Question

Introduction

Decision making in finance is rarely black and white and one decision can be appropriate for one situation and not appropriate for another. Point and counter-point discussions should highlight this as well as expand upon the ability to support a decision that may not be supported by others in the same department.

Initial Post Instructions

Consider the following point and counter-point arguments then use the Internet to learn more about the issue. Which argument to you support? Explain why and offer your own opinion on the issue.

• Point: Investors should not care about an MNC’s translation exposure. The present value of an MNC’s cash flows is based on the cash flows that the parent receives. Any impact of the exchange rates on the financial statements is not important unless cash flows are affected. MNCs should focus their energy on assessing the exposure of their cash flows to exchange rate movements and should not be concerned with the exposure of their financial statements to exchange rate movements. Value is about cash flows, and investors focus on value.
• Counter-Point: Investors should care about an MNC’s translation exposure. Investors do not have sufficient financial data to derive cash flows. They commonly use earnings as a base, and if earnings are distorted, so will be their estimates of cash flows. If they underestimate cash flows because of how exchange rates affected the reported earnings, they may underestimate the value of the MNC. Even if the value is corrected in the future once the market realizes how the earnings were distorted, some investors may have sold their stock by the time the correction occurs. Investors should be concerned about an MNC’s translation exposure. They should recognize that the earnings of MNCs with large translation exposure might be more distorted than the earnings of MNCs with low translation exposure.

Answer 1

We support the Counter-Point argument as it is more reasonable & valid.

The term translation exposure refers to the risk that a company's assets, liabilities, equity or income will change as a result of changes in the exchange rates. This happens when a company denominates a part of any of these items in a foreign currency. So as a result, the values of the portion of these items denominated in foreign currency keep changing with the exchange rate.

The investors cannot keep assessing the exposure of their cash flows to exchange rate movements (as argued in the point argument). Rather most investors rely on financial statements to judge the value of the stock & take buy or sell decisions consequently.

Secondly, Value is about cash flows, but not only current cash flows it is much more about expected future cash flows. An investor cannot correctly judge the expected future cash flows of a multinational company having assets & liabilities denominated in multiple foreign currencies if he does not take the exposure to those foreign currency rates in consideration. So investors should care about translation exposure.