Question

One of the ways to reduce economic and transaction exposure is to restructure. This restructuring involves shifting sources of revenues and costs to other locations in order to match cash inflows and outflows in foreign currencies. Explain the basics of this approach and did the MNC that you chose to write your report on, undertake any such restructuring? Would this restructuring increase translational risk? Does it make sense for an MNC to reduce one risk at the cost of exposing itself to another. Explain.

Answer 1

Foreign exchange risk management is vital for all MNC. One of the ways to mitigate economic and transaction exposure isto restructure. Foreign exchange rates are determined by various factors like interest rate, inflation rate, monetary policy. These factors cannot be controlled or predicted by companies, but they can reduce it by following methods:

• Diversification - When revenue is obtained in various currencies, depreciation of one currency may offset appreciation of another
• Match currency flows: This means inflow and outfloow should be matched. Eg: If major revenue for Apple Inc is in Euros, then it should consider borrowing in Euros.
• Operating from different countries - This would agin diversify and would offset the risk of revenues with risk of operating costs, as they are in same currency.

Apple manages foreign exchange risk effectively by hedging. Suppose, Apple wants to pay Chinese manufcturers and say Dollar value depreciates with respect to Chinese currency Renminbi, in that case, Apple would be shelling out more money to Chinese manufacturers. To avoid such conditions, they diversify their risk by manufacturing from different locations.

Restructuring wold not necessarily increase translational risk. Translational risk can be mitigated by hedging i.e.; by selling forward currency of firm's foreign subsidiary. This can be managed by making equal asset and liabilities items translated at current rates.