Economic Exposure

BO = %O , %X Bo BR = %R , %X BC = %C , %X = Measure of operating cash flow exposure (operating exposure). Similar to an elasticity measure. BR = Measure of revenue exposure. BC = Measure of operating cost exposure. O = Operating cash flows(OCF) in base currency. Base currency OCF increases (+), OCF decreases (-) R = Revenue in base currency. Base currency revenue increases (+), Base currency revenue decreases (-) C = Operating costs base currency. Base currency operating costs increase (+), Base currency operating costs decrease (-). %X = Percent change in non base currency. Non base currency appreciates (+), Non base currency depreciates (-).

#1: Assume: 1. The base currency is in British pounds. 2. Current spot exchange rate is 1.50$/. 3. R0 = 500,000 per year. 4. Exchange rate changes to 1.80$/. 5. R1 = 750,000 per year. What is the operating revenue exposure, BR? Ans.

1) Non base currency depreciates (-) %X = Percentage change in non base currency, in this case the $. Dollar depreciated by (1.50/1.80) - 1 = -16.67% 2) Base currency revenue increases (+) %R = 750/500 - 1 = .50 3) BR = 0.50/(-.1667) = -3.0

#2: Assume: 1. Base currency operating revenues are A$500,000/yr. 2. Current exchange rate is 0.6667 A$/$ 3. Operating revenue exposure to changes in the A$/$ exchange rate of BR = 0.6. 4. The U.S. dollar appreciates by 20%. What is the new base currency operating revenues, R1?

Ans. R1 = R0 [BR (%X)+1] = A$500,000[.6(.2)+1] = A$560,000 Non base currency appreciates (+). %X was (+).

#3: Assume: 1. Base currency is U.S. dollars. 2. Spot exchange rate is 1.50$/. 3. O0 in base currency terms is $500,000/yr. 4. Exchange rate changes to 1.80$/. 5. O1 in base currency terms is $750,000/yr.

Find BO.

Ans.

1) Base currency operating cash flows increase (+). %O = ($750/$500) - 1 = .50 2) Non base currency appreciates (+). %X = (+) (1.80/1.50) - 1 = .20 3) BO = .50/.20 = 2.50

#4: Assume: 1. Base currency is U.S. dollars. 2. Spot exchange rate is 5FF/$. 3. O0 in foreign currency terms is FF 1,000,000/yr. or $200,000 in base currency terms. 4. BO = 1.0 5. French franc, non base currency, depreciates by 10% relative to the dollar. Find O1.

Ans.

1) Non base currency depreciates (-) 2) O1 = O0 [BO (%X) + 1] 3) O1 = $200,000 [1.0(-0.10) + 1] = $180,000

#5: Assume: 1. BR = 1.0 2. BC = 0.5 3. Expected Operating Cash Flow Margin (O/R) is 0.10. R/O = 10 and C/O = 9 since C/O = R/O - 1 Find BO. Ans. 1) BO = BR (R0/O0) - BC (C0/O0) 2) BO = 1.0 (10) - .5 (.9R/ .1R) = 5.5 Find % in O if non base currency depreciates by 7% relative to the base currency. 1) Non base currency depreciates (-). BO = %O / %X BO (%X) = %O = 5.5(-.07) = -.385 The base currency operating cash flows decreased by 38.5%

#6: Assume: 1. Base currency is pounds. 2. Sales volume is 500,000 units at $2/unit = $1,000,000. 4. Spot rate is 1.5$/. 5. The dollar price and volume will not change if the exchange rate changes. BR = 1.0 6. Dollar, non base currency, increases in value by 10%.

Find R1. Ans. 1) Non base currency appreciates (+) 2) R0 = $1,000,000/1.50 = 666,667 3) R1 = (BR (%X) + 1) R0 = (1(.10) + 1)666,667 = 733,335 4) %R = (733,334/666,667) - 1 = .10 or 10%

#7: Assume: 1. Base currency is yen. 2. Dollar is currency of determination. 3. Sales volume of 1,000 units at 100,000/unit. R0 = 100 million. 4. Dollar, non base currency, appreciates by 15%. Find R1. Ans.

1) Non base currency appreciates (+) 2) R1 = (BR (%X) + 1) R0 3) BR = 1.0 the non base currency is currency of determination so prices are set in the non base currency 4) R1 = (1.0 (.15) + 1) 100 million = 115 million

#8: Assume: POZ example 1. Base currency is the dollar. 2. Dollar is the currency of determination. 3. Current spot rate is 1.20/ECU. 4. R0 = 10,000 ($144) = $1,440,000 5. ECU, non base currency, depreciates by 10%. 6. Volume falls to 8,700 units, but dollar price stays the same. R1 = 8,700 ($144) = $1,252,800 Find BR. Ans. 1) Non base currency depreciates (-) 1) Base currency revenue decreases (-) 2) BR = (1,252,800/1,440,000 - 1)/(-.10) = 1.30

#9: Assume: 1. 30% of R have BR = 1.0. 2. 20% of R have BR = -0.44. 3. 50% of R have BR = 0.00. Find BR. Ans. 1) Beta of a portfolio is the weighted average of the betas of the securities in the portfolio. 2) BR = .30(1.0) + .20(-.44) + .50(0.00) = 0.212 Assume: 1. 15% of C have BC = 1.0 2. 25% of C have BC = 0.40 3. 60% of C have BC = 0.00 Find BC. Ans. 1) BC = .15(1.0) + .25(.40) + .60(0.00) = 0.25

#10 Assume: 1. OCF margin (O/R) = 25%. 2. BR = -0.35 3. 60% of costs are dollar based with BC = 1.0 Find BO. Ans. 1) BR = -0.35 2) BC = 0.60 3) R/O = 4 from (1/.25) 4) C/O = 3 from C/O = R-O/O = R/O -1 = 3 5) BO = (-0.35)(4) - (0.60)(3) = -3.20

#11 Assume: 1. Base currency is the pound. 1. Currency of determination is the dollar. 2. BR = 1 because prices are set in dollars. 3. OCF margin (O/R) = 25%. So R/O = 4 and C/O = 3. 4. BC = 1 because all costs are incurred in dollars. Find BO. Ans. 1) BO = (1)(4) - (1)(3) = 1.0

#12 Assume: 1. Base currency is the yen. 2. Selling price is determined as follows: 60% by the dollar, BR = 1 dollar is currency of determination. 40% by the yen. BR = 0 yen is currency of determination. 3. No demand exposure. 4. OCF margin = 25%. So R/O = 4 and C/O = 3. 5. Costs are determined as follows: 30% by the dollar, BC = 1 70% by the yen. BC = 0 Find BO. Ans. Remember that the beta of a portfolio is the weighted average of the betas of the securities in the portfolio. 1) BR = (.60)(1.0) + (.40)(0.00) = 0.60 2) BC = (.30)(1.0) + (.70)(0.00) = 0.30 3) BO = (.60)(4) + (.30)(3) = 1.50

#13 Assume: 1. Base currency is the dollar. 2. For domestic sales, prices are set as follows: 78% the dollar is currency of determination. BR = 0 22% the pound is the currency of determination. BR = 1 BR(U.S.) = .78 (0) + .22 (1) = .22 3. For U.K. sales, prices are set as follows: 65% the pound is the currency of determination. BR = 1 35% the dollar is the currency of determination. BR = 0 BR(U.K.) = .65 (1) + .35 (0) = .65 4. 33.33% of dollar revenue is earned in U.K. 5. 66.67% of dollar revenue is earned in the U.S. Find BR. Ans. 1) BR for U.K. =.65 2) BR for U.S. =.22 3) BR(Port) = .67(.22) + .33(.65) = .36

#13(cont) Additional assumptions: 1. Currently U.K. sales are 1,000 units at a selling price of 100/unit. 2. Currently U.S. sales are 2,000 units at $150/unit. 3. Assume the dollar (base currency) appreciates by 25% from the current exchange rate of 1.50$/. Exchange rates change from 1.50$/ to 1.20$/, pound depreciates by 20%=(1.20/1.50) - 1 4. Sales volume is not affected by exchange rates. 5. Sales prices are set by respective currencies of determination. Domestic market (U.S.): 22% of the $150/unit selling price declines by 20%, since the pound depreciates by 20%. New price is: $150 - 0.20(0.22)150 = $143.40/unit. New operating revenues from domestic U.S. operations are: ($143.40/unit)(2,000 units) = $286,800. Foreign market (U.K.): Since the dollar appreciated by 25%; 35% of the selling price increased by 25%. New selling price is: 100 + 0.25(0.35)100 = 108.75/unit. Since the new exchange rate is 1.2$/, the new foreign currency operating revenues are: (108.75/unit)(1,000 units)(1.20$/) = $130,500 6. The new total expected base currency operating revenue is: R1 = $286,000 + 130,500 = $417,500 #13 continued

7. Relative to the original expected total base currency operating revenues of ($150/unit)(2,000 units) + (100/unit) (1,000 units)(1.5$/) = $450,000, the expected base currency operating revenues for the firm as a whole have changed by $417,300/$450,000 - 1 = -0.072667, or declined by 7.2667%. Base currency revenues declined (-). Given the 20% depreciation of the pound (non base currency depreciated (-)), BR = -0.072667/(-0.20) = 0.3633