Measurement And Management Of Foreign Exchange Economic Exposure

In November 2001,China joined the World Trade Organization, which means that China economy will melt into the worldwide economy more deeply and more widely. As more and more foreign firms and products come to China, and more and more Chinese firms and products go to foreign countries, foreign exchange exposure isn't only transaction exposure, but also takes another form: economic exposure. The later one will affect a firm's value by changing its costs, sales price, sales volumes, and etc, and it will affect almost all the firms in China, including the pure local firms which have their operation only in China. Do all the Chinese firms face economic exposure and how to measure and manage it? This is what we will analyses in this thesis.The thesis comprises four chapters:Chapter one: "Introduction of economic exposure".Firstly, three kinds of foreign exchange exposure are defined in this chapter: transaction exposure, economic exposure and accounting exposure.Secondly, we introduce the four levels of an unexpected change in exchange rate impacting a firm's cash flows: short run, medium run equilibrium, medium run disequilibrium and long run. In the reality, not all the four parity relationships are satisfied, so we point out that we will only analyses the medium run disequilibrium in this thesis.The first chapter plays an important role in the whole thesis, which is the basis of making further analysis in the following chapters.Chapter two: "The measurement of economic exposure".In chapter two we discuss two methods to measure economic exposure: the sensitivity method and the least-squares estimation method. The sensitivity method is measuring the cash flow changes by analyzing the changes of different variables (cost, sales price, sales volumes, and etc) when the exchange rate changes unexpectedly. Firstly, we keep all the variables unchanged when the foreign exchange rate changes. Secondly, we only make one variable change and keep other variables unchanged when the foreign exchange rate changes. At last, we make all the variables change when the foreign exchange rate changes. The least-squares estimation method measures economic exposure by regressing the firm's value and the exchange rates. At first, we regress the firm's value with one foreign exchange rate. Then we regress the firm's value with more foreign exchange rates. After this, we compare the advantages and disadvantages of the two methods. In the end of the chapter, we list some positive analyses done by foreign economists, and we also do the positive analysis of China economy.Chapter two not only discusses the methods of the economic exposure measurement, but also makes clear the way that an unexpected change in foreign exchange rate impacting a firm's value.Chapter three: "The management of economic exposure".Chapter three discusses two policies to manage economic exposure: operating policies and financing policies. Operating policies manage economic exposure by operating policies. At this chapter we discuss four operating policies. First, diversifying operations. A firm can diversify its raw and processed materials buying, manufacturing and sale in different countries and different fields to diversify economic exposure. Second, using a reinvoicing center. A firm can set up a reinvoicing center to influx its economic exposure and manage it for less cost. Third, requiring customers to share the risk through currency clause. A firm can make a currency clause with its customers to share the economic exposure but also the earnings. At last, pricing policies. A firm can choose the appropriate currency as its pricing currency, and change the price when the foreign exchange rate changes. Financing policies manage economic exposure by financing policies. First, diversifying financing. A firm can finance in different currencies to reduce the influence of the change of foreign exchange rate to its financial costs. Second, matching cash follows. A firm can match its currency cash follows as nature hedges. Third,...