What options did it have to hedge its operating exposure?

Questions

1. What were the key components of Laker Airways’ operating exposure?

2. What options did it have to hedge its operating exposure?

3. Could Laker have hedged its “natural” dollar liability exposure?

4. Should Laker have financed its purchase of DC 10 aircraft by borrowing sterling from a British bank rather than using the dollar-denominated financing supplied by McDonnell Douglas and the Eximbank? Consider the fact that Eximbank, a U.S. government agency, subsidized this financing in order to promote U.S. exports.

10 Stephen Power, “Porsche Powers Profit With Currency Plays,” the Wall Street Journal December 8, 2004, C3.

11 Ibid.

12 Fred R. Bleakley, “How U.S. Firm Copes with Asian Crisis,” Wall Street Journal, December 26, 1997, p. A2.

11.7 Summary and Conclusions

In this chapter, we examined the concept of exposure to exchange rate changes from the perspective of the economist. We saw that the accounting profession’s focus on the balance sheet impact of currency changes has led accountants to ignore the more important effect that these changes may have on future cash flows. We also saw that to measure exposure properly, we must focus on inflation-adjusted, or real, exchange rates instead of on nominal, or actual, exchange rates. Therefore, economic exposure has been defined as the extent to which the value of a firm is affected by currency fluctuations, inclusive of price-level changes. Thus, any accounting measure that focuses on the firm’s past activities and decisions, as reflected in its current balance sheet accounts, is likely to be misleading.

Although exchange risk is conceptually easy to identify, it is difficult in practice to determine what the actual economic impact of a currency change will be. For a given firm, this impact depends on a great number of variables including the location of its major markets and competitors, supply and demand elasticities, substitutability of inputs, and offsetting inflation.

Finally, we concluded that since currency risk affects all facets of a company’s operations, it should not be the concern of financial managers alone. Operating managers, in particular, should develop marketing and production initiatives that help ensure profitability over the long run. They should also devise anticipatory or proactive, rather than reactive, strategic alternatives in order to gain competitive leverage internationally.

The key to effective exposure management is to integrate currency considerations into the general management process. One approach that many MNCs use to develop the necessary coordination among executives responsible for different aspects of exchange risk management is to establish a committee for managing foreign currency exposure. Besides financial executives, such committees should—and often do—include the senior officers of the company such as the vice president-international, top marketing and production executives, the director of corporate planning, and the chief executive officer. This arrangement is desirable because top executives are exposed to the problems of exchange risk management, so they can incorporate currency expectations into their own decisions.

In this kind of integrated exchange risk program, the role of the financial executive is fourfold: (1) to provide local operating management with forecasts of inflation and exchange rates, (2) to identify and highlight the risks of competitive exposure, (3) to structure evaluation criteria so that operating managers are not rewarded or penalized for the effects of unanticipated currency changes, and (4) to estimate and hedge whatever operating exposure remains after the appropriate marketing and production strategies have been put in place.

Place Your Order Here!

Leave a Comment

Your email address will not be published. Required fields are marked *