Question

Please read the statement, identify the problem that a MNC would face in operating in a global environment and make recommendations to remedy the problem

There are as many different approaches to foreign exchange transaction exposure management as there are firms and no real consensus exists regarding the best approach. List and discuss three different exposures you can hedge and three different types of hedges.

Answer 1

Multinationals face basically face three types of exposure, transaction exposure, Economic exposure and translation exposure.

· Transaction Exposure: This transaction exposure basically relates to the short-term exposure of the company where the company has entered into business transaction where it has to pay or will receive foreign currency. This results in foreign exchange risk.

· Economic exposure: Economic exposure basically relates to the long-term fluctuation in the currency exchange rate which can negatively affect the long-term performance of the company. It is also known as operating exposure due to unfavorable exchange rate movement.

· Translation exposure: Translation exposure is basically related to the consolidation of the parent income with the subsidiary balance sheet. It is more of an accounting nature but can affect the parent company balance sheet in a significant way.

Three different types of hedges are Fair value hedges, cash flow hedge and hedging of net investment in a foreign operation.

· Fair-value hedge relates to the recognition of the gains or losses arising out of the derivative instruments for that accounting period and is recognized in the same period.

· Cash flow hedging is used to reduce the variability of the cash flows that is either expected to received or is to be paid.

· Hedging of net investment in foreign subsidiary relates to the hedging where the parent company is expected to make the investment and it would want to reduce the variability in amount that has to be committed.