Foreign Exchange Exposure for Currencies

1. What is the magnitude of the foreign exchange exposure for each of the currencies in exhibit 1?

EXHIBIT 1:

2. Does the exposure to the Euro help or hinder to the competitive performance of Expert Motor?

To some extent the increased importance for companies in addressing the problems of foreign currency exchange rates is as a result of the internationalization of modern business (Copeland, 2005). This process is resulting in the growth of world trade relative to national economies and is also reflective of a trend towards economic integration in Europe in particular (Butler, 2000). Therefore as a multinational automobile company the management of exposure is a critical strategic decision in the company gaining a competitive advantage over its major competitors in different European countries. The exposure to the Euro can be discussed from both positive and negative perspectives which respectively affect the competitive performance of EM trades and international operations. Firstly the Euro is a relatively strong currency recently thus the competitiveness of domestic producers in Euro countries is not as robust when compared to the position of manufacturers that are based in weak currency countries. This is due to the high costs faced by those manufacturers which as a result are able to provide EM as a non-domestic company resulting price advantages.

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Secondly corresponding to the strong performance of the Euro Expert Motors has tended towards diversifying its production locations in order to benefit from lower wage levels and weaker currency countries and balance its exposure to Euro accordingly. Nevertheless since 1979 the member countries of the EU have operated national policies coordinating currency relationships towards closer monetary integration thus minimizing the ability to benefit from varied currency cost levels within Europe (Christou, 1992). So EM can benefit from its treasure function being located in Budapest in certain ways. From this point of view it is interesting to note that when the Euro depreciated against the US dollar but appreciated against the mark it is hard to say that exposure to the Euro only had negative influences. In contrast exposure including transaction exposure and translation exposure obviously may hinder the competitive performance of EM or create losses for the company. For example the diversified locations of producers can not only reduce economies of scale, which is particularly vital for a motor maker, but also raise the cost of goods transactions. Additionally in terms of investment the exposure to Euro might reduce the profit margins ultimately on investment return due to appreciation of the Euro which might occur in the future.

3. How would the parent company in Florida view the situation if the gross buys and gross sales in Germany were reversed?

EM’s main business is conducted in Germany thus there will be a significant influence on the strategic decision process made in the parent company in Florida due to a change in the gross buys and gross sales evidenced thus far by EM. It is obvious in exhibit one that the purchasing of product elements occurs mainly in Germany and also at the same time that the major revenues of the company also originates from Germany. Therefore if the gross buys and gross sales were reversed there will be a decisive effect on EM’s profit levels as a result of currency exposure (Pike & Neale, 2003). Additionally the German Mark is relatively strong and the strategic exposure management decisions made in the parent company will see it is a good point for the company’s investment in terms of return. Although the cost of material and labour is comparatively higher in Germany profit return levels are attractive. Furthermore competitive market share might be achieved by the reversed gross sales in terms of competing with EM’s main competitors Volkswagen/Audi and Opel/ Vauxhall. Through its diversified suppliers in weaker currency countries the value of investment in Germany might drive the parent company to decide to use revenues in Germany to balance its exposure elsewhere.

4. The data in the case address the currency flows for Expert Motors in Europe that tracked by the regional treasury centre in Budapest. However, another issue involves the stock of assets that the firm has in Europe. Speculate on what you think might be happening to the value of Expert Motors‘ investment in Europe in the light of various currency appreciations and depreciations, especially the Euro.

When hard currencies such as the Euro are likely to appreciate the value of assets will increase while the value of liabilities within EM’s investments will decrease. In contrast if soft currencies depreciate the value of will assets tend to decrease but the value of liabilities will increase (Dixit & Pindyck, 1995). In relation to the occurrence of devaluation EM should tighten its credit terms in order to decrease accounts receivable and reduce levels of cash flow. This is to say the value of investment might be higher than the expected level as well as display an unexpected loss. There is a significant effect on currency flows in terms of which when the home currency appreciates EM should avoid receiving payment from suppliers but instead adopt a policy of using forward contracts to reduce exposure risks. At the same time there might also be relatively small changes in exchange rates in other European countries which can provide EM with opportunities to balance its cash flow. In addition in this case the company received a range of tax benefits from nationally pursued governmental policies in Hungary. By setting up a regional coordination centre there Expert Motors not only benefits from the absence of registration tax but also enables banks to finance investment projects through the centre at a much lower level than that available in other European countries. This provides EM with a competitive advantage in terms of investment in Hungary which allows the company to respond to depreciation and appreciation events more effectively in balancing its investments across Europe holistically.

5. What techniques and financial instruments might the TRC employ to control its currency exposure? Explain these techniques in the light of Czech Republic currency situation?

The concept of hedging is essential in managing currency exposure risk including both translation and transaction exposure. Hedging currency exposure means establishing an offsetting currency position so whatever is lost or gained on the original currency exposure is exactly balanced by a corresponding foreign exchange gain or loss on the currency hedge, (Shapiro, 2003). In terms of transaction exposure the company might employ protection measures which include the usage of forward contracts, price adjustment, currency options, and borrowing or lending in the foreign currency. Likewise the TRC could try to invoice all transactions in dollars. However this can not avoid currency exposure risks entirely because of the future costs and revenues involved in such transactions. In the case of Czech Republic currency situation where the Czech Republic Koruny is comparatively weak EM has a competitive advantage over their major competitors due to the political contexts in which the TRC is embedded. In a forward market hedge EM can transform the currency by selling or buying forward dependent on if the company is long or short CRK. In doing this, no matter what happens to the exchange rate of CRK EM still can collect its sale revenue upon which the dollar value is fixed. Alternatively EM could avoid its transaction exposure altogether if the supplier allowed it to price the sale in dollars which shifts risks from EM to the buyers. This is because firms attempt to invoice exports in strong currencies and imports in weak currencies, (Shapiro, 2003). Additionally the call option is one which might be quite appropriate to EM’s situation in the Czech Republic. It is a valuable risk management tool because by buying a call option on the foreign currency the firm is able to purchase at a maximum dollar price together with forward contracts in order to hedge the exposure to foreign currency.

