How Exchange Rate Fluctuations Lead to Economic Exposure

Assessment

Contents
INTRODUCTION.....................................................................................................................................3
MAIN BODY.............................................................................................................................................3
(a) Explain how exchange rate fluctuations may lead to economic exposure....................................3
(b) Preparation of discussion paper:..................................................................................................4
CONCLUSION..........................................................................................................................................8
REFERENCES..........................................................................................................................................9

INTRODUCTION
The report is based on an engineering company that is SIRI BHD. Currently company is
planning to invest in a larger project which is needed an investment of RM 400 million. In
addition to this, company wants that the funding of such project must be fulfilled by sale of its
equity investment in a USA company and from cash flows generated from its normal business
activity. For this purpose, various kinds of aspects are evaluated in order to take decision
whether above company needs to make investment in larger project or not. In detailed manner,
the project is divided into two parts in which first part contains information about impact of
change in exchange rate on economic exposure. While in second part different kinds of elements
are included like calculation of dividend capacity, selection of hedging technique and many
more.
MAIN BODY
(a) Explain how exchange rate fluctuations may lead to economic exposure.
The term economic exposure is known as extent to which a business’s cash flow is
affected due to changes in exchange rates (Prasad and Suprabha, 2015). In other words,
the economic exposure raises as foreign exchange volatility raises and decreases as it
drops. This is defiantly higher for global companies which have different kinds of
subsidiaries companies and higher volume of transactions including foreign currencies.
In the case when PPP (Purchasing power parity) holds, then companies might not get
affected due to change in exchange rates as low currency value may be compensated
through efficiency to increase prices because of higher level of inflation. In addition to
this, if one nation has increases rate of inflation instead to other then its currency is
estimated to reduce during entire time. Though, as the PPP (Purchasing power parity) the
rule of one price contains because any issue in one currency will be compensated by rate
of inflation in currency’s nation or any group of nation in the case of USD. Though, a
regular change in exchange rate can occur but due to relative inflation rate differentials.
In the case when rule of one price will not be considered and prices re-changed to a new
or larger or fixed rate. For instance, the United Kingdom to USA rate dropped in the 20th
century, as USA’s economy raised in an effective manner as compared to United
Kingdom. The rate approximately reached at parity in 1985 just before recovering.