1. Instead of its previous policy of always hedging its foreign currency receivables, Sun Microsystems has decided to hedge only when it believes the dollar will strengthen. Otherwise, it will go uncovered. Comment on this new policy.
Hedging itself is defined as enter into a forward contract in order to protect the home currency value of foreign-currency-denominated assets or liabilities. Sun Microsystems however is using this as a way to make money by using selective hedging that is designed to protect against anticipated currency movements (profit centers). This is done because the desire to reduce the expected costs of hedging and increase profits, often leads to taking higher risks by hedging only when a currency change is expected and going unhedged otherwise.
2. The Montreal Expos are a Major League Baseball team located in Montreal, Canada. What currency risk is faced by the Expos, and how can this exchange risk be managed?
They face a currency risk because the team itself plays in Montreal which uses Canadian money but at the same time, the US is paying them to play in US dollars. Payroll costs account for the lion's share of baseball costs. This will end up being a hurting the US when their dollar appreciates against the Canadian dollar.
Chapter 10
1.a. Define exposure, differentiating between accounting and economic exposure. What role does inflation play?
Accounting exposure also known as translation is the change in value of a firm’s foreign-currency-denominated accounts doe to a change in the exchange rate. Where economic exposure measures the extent to which the value of the firm will change due to an exchange rate change. Inflation’s role as well as the interest rate both are known to affect the exchange rate itself. The real exchange what is defined as the nominal exchange rate adjusted for changes in the relative purchasing power of each currency since some base period. Therefore, a dramatic change in the nominal exchange rate accompanied by an equal change in the price level should have no effects on the relative competitive positions of domestic firms and their foreign competitors and, therefore, will not alter real cash flows. Alternatively, if the real exchange rate changes, it will cause relative price changes—changes in the ratio of domestic goods’ prices to prices of foreign goods.
1.b. Describe at least three circumstances under which economic exposure is likely to exist.
They entered into sales or purchase contracts fixed in a foreign currency.
They are selling or buying abroad or it faces domestic competition from imports and the real exchange rate changes.
They are operating in a foreign country whose government taxes nominal rather than real income.
1.d. What is exchange risk, as distinct from exposure?
