Question

• Recall that when you created your business idea, it was assumed that your receivables would be denominated in the foreign currency of concern upon the sale of your products. Describe your exposure to exchange rate risk. That is, describe the exchange rate conditions affecting the performance of your business. • Is your business subject to transaction exposure? Economic exposure? Translation exposure? Explain why your business is or is not subject to each of these types of exposure. • Assuming that your international business is successful, identify reasons why it may be feasible to establish a small subsidiary in the foreign country rather than continue exporting. • Identify the disadvantages associated with establishing a small subsidiary in the foreign country of concern.

Answer 1

Foreign exchange risk refers to the losses that an international financial transaction may incur due to currency fluctuations. