Question

Why should a MNC identify net exposure? EXPLAIN what decision will be made? Once you have identified net exposure what are your options, explain each option in terms of pro and con (what you hope to happen, what happens If you are wrong)

Answer 1

Multinational companies hedge against foreign exchange risk internally hedge by shifting balances to the currencies they will pay/receive in a certain country, at some future time and don’t want to take the risk of that currency being more expensive to buy when they need it.

And what amount will the need is decided by  Net Exposure

For example,

XYZ Co., located in Canada, has imported machinery from the United States and regularly exports to Europe.

The company must pay $10 million to its U.S. machinery supplier in three months, at which time it is also expecting a receipt of EUR 5 million and CHF 1 million for its exports. The spot rate is EUR 1 = USD 1.35, and CHF 1 = USD 1.10. How can Widget Co. use exposure netting to hedge itself?

The company’s net currency exposure is USD $2.15 million (i.e., USD $10 million - [(5 x 1.35) + (1 x 1.10)]).

If XYZ Co. is confident that the Canadian dollar will appreciate over the next three months, it would do nothing, since a stronger Canadian dollar would result in U.S. dollars becoming cheaper in three months.

On the other hand, if the company is concerned the Canadian dollar may depreciate against the U.S. dollar, it may elect to lock in its exchange rate in three months through a forward contract or a currency option. Exposure netting is thus a more efficient way of managing currency exposure by viewing it as a portfolio, rather than hedging each currency exposure separately.

PRO's

If the Canadian dollar may depreciate against the U.S. dollar then you are hedged because you have a  forward contract or a currency option.

CON's

If Canadian dollar appreciates you may have to pay a transaction fess or premium