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In today’s world, changing exchange rate has a great impact on the working and reliability of companies. The fluctuating exchange rate affects MNCs, large corporations along with smaller industries. Not only do business owners need to be aware of the impact of exchange rate risk, but also to investors since it can influence their investments. Transaction exposure is due to the international transactions made by a company. Economic exposure is uncalled for currency fluctuations that occur. If the currency increases then the competition between the companies will increase consequently. If the currency varies at a lower level it is desirable but a high level is desired where two differing currencies are used to show inflows and outflows.
Domestic firms may suffer adversely if the currency rate strengthens, since with that consumers would start preferring foreign goods. Translation exposure is greater when the percentage of business conducted by subsidiaries is higher.
One way of how exchange rate can have an impact on earnings is when we compare earnings in foreign market. Cieplak, Inc, a U.S based MNC has expanded into Asia. Its U.S parent has exports with some Asian countries and hence the dominating currencies are Asian. A larger subsidiary of it lies in Malaysia. Cieplak’s reduced earnings during the Asian crisis are related to exposure to exchange rates. Due to the lowered Asian currencies, the exports received were converted to fewer dollars. Also, any funds dispatched by the Malaysian subsidiaries were converted to fewer dollars for the parent. Lastly, the earnings made by the Malaysian subsidiary were converted to still fewer dollars on the translation exposure even if it did not dispatch any earnings to the parent.
Question 2
“If the foreign currencies to be received by a U.S.-based MNC suddenly weaken against the dollar, the MNC will receive a lower amount of dollar cash flows than was expected. This may reduce the cash flows of the MNC.” (Madura, p.17). Several factors affect a firm’s degree of transaction exposure in a particular currency. These factors include money market hedge on receivables and payables, net transaction exposure, hedging with futures, currency options and cross hedging.
If for instance, a company corporate in the U.S decides to use Singaporean dollars for investment since the amount reclines upon conversion, it creates a money market hedge. This offsets the transaction exposure due to the future receivables in Singapore dollars.
Assuming that a company has a high interest rate that belongs to a different State, the U.S firm could implement a money market hedge that could deposit the interest in a bank accumulating to a large amount that can take care of the net payables. (The Manage Mentor, 2003)
When identifying the net transaction exposure, an MNC could reduce the amount of cash flow that needs to be hedged that can reduce the transaction costs related to hedging.
Some ways of reducing economic exposures are by shifting expenses to areas of larger revenues. In this way the burden on one economy is reduced. Next, tradeoffs can be operated when economic exposure should be reduced. Having scattered production plants in order to strengthen the weaker currency is an option however economies of scale are neglected here.
Also, a firm can hedge translation exposure by selling forward the currency of the firm’s foreign subsidiary. Hence if the value of foreign currency falls, the translation loss will be compensated by the gain on the short position created by the forward contract.
Similarly, the U.S Corporation could sell the Malaysian ringgit with the help of a forward contract. The process involves consulting a bank to give access to the ringgit for the exchange of dollars in return which will be at the precise rate dated for some time in the future. In this way the net receivables are hedged bringing profit to both the firms and minimizing any losses due to currency exchange rate.
References
Lingnan. Review.Retrieved from http://www.lingnan.net/jpkc/ifm/UploadFile/review/11.htm
Madura, J. (2012) International Financial Management (11th ed).
The Manage Mentor. (2003) Enlightenment to areas/Finance/Hedging. Retrieved
fromhttp://www.themanagementor.com/enlightenmentorareas/finance/IF/
Hedging. htm
