asset exposureHome currencyvalueofassetsand liabilitiesExchangeratefluctuationsFirm valueoperatinglexposureFutureoperatingcashflowsChannelsofEconomicExposure
Channels of Economic Exposure Home currency value of assets and liabilities Future operating cash flows Exchange rate fluctuations Firm value
MeasurementsofEconomicExposureTo determine the magnitude ofexposureExposure to currency risk can bemeasured by the sensitivities of :(1) the future home currency values of thefirm's assets (and liabilities )(2) the firm's operating cash flows to randomchanges in exchange rates
Measurements of Economic Exposure ❖To determine the magnitude of exposure ❖Exposure to currency risk can be measured by the sensitivities of : (1) the future home currency values of the firm’s assets (and liabilities ) (2) the firm’s operating cash flows to random changes in exchange rates
HowtoMeasureAssetExposureThere exist statistical measurements of sensitivity If a U.S. MNC has an asset in U.K., its exposure tocurrencyrisk can be measured by the coefficient inregressing on the dollar value (P) of its British assetson the dollar pound exchange rate, S($/), theregression would be of the form:P=a+bxS+e.Where a is the regression constant and e is the randomerror term with mean zero. The regression coefficient bmeasures the sensitivity of the dollar value of the assets(P) to the exchange rate, S
How to Measure Asset Exposure ❖ There exist statistical measurements of sensitivity ❖ If a U.S. MNC has an asset in U.K., its exposure to currency risk can be measured by the coefficient in regressing on the dollar value (P) of its British assets on the dollar pound exchange rate, S($/£), the regression would be of the form: P = a+bS +e •Where a is the regression constant and e is the random error term with mean zero. The regression coefficient b measures the sensitivity of the dollar value of the assets (P) to the exchange rate, S
HowtoMeasureAssetExposureThe exposure coefficient, b, is defined asfollows:Cov(P, S)b =Var(S)Where Cov(P,S) is the covariance betweenthe dollar value of the asset and the exchangerate, and Var(S) is the variance of theexchange rate
How to Measure Asset Exposure The exposure coefficient, b, is defined as follows: Var( ) Cov( , ) S P S b = Where Cov(P,S) is the covariance between the dollar value of the asset and the exchange rate, and Var(S) is the variance of the exchange rate
Howto MeasureAssetExposureCov(P, S)b:Var(S)The exposure coefficient shows thatthere are two sources of economicexposure: the variance of the exchangerate and the covariance between thedollarvalue ofthe asset andexchangerate
How to Measure Asset Exposure • The exposure coefficient shows that there are two sources of economic exposure: the variance of the exchange rate and the covariance between the dollar value of the asset and exchange rate. Var( ) Cov( , ) S P S b =