Question;Essay Questions;11.1 Trident Corporation: A Multinational's;Operating Exposure;1) An expected;change in foreign exchange rates is not included in the definition of;operating exposure, because both management and investors should have factored;this information into their evaluation of anticipated operating results and;market value. Describe how the expected change in foreign exchange rates would;be reflected in the decision-making process from the perspective of a);management, b) debt service, c) the investor, and d) the broader macroeconomic;perspective.;Answer: From a management perspective, budgeted;financial statements already reflect information about the effect of an;expected change in exchange rates.;From a debt service perspective, expected cash flow to amortize;debt should already reflect the international Fisher effect. The level of;expected interest and principal repayment should be a function of expected;exchange rates rather than existing spot rates.;From an investor's perspective, if the foreign exchange market is;efficient, information about expected changes in exchange rates should be;widely known and thus reflected in a firm's market value. Only unexpected;changes in exchange rates, or an inefficient foreign exchange market, should;cause market value to change.;From a broader macroeconomic perspective, operating exposure is;not just the sensitivity of a firm's future cash flows to unexpected changes in;foreign exchange rates, but also its sensitivity to other key macroeconomic;variables. This factor has been labeled as macroeconomic uncertainty.;11.2 Measuring Operating Exposure;1) An unexpected;change in exchange rates impacts a firm?s expected cash flows at four levels;a) the short run, b) medium run: equilibrium, c) medium run: disequilibrium;and d) the long run. Describe the impact on cash flows over each of these;categories identifying the time frame for each as well as the price changes;volume changes, and structural changes associated with each stage.;Answer;Phase;Time;Price;Changes;Volume;Changes;Structural;Change;Short Run;Less than one;year;Prices are;fixed/contracted;Volumes are;contracted;No competitive;market changes;Medium Run;Equilibrium;Two to five;years;Complete;pass-through of exchange rate changes;Volumes begin a;partial response to prices;Existing;competitors begin partial responses;Medium Run;Disequilibrium;Two to five;years;Partial;pass-through of exchange rate changes;Volumes begin a;partial response to prices;Existing;competitors begin partial responses;Long Run;More than five;years;Completely;flexible;Completely;flexible;Threat of new;entrants and changing competitor responses;11.3 Strategic Management of Operating Exposure;1) Diversification;is possibly the best technique for reducing the problems associated with;international transactions. Provide one example each of international financial;diversification and international operational diversification and explain how;the action reduces risk.;Answer: An MNE well known in the financial markets;could borrow money in a country in which the firm receives foreign currency.;The MNE could then use the receivables to repay the loan in the foreign;currency and avoid uncertainties in exchange rates.;An MNE could;establish production facilities in several countries. This could be beneficial;in at least two ways. First, such diversification reduces the probability of;unfavorable changes in exchange rates for one country from significantly reducing;the firm's profitability. Second, an MNE with facilities in several countries;is well positioned by using internal sources to recognize when a disequilibria;in the market arises.;11.4 Proactive Management of Operating Exposure;1) A British firm;has a subsidiary in the U.S., and a U.S. firm, known to the British firm, has a;subsidiary in Britain. Define and then provide an example for each of the;following management techniques for reducing the firm's operating cash flows.;The following are techniques to consider;(a) matching currency cash flows;(b) risk-sharing agreements;(c) back-to-back or parallel loans;rates.;Back-to-back;loans provide for parent-subsidiary cross border financing without incurring;direct currency exposure. For example, using our British and U.S. firms, the;British firm could lend pounds to the U.S. subsidiary in Britain at the same;time that the U.S. firm lends an equivalent amount of dollars to the British;subsidiary in the U.S. Later, the loans would be simultaneously repaid.
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