COMPETITIVE / OPERATING EXPOSURE

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 “Let’s face it. If you’ve 75% of your assets in
the US and 50% of your sales outside it, and
the dollar’s strong, you’ve got problems. “
Donald V. Fites
Executive Vice President
Caterpillar Inc.

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 Operating Exposure
Operating exposure, also called economic
exposure, competitive exposure, and even
strategic exposure on occasion, measures
any change in the present value of a
firm resulting from changes in future
operating cash flows caused by an
unexpected change in exchange rates.

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 Attributes of Operating
Exposure
Measuring the operating exposure of a firm
requires forecasting and analyzing all the
firm’s future individual transaction exposures
together with the future exposures of all the
firm’s competitors and potential competitors
worldwide.
The analysis of longer term – where exchange
rate changes are unpredictable and therefore
unexpected – is the goal of operating
exposure analysis.

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 Financial and Operating Cash Flows Between
Parent and Subsidiary

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 Attributes of Operating
Exposure
Operating exposure is far more important for the
long-run health of a business than changes
caused by transaction or translation exposure.

However, operating exposure is inevitably

subjective because it depends on estimates of
future cash flow changes over an arbitrary time
horizon.

Planning for operating exposure is a total

management responsibility because it depends
on the interaction of strategies in finance,
marketing, purchasing and production.

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 Proactive Management of
Operating Exposure
 Operating and transaction exposures can be
partially managed by adopting operating or
financing policies that offset anticipated foreign
exchange exposures.
 The most commonly employed proactive policies
are:
 Matching currency cash flows
 Risk-sharing agreements
 Back-to-back or parallel loans
 Currency swaps
 Reinvoicing center

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 Proactive Management of
Operating Exposure
 In this example, a US firm has continuing
export sales to Canada.
 In order to compete effectively in Canadian
markets, the firm invoices all export sales in
Canadian dollars.
 This policy results in a continuing receipt of
Canadian dollars month after month.
 This endless series of transaction exposures
could be continually hedged with forwards or
other contractual agreements.

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 Matching:
Debt Financing as a Financial Hedge

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 Proactive Management of
Operating Exposure
Matching currency cash flows.
 One way to offset an anticipated continuous long
exposure to a particular company is to acquire
debt denominated in that currency (matching).

 Another alternative would be for the US firm to

seek out potential suppliers of raw materials or
components in Canada as a substitute for US or
other foreign firms.

 In addition, the company could engage in

currency switching, in which the company would
pay foreign suppliers with Canadian dollars.

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 Proactive Management of
Operating Exposure
Currency Clauses: Risk-Sharing:
An alternate method for managing a long-term cash
flow exposure between firms is risk sharing.
This is a contractual arrangement in which the
buyer and seller agree to “share” or split currency
movement impacts on payments between them.
This agreement is intended to smooth the impact
on both parties of volatile and unpredictable
exchange rate movements.

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 Proactive Management
of Operating Exposure
Back-to-Back Loans:
A back-to-back loan, also referred to as a
parallel loan or credit swap, occurs when two
business firms in separate countries arrange
to borrow each other’s currency for a specific
period of time.
At an agreed terminal date they return the
borrowed currencies.
Such a swap creates a covered hedge
against exchange loss, since each company,
on its own books, borrows the same currency
it repays.

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 Using a Back-to-Back Loan for
Currency Hedging

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 Proactive Management
of Operating Exposure
There are two fundamental impediments to
widespread use of the back-to-back loan:
It is difficult for a firm to find a partner,
termed a counterparty for the currency
amount and timing desired.
A risk exists that one of the parties will fail
to return the borrowed funds at the
designated maturity – although each party
has 100% collateral (denominated in a
different currency).

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 Proactive Management
of Operating Exposure
Currency Swaps:
A currency swap resembles a back-to-back
loan except that it is through a swap dealer
who agrees to exchange an equivalent
amount of two different currencies for a
specified amount of time.

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 Using a Cross-Currency Swap to
Hedge Currency Exposure

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 Proactive Management
of Operating Exposure
 Reinvoicing Centers: There are basic benefits
arising from the creation of a reinvoicing
center:
 Managing foreign exchange exposure

 Managing intra-subsidiary cash flows

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 Use of a Reinvoicing Center

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 Revisit the opening quote and explain the
statement.
Why assets?

(not diversified: manufacturing base in US,

so no insulation.

Why sales?

Dollar strengthens than US companies (here

exporters)lose in competition
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