Question

You are the CFO of a U.S. firm whose wholly owned subsidiary in Mexico manufactures component parts for your U.S. assembly operations. The subsidiary has been financed by bank borrowings in 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 next year. What actions, if any, should you take?

Answer 1

There are positives and negatives to this fluctuation in the exchange rate. By the peso depreciating by 30 percent against the dollar, our firm will save money on the production costs of our products. This could also affect the companies’ market in Mexico negatively, as it could drive up the price of their products making consumer demand decrease. If planned out properly, this deprecation of the value of the peso could be extremely profitable for our firm.

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 you're in expense control mode, refinance the US debt at the modern, lower amount (save on debt costs)

- if you're 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 free'd up with the refinancing to fund these contracts.