You Are the Cfo of a U.S. Firm Whose Wholly Owned Subsidiary Within Mexico Manufactures Component Parts for Your U.S. Assembly Operation
You Are the Cfo of a U.S. Firm Whose Wholly Owned Subsidiary Within Mexico Manufactures Component Parts for Your U.S. Assembly Operation
Question:You are the CFO of a U.S. firm whose wholly owned subsidiary within Mexico manufactures component parts for your U.S. assembly operation. The subsidiary has be financed by bank borrowings contained by the United States. One of your analysts told you that the Mexican peso is expected to depreciate by 30 percent against the dollar on the foreign exchange markets over the subsequent year. What actions, if any, should you purloin?
Answers:
In effect, your US $ buying power will increase. Also, the value of your US debt relative to the peso will increase. This presents several opportunity:
– If youre in expense control mode, refinance the US debt at the modern, lower amount (save on debt costs)
– if youre in a growth mode, refinance and wish out new superfluous financing with the extra 30% to invest more heavily within the company (keep the same debt costs but catch more for it)
– buy futures contracts / arbitrage on the currency markets to mitigate your risk (e.g. what if the peso lone goes down 10%? what if it go down 50%?). You could possibly use some of the money you freed up with the refinancing to fund these contracts.
Answer: This question deals with the risk faced by businesses related to changes in exchange rates. If the peso depreciates as expected peso relative to the dollar, the dollar value of the companys Mexican subsidiary would decrease substantially. This would then reduce the total dollar value of the firms equity reported in its consolidated balance sheet, raising the apparent leverage of the firm, which could increase the firms cost of borrowing and limit its access to the capital market. Most students will suggest that the company explore the use of forward contracts and swaps to protect itself from the currency movement for individual transactions. In addition, the company may want to engage in a lead strategy and collect its foreign receivables early.
Reduce your inventory now and increase it when the value has gone down. The cost in US dollars would be substantially less when it does. You also need to budget or forecast an affect on the balance sheet that is in US dollars with the value of the assets in Mexico. It would have an effect. It will also affect the collateral for the loan since the loan is in US dollars and the collateral is in Pesos.
To manage foreign exchange exposure effectively, the firm must exercise centralized oversight over its foreign exchange hedging activities, recognize the difference between transaction exposure and economic exposure, forecast future exchange rate movements, establish good reporting systems within the firm to monitor exposure positions, and produce regular foreign exchange exposure reports that can be used as a basis for action.
1)Pay now
2)Lock in a forward rate
3)Use funds in the U.S. to pay, depends on the size of the loan, any restrictions on the loan, and where funds are most efficiently available for paying off the loan
}Your financing and operating capital are in dollars, yet many of your costs (labor) must be in peso. Your hard assets are all in peso, and