Coca Cola most recent financial statements for the year the fiscal year ended 31st December 2015, addresses foreign currency exchange risk in Item 7A. Quantitative and Qualitative Disclosers about Market Risk (Coca Cola, 72). The company faces significant foreign exchange risk because it operates in 72 currencies and earns $23.934 billion from operations outside the United States (Coca Cola, 72). Coca Cola operates in over 200 countries and faces three types of foreign exchange risk, transaction risk, translation risk, and economic risk. The company manages its foreign exchange rate risk on a consolidated basis.
The transaction risk is the risk that the foreign exchange movements between the transaction date and when cash payment or receipt is made will adversely affect the value of the transaction (Narvaez). Coca Cola manages transaction risk by using internal and external hedging techniques. For the internal hedging techniques the company employs netting and matching that allows the company to offset certain exposures. The company also uses derivatives to manage the foreign exchange rate risk. The company enters into forward contracts, purchases options (mainly in Japanese yen and Euros), and collars (Coca Cola Annual Report, 72). As at 31st December 2015, the company had total derivatives worth $23.553 billion (Coca Cola Annual Report, 72). Coca Cola hedges only for the major currencies such as the Euro and the Yen, because it would be too costly for the company to hedge for all its currencies and especially for volatile emerging market currencies such as Mexico, Brazil and Venezuela (Esterl). According to Wikinvest, countries that pose the biggest foreign exchange risk to Coca Cola are Brazil, Venezuela, South Africa, Britain, Japan and Australia.
Economic risk is the risk that long-term exchange rate movements will affect the cash flows of the firm and consequently the value of the firm (Narvaez).Most firms find it difficult to hedge economic risk. The company forecasts the US dollar to strengthen in 2016 relative to major currencies, and this is projected to reduce revenues by 7% while operating profit is expected to decline by 11%.
Translation risk arises when a firm with foreign subsidiaries prepares consolidated financial statements and has to translate the foreign assets and liabilities. A firm will post a translation loss when the home currency strengthens relative to the foreign currency and a translation gain if the home currency weakens relative to the foreign currency (Narvaez). Coca Cola need not hedge translation risk because the risk does not result into actual cash flows. However, translation risk has had a significant impact on Coca Cola reported earnings McGarth notes that the devaluation of the Venezuelan Bolivar caused Coca Cola a 55% decline in profits in the fourth quarter of 2014. Due to the currency crisis in Venezuela, Coca Cola charged $393 million to its earnings in the fourth quarter of 2014.
Venezuela has experienced three consecutive years of economic and social crises since 2014 (Kissi). Venezuela heavy reliance on oil that has declined from $100 to about $30 per barrel and the government extravagant spending paints a bleak future for Venezuela (Kissi). Without a change in ideology or government, Venezuela crisis will only get worse. Coca Cola expects the Venezuela crisis to persist into 2017 (Esterl). Multinationals such as Coca Cola will face increased translation risk as they will have to mark down the assets denominated in Venezuela Bolivar.
Works cited
Coca Cola. "Annual Report." Coca Cola. 2015. Web. 1 Apr. 2016.
Esterl, Mike. "Coca-Cola Warns Battle With Strong Dollar Will Continue." WSJ. 21 Oct. 2015.
Web. 01 Apr. 2016.
Kissi, Dawn. "Venezuelan Default: Worse than Argentina?" CNBC. 07 Feb. 2016. Web. 01 Apr.
2016.
McGarth, Maggie. "Currency Swings Take The Air Out Of Coca-Cola Fourth Quarter Profit."
Forbes. Forbes Magazine, 10 Feb. 2015. Web. 01 Apr. 2016.
Narvaez, Kristina. "What CFOs Should Know About Foreign Exchange Risks." CFO. 21
May 2015. Web. 01 Apr. 2016.
Wikinvest. "Coca-Cola Company (KO)." Foreign Exchange for Coca-Cola_Company (KO).
2010. Web. 01 Apr. 2016.
