Question

We define economic exposure as the impact of exchange rate fluctuations on a firm’s future

earnings, cash flows and foreign investments. Explain in detail how you would restructure your MNC operating in Iraq and Kuwait to reduce economic exposure. (HOw MNC is able to reduce economic exposure in unstable environment?)

Answer 1

Economic exposure, also known as operating exposure refers to an effect caused on a company’s cash flows due to unexpected currency rate fluctuations. Economic exposures are long-term in nature and have a substantial impact on a company’s market value.

Economic exposure can prove to be difficult to hedge as it deals with unexpected fluctuations in foreign exchange rates. As the foreign exchange volatility rises, the economic exposure increases and vice versa. Multinational companies having numerous subsidiaries overseas and transactions in foreign currencies face a greater risk of economic exposure.

The following are the two factors that help in determining economic exposure:

• Economic exposure is higher for firms having both, product prices and input costs sensitive to currency fluctuations. It is lower when costs and prices are not sensitive to currency fluctuations.
• Economic exposure is higher for firms which do not adjust its markets, product mix, and source of inputs in accordance with currency fluctuations. Flexibility in adapting to currency rate fluctuations indicates lesser economic exposure.

The risk of economic exposure can be hedged either by operational strategies or currency risk mitigation strategies

1-DIVERSIFYING PRODUCTION FACILITIES AND MARKETS FOR PRODUCTS

2-DIVERSIFYING FINANCING

3-CURRENCY RISK MITIGATION STRATEGIES

An awareness of the impact of economic exposure can help firms take steps to mitigate this risk. Investors should identify stocks and companies that have major exposures and make better investment choices during times when exchange rate volatility is at its peak.