Kenneth R. Szulczyk
for six months and use a forward contract to transfer funds to Guatemala to pay off its
obligation.
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=$1, 148 , 639. 41 (23)
An international company could hedge naturally and protect its current contractual contracts
in a foreign country by using different strategies. First, a company has both accounts receivables
and accounts payable in the same foreign country. If they are roughly equal with similar
maturities, then the company uses the proceeds from the accounts receivable to pay its accounts
payable with no exchange rate exposure. Second, a company could require payment in its home
currency. For example, U.S. firms would require all payments are made in U.S. dollars while
companies in the Eurozone would require payments in euros. Thus, the companies force the
exchange rate risk upon the other parties. Finally, a company could require payment in Special
Drawing Rights because the International Monetary Fund sets the value of the SDRs to equal a
currency basket of British pounds, euros, U.S. dollars, and Japanese yen.
Measuring and Protecting against Economic Exposure
Analysts have difficulties measuring economic exposure. A firm must accurately forecast
cash flows and exchange rates because the transaction exposure alters future cash flows as the
currency exchange rates fluctuate. If a subsidiary sees positive cash flows after correcting for the
currency exchange rates, then its net transaction exposure is low. Analysts can estimate
economic exposure accurately if currency exchange rates display a trend, and they know future
cash flows with certainty.
Some companies, for example, have an unfavorable exposure. For example, PEMEX,
Mexico’s National Petroleum Company, has a monopoly in the extraction, refining, and
distribution of petroleum in Mexico. Furthermore, PEMEX sells petroleum to the international
markets. However, PEMEX does not have a favorable exposure because it pays costs,
denominated in pesos while receives petroleum revenues, priced in U.S. dollars. As the U.S.
dollar depreciates, PEMEX's exposure causes its revenues to fall and its costs to rise, squeezing
profits.
An analyst measures the economic exposure by estimating a regression equation, shown in
Equation 24. Using a simple example, our home country is the United States while Europe is the
foreign country. Thus, the price, P, is the foreign asset’s price in U.S. dollars while S indicates
the spot exchange rate, defined as U.S. dollars per euro. Regression equation measures the
association between the asset’s price and the exchange rate. We assume the random error term,
equals zero with a constant variance while and are the estimated parameters.
Consequently, this equation estimates a straight line between P and S with an intercept of and
a slope of . We refer the parameter as the Forex Beta or Exposure Coefficient, and it
indicates the exposure level.