How does the change in exchange rate affect the long term cash flows of a company? How do you predict it? How do you measure it? Planning for Economic Exposure is a total management responsibility: Interaction of finance, marketing, purchasing and production functions will help development of the strategies to manage Economic Exposure. No change in terms of parent currency Volume increases because the product becomes cheaper other things remaining constant Price becomes lower-other things remaining constant. A combination is more likely. What will be the overall impact? Introduction of a product- delayed, rushed? Accessing a new market-delayed, rushed? Sourcing Diversifying operation Preference for setting up subsidiaries with negative (low) correlation in growth. Sourcing issues for critical material Sourcing financing Parent country or host country? How do you minimize exposure Matching currency cash flows: You expect the subsidiary to generate a certain amount of cash flows per month (local currency). If you used local financing for initial investment, then payment obligation will be in local currency and your exposure will be reduced. Source required material for global operation from the subsidiarys country. Subsidiarys inflow can be matched with the required outflow. Net amount remains exposed. (Natural hedge) Enter into agreements with suppliers who will accept subsidiary currency for payment.
How do you minimize exposure Risk Sharing (long-term buyer-supplier relationship): Suppose you have a 5 year supply contract. Present cost 5,000,000 of local currency per year. You have projected exchange rate for 5 years based on inflation expectation data. Identify a band for future exchange rates. If actual exchange rate is outside the band, the loss of the losing party is shared half by the gaining party. 4. British Firms Dutch Subsidiary borrows Euros from Dutch Parent 1. British firm wishes to invest in Dutch Subsidiary 2. British firm identifies a Dutch firm wishing to invest in a British Subsidiary British Parent Firm Dutch Parent Firm Dutch Firms British Subsidiary British Firms Dutch Subsidiary 3. British Firm loans British Pounds directly to Dutch firms British Subsidiary
Sales to US Debt in Yen
Sales to Japan Debt in US $
Japanese Corporation US Corporation Assets Liabilities Inflow In US $ Assets Liabilities Inflow in Yen Swap Dealer Pay Dollars Receive Yen Pay Yen Receive Dollars Leading: Pay sooner to avoid an appreciation Lagging: Delay payment to take advantage of a devaluation.
There are usually limits on how far you can lead and lag
Intra-company Intercompany A separate Corporate subsidiary that serves as a middleman Paper work through the reinvoicing center. Actual flow of goods normal. Benefits: Exposure Netting Guaranteeing Exchange Rates for Future Orders Managing Intra-Subsidiary cash flows Subsidiary W to pay $38,000 to Subsidiary X by the end of September Subsidiary X to pay Subsidiary Y $49,000 by September 22 Subsidiary Y to pay Subsidiary W $62,000 by September 28 Subsidiary X to pay Subsidiary Z $55,000 by September 25 Subsidiary Z to pay Subsidiary Y $70,000 by September 20 Receiving SubsidiaryW X Y Z Paying Subsidiary Total w 38000 38000 x 49000 55000 104000 y 62000 62000 z 70000 70000 Total 62000 38000 119000 55000 274000 Pay Receive Net w 38000 62000 24000 x 104000 38000 -66000 y 62000 119000 57000 z 70000 55000 -15000 Total 274000