The U.K. based auto manufacturing company with a pro forma statement analysis has estimated the dependence of various cash-flow elements, in millions of £, for next year to the two main risk factors that it faces, x1 the £/$ exchange rate and x2 the GBP Libor in percentage points:

Sales = 95 + 720x₁−640x₁²+ 20x₂,

Operating costs = 240 + 10x₂

Interest payments = 30 + 20x₂

Taxation is 25% on profits and 10% (tax credit) on losses. The GBP Libor is expected to be1% and the exchange rate is expected to stay at £ 0.5/$.

(a) What risk factors does the company face?

(b) What are the exposures of the before tax and after-tax earnings to the two risk factors?

(c) What are the relevant exposures for hedging earnings? before tax exposures or after tax exposures

Answer rating: 100% (QA)

A Companies are exposed to the three types of risk caused by currency volatility transaction exposur... View the full answer