6. What financial benefits if any, does Expert Motors have for locating its treasury function in Budapest, Hungary? What benefits, if any, accrue to Hungary?

The treasury function helps EM to centralize its treasury decisions and act in a coordinated fashion in treasury matters. Additionally Hungary has provided an excellent environment for EM in terms of varied forms of tax benefits and exemptions from foreign exchange regulations. In general then translation exposure is treated as a ‘group’ matter, (Heywood, 1984). In that the hedging decisions are made at head office with a focus on protecting future streams of earnings. Yet the protection of current earnings may be better handled it can be argued at local level by an increase in the response times to currency rate fluctuations. Through location of its treasury function in Budapest EM is able to take advantage of locating on the European continent which is the main area in which it does business. First of all the advantage comes from the obvious benefits from tax breaks as well as investment opportunities. In this way when currencies in other European countries depreciate the risks can be shifted through the potential gains at treasury functional level. This is the simplest way for EM to deal with small amounts in the same way which is able to propose new commercial contracts in a foreign currency over a certain size. Secondly the benefit can be seen from having the treasury function in Budapest by increasing the ability of the centre to gross up exposures in one currency from several of the operating companies. Nevertheless the parent company in Florida is able to offer forward cover at market rates to the treasury function in Hungary thus it can retain its own decisions reflected in their local accounts. However the cost of hiring professionals working in local treasury function might cause extra expense but from a long term view this can be viewed as an investment opportunity in retaining skilled staff at local rates.

From Hungary’s point of view there are certain benefits of attracting foreign investment such as EM to set up treasure functions within the country. As Copeland (2005) points out the labour market is a critical factor in determining how smoothly adjustment proceeds. Therefore at the pre-existing money wages when foreign prices increase the domestic production has to become more competitive because real wages are now lower than before. It is useful to improve the performance of local companies when competing against foreign companies. Conversely the value of investment in terms of direct investment or indirect investment means increasing opportunities for jobs in the home country. This is valuable for Hungary’s labour market and decreases the rate of unemployment because of tax concessions for expatriate employees which drives EM towards preferring to employ more local workers in order to achieve the tax benefits offered by government policies. This is based on the reason of mobility of labour in that those who can not find jobs in the domestic economy will move abroad. As a result the domestic economy loses skilled and qualified labour. Thus it is believed that labour mobility prevents the need for exchange rate flexibility, (Eiteman, Stonehill & Moffett, 1993).

7. What parties, if any might be harmed by the existence of regional treasury function like Expert Motors?

In consideration of the macroeconomic environment the regional treasury function as a tool for companies like Expert Motor to administrate their foreign currency exposure have significant influences on the conditions within weaker currency countries. Firstly labour market conditions in those countries might be hurt because the comparatively cheap and convenient exploitation based on currency speculations from multinational companies like EM. In the short term it can be argued that it is good for local governments to improve their unemployment rates through foreign companies locating there yet in the longer run exploitation might cause a key segmentation of secondary markets much larger than the primary segmentation in the labour market. In other words the skill level of the employees is low which has a vital influence on the competitive capability of the domestic companies to compete in an international context. Torrington, Hall and Taylor (2005) argue that the numbers of people and skills available in a labour market as well as the complexity of employment regulation are significant elements in human resource decision making processes in a country.

Secondly the treasury function in multinational trading companies like EM might also have an influence on local monetary policies that might have adverse effect on central bank policies. In practice the types of monetary policy depend to a large extent on the character and political complexion of the central bank more than anything else (Lane, 2001). Therefore the relationship between US and European countries can have significant impacts on the operating process in regional treasury centres. Pressure from political authorities might de-emphasise role of central banks to some extent in order to maintain a more stable currency situation to attract long term foreign investment in particular in a global economic context.

References

Butler, K.C. (2000) Multinational Finance 2nd eidition, South-Western College Publishing, Cincinnati, OH

Copeland, L. (2005) Exchange Rates and International Finance fourth edition, FT Prentice Hall, UK.

Christou, C. (1992) National Monetary Policies and the European Monetary Union, Greek Economic Review, August.

Dixit, A. & Pindyck, R. (1995) The Options Approach to Capital Investment, Harvard Business Review, May-June

Eiteman, D.K., Stonehill, A.I. & Moffett, M.H. (1993) Multinational Business Finance sixth edition, Addison-Wesley Publishing Company, US.

Heywood, J. (1984) Foreign Exchange and the Corporate Treasurer fourth edition, Adam & Charles Black Publishers Ltd, London.

Lane, P.(2001) The New Open Economy Macroeconomics: a Survey, Journal of International Economics, 54 (2)

Pike, R. & Neale, B. (2003) Corporate Finance and Investment: Decisions and Strategies 4^TH edition, Prentice Hall, UK.

Shapiro, A. (2003) Multinational Financial Management 7^th edition, John-Wiley, London.

Torrington, D., Hall, L. & Taylor, S. (2005) Human Resource Management 6^th edition, FT Prentice Hall, Pearson Education Limited, UK.