rate changes, in combination with price changes, will alter a company's future operating cash flows.
Operating exposure isrelated to transaction exposure, in that both exposures concern the potential changes in the value of a firm’s foreign-currency denominated future cash flows.
The difference between the two is that while transaction exposure covers the cash flows that are obligations under contracts, operating exposure relates to the expected future cash flows.
Attributes of Operating Exposures
Since the expectedcash flows that constitute operating exposure are not contractual and often span over long time periods, the measurement and management of operating exposure is significantly more complicate than that of transaction exposure. The present value of expected foreign currency denominate cash flows can change in various ways. Most importantly, unexpected changes in values of foreign currencies willaffect not only the home currency value of those cash flows but also the demand for exported goods in foreign countries.
If the €/$ exchange rate is 1.0 and a Washington apple costs $ 1 in the U.S. and € 1 in France, a euro depreciation to € 1.20/$ will increase the apple cost to € 1.20, if the U.S. exporter does not adjust the dollar prices.
Frenchmen may find the Washington apple tooexpensive after the 20% price hike, which will affect the demand of U.S. apples in France. Alternatively, if the euro prices is kept unchanged at €1, the balance between the French supply and demand is not affected, but the exporter now only receives 1/1.20 = $ 0.83 for the apple. In practice, we often end up somewhere between these two extremes.
Measuring and Management of Operating ExposureMeasuring and managing operating currency exposure is difficult at best. Prior research finds that this exposure depended on the characteristics of the industry, firm specific operating activities, and the relative strength of the dollar vis-a-vis the relevant foreign currency. The valuation effects on a firm from corporate foreign investment decisions depend on accounting versus economic effects, andhome versus foreign market effects. It has also been shown that the effects on firm value from foreign expansion or retraction is different by industry, by changes in exchange rates, and by the degree of foreign involvement before events.
Unlike transaction and accounting exposure, managing operating exposure involves all the aspects of a corporation, including financial, marketing, management,production, and others. The international investment is one of major instruments of managing operating exposure.
Strategic Management of Operating Exposure
Recall that while most of the international parity conditions have a poor track record in short term, they are valuable tools in forecasting longer-term currency trends. Management of a MNE with diversified operations can react to imbalances inparity conditions by shifting the company’s operations to take advantage of product market disequilibrium conditions. A MNE with diverse operations is better equipped to take advantage of such strategic opportunities than domestic corporations in part because they have a direct data source in different countries where they can follow their own sales on day-to-day basis. Recall that once thedisequilibrium is public knowledge, we should expect it to be already discounted in prices and exchange rates. Therefore, companies relying on public data are ill equipped to take advantage of such imbalances. For a domestic company switching raw material sources of manufacturing locations across borders also requires investments into new territories with expected “learning curve effects”.