Question

Which of the following is not true regarding the restructuring of operations to reduce economic exposure?

a. Although economic exposure is a long-term solution, the necessary restructuring of operations to reduce economic exposure is hardly more complicated than hedging any single foreign currency transaction.

b. Any restructuring that is used to reduce economic exposure may only be reversed or eliminated at a high cost.

c. Any restructuring of operations that can reduce the periodic difference between a foreign currency's inflows and outflows can reduce the firm's economic exposure to that currency's movements.

d. The management of economic exposure serves as a long-term solution.

Answer 1

Economic exposure refers to the effect that exchange rate fluctuations have on a company's cash flows.One of the ways to mitigate economic exposures is through restructuring of operations. Restructuring of operations involve shifting the sources of revenue and/or costs from one location to another taking into consideration the sensitivity of the new location to various possible exchange rate scenarios.

a. Although economic exposure is a long-term solution, the necessary restructuring of operations to reduce economic exposure is hardly more complicated than hedging any single foreign currency transaction - this statement is NOT TRUE.

Restructuring of operations involves shifting from one location to another and thereby involves incremental expenses in shifting from old location, complying with various regulations of the new location, risk involved in the general business climate of the new location and various other challenges. Hedging is accomplished by purchasing an offsetting currency exposure which involves entering into required forward contracts with the other party. This only involves some documentation and paper work. Thus, restructuring of operations is extremely more complicated than hedging any single foreign currency transaction.

b. Any restructuring that is used to reduce economic exposure may only be reversed or eliminated at a high cost. - this statement is TRUE.

As mentioned above, Restructuring of operations involves involves incremental expenses in shifting from old location, complying with various regulations of the new location, risk involved in the general business climate of the new location and various other challenges. A reversal of such decision again necessiatates all these incremental expenses and regulatory compliances. Further, recapturing the market back or re-enjoying the economies of scale previously enjoyed could be major challenges. Thus, restructuring may only be reversed or elimited at a high cost.

c. Any restructuring of operations that can reduce the periodic difference between a foreign currency's inflows and outflows can reduce the firm's economic exposure to that currency's movements. - this statement is TRUE

Restructuring of operations involve shifting the sources of revenue and/or costs from one location to another taking into consideration the sensitivity of the new location to various possible exchange rate scenarios.Thus, it reduces the periodic difference between a foriegn currency inflows and outflows thereby reducing the exchange fluctuations of that currency .

d. The management of economic exposure serves as a long-term solution. - this statement is TRUE.

As mentioned above, management of economic exposure comes at a high costs and sometimes with serious business impact. These are to be strategised basis the company's overall goals and requirements. Thus, the economic exposure management is a long term solution.