Tutorial 5 Answers
10.Translation Exposure. Consider a period in which the U.S. dollar weakens against the euro. How will this affect the reported earnings of a U.S.-based MNC with European subsidiaries? Consider a period in which the U.S. dollar strengthens against most foreign currencies. How will this affect the reported earnings of a U.S.-based MNC with subsidiaries all over the world?
ANSWER: The consolidated earnings will be increased due to the strength of the subsidiaries’ local currency (the euro).
The consolidated earnings will be reduced due to the weakness of the subsidiaries’ local currencies.
12.Economic Exposure. Longhorn Co. produces hospital equipment. Most of its revenues are in the United States. About half of its expenses require outflows in Philippine pesos (to pay for Philippine materials). Most of Longhorn’s competition is from U.S. firms that have no international business at all. How will Longhorn Co. be affected if the peso strengthens?
ANSWER: If the peso strengthens, Longhorn will incur higher expenses when paying for the Philippine materials. Because its competition is not affected in a similar manner, Longhorn Company is at a competitive disadvantage when the peso strengthens.
19. Comparing Transaction and Economic Exposure. Erie Co. has most of its business in the U.S., except that it exports to Belgium. Its exports were invoiced in euros (Belgium’s currency) last year. It has no other economic exposure to exchange rate risk. Its main competition when selling to Belgium’s customers is a company in Belgium that sells similar products, denominated in euros. Starting today, Erie Co. plans to adjust its pricing strategy to invoice its exports in U.S. dollars instead of euros. Based on the new strategy, will Erie Co. be subject to economic exposure to exchange rate risk in the future? Briefly explain.
ANSWER: Economic exposure still exists because a weak euro would encourage Belgian customers to switch to local competitors.
7.Limitations of Hedging Translation Exposure. Bartunek Co. is a U.S.-based MNC that has European subsidiaries and wants to hedge its translation exposure to fluctuations in the euro’s value. Explain some limitations when it hedges translation exposure.
ANSWER: The limitations are as follows. First, Bartunek Inc. needs to forecast its foreign subsidiary earnings and may forecast inaccurately. Thus, it will hedge against a level of foreign earnings that differs from actual foreign earnings.
Second, forward contracts are not available for all currencies, although Bartunek will not be affected by this limitation since forward contracts in euros are available.
Third, transaction exposure may be increased as a result of hedging translation exposure.
10.Comparing Degrees of Translation Exposure. Nelson Co. is a U.S. firm with annual export sales to Singapore of about S$800 million. Its main competitor is Mez Co., also based in the United States, with a subsidiary in Singapore that generates about S$800 million in annual sales. Any earnings generated by the subsidiary are reinvested to support its operations. Based on the information provided, which firm is subject to a higher degree of translation exposure? Explain.
ANSWER: Since Nelson Company does not have any subsidiaries, its exposure to exchange rate fluctuations would not be classified as translation exposure. Conversely, Mez Company is subject to translation exposure.
11.Managing Economic Exposure. St. Paul Co. does business in the United States and New Zealand. In attempting to assess its economic exposure, it compiled the following information.
a.St. Paul’s U.S. sales are somewhat affected by the value of the New Zealand dollar (NZ$), because it faces competition from New Zealand exporters. It forecasts the U.S. sales based on the following three...