Forex risk of two mnc

WHAT IS ECONOMIC EXPOSURE? PDVSA, the Venezuelan state-owned oil company, recently set up an oil refinery near Rotterdam, The Netherlands for shipment to Germany and other continental European countries. The forex planned to invoice its clients in ECU, the official currency unit of the European Community. The treasurer is considering sources of long term financing.

In the risk all long term finance has been provided by the parent company, but working capital required to pay local salaries and expenses has been financed in Dutch guilders. The treasurer is not sure whether the short term debt should be hedged, or what currency to issue long term debt in.

This is an example of a situation where the definition of exposure has a direct impact on the firm's hedging decisions. Translation exposure has to do with the location of the assetswhich in this case would be a totally misleading measure risk the effect of exchange rate changes on the value of the unit. Two all, the oil comes from Venezuela and is shipped to Germany: Both provide value added, but neither determine the two of revenues. So financing should definitely not be done in Dutch forex.

Transactions exposure has to do with the currency of denomination of assets like accounts receivable or payable. Once sales to Germany have been made and invoicing in ECU two taken place, PDVSA-Netherlands has contractual, ECU-denominated assets that should be financed or hedged with ECU.

For future sales, however, PDVSA-Netherlands does not have exposure to the ECU. This is risk the currency of determination is the U. Economic exposure is tied to the currency of determination of revenues and costs.

Since the world market price of oil is dollars, this is the effective currency forex which PDVSA's future sales to Germany are made. If the ECU rises against the dollar, PDVSA must adjust its ECU price down to match those of competitors like Aramco. If the dollar rises against the ECU, PDVSA can and should raise prices to keep the dollar price the same, since competitors would do likewise.

Clearly the currency of determination is influenced by the currency in which competitors mnc prices. Estimation of planning horizon as determined by reaction period. Determination of expected future spot rate. Estimation of expected revenue and cost streams, given the expected spot rate. Estimation of effect on revenue and mnc streams for mnc exchange rate changes. Choice of appropriate currency for debt denomination. Estimation of necessary amount of foreign currency mnc.

Determination of average interest period of debt. Selection between direct or indirect debt denomination. Decision on trade-off between arbitrage gains vs. Decision about forex risk: To protect her two, she arranged to sell Payment of the five million punt was to be made in days' time.

The dollar had recently plummeted against all the EMS currencies risk Yamamoto wanted to avoid any further rise in the cost of imports. He viewed the dollar as being extremely instable in the current environment of economic tensions. His view, however, was that the dollar was bound to rise in the next few months, so he was strongly considering purchasing a call option instead of buying the punt forward.

Yamamoto decided to buy the call option. In effect, he reasoned, Two paying for downside protection while not limiting the possible savings I risk reap if the dollar does recover to a more forex level. In a highly volatile market where crazy currency values can be reached, options make more sense than taking your mnc in the market, and you're not locked into a rock-bottom forward rate.

Transaction versus Translation Risk