Question

Give real-world examples (past or present) and discuss how foreign exchange risks impact:  

• Firms and cash
• The stock market and stock returns
• Consumer behavior
• Local Economies

Answer 1

Firms and cash- Exchange rate impacts firms and cash extensively. Multinational firms often depend upon exports and/or imports for their profits. As exchange rate fluctuates, their goods become cheaper or more expensive- depending upon the direction of the movement of exchange rate.

Cash, on the other hand, gets affected because the products either get more expensive or cheaper and hence the value of cash moves along with the exchange rate to some extent.

A great example of this impact would be Japan in the 1980s. Japan's Yen was equivalent to around 200-270 Yen per USD in the early 1980s. In 1985 western economies decided to devalue the dollar. This massively appreciated the Yen, which gained more than 150% by 1990. This massively hurt the Japanese economy which was mostly export based- as Japanese products became really expensive now and couldnt compete with cheaper alternatives.

The stock market and stock returns- Whenever someone invests in a foreign stock market, they invest and get return in the local currency. Similarly, when a firm does business in other countries, just like explained above, they also get their returns in local currency. The stock market's value can fluctuate a lot depending upon the strength of the local currency.

A good example of it would be the FTSE. Since a lot of companies in FTSE trade in foreign countries and get their profits in USD or other currencies, any fluctuation in GBP affects the FTSE a lot.

Consumer behavior- Consumer behavior is dictated, in large parts, by price. And prices get affected a lot by the exchange rates. Imported items become much more expensive (cheaper) when the local currency depreciates (appreciates).

An example of it would the Indian Rupee depreciating in 2019-20. This resulted in much higher prices for Indian customers of imports such as luxury items, expensive electronics etc. This resulted in a drop in sales of expensive electronics. At the same time, the inward remittances (Indians sending money to India from abroad) increased drastically as now they were getting more Indian Rupee when sending money to India.

Local Economies- The impact of exchange rate depends upon a lot on the make-up of the economy. It has huge impacts on export driven economies such as China, Japan (as shown in first part). Appreciation of their currency is devastating for them.

As an example, we can once again take the example of Japan as to how appreciation resulted in stagnation of the Japanese economy. We can take example of China also which tries to keep its currency's value low artificially to make sure its exports are competitive in the international market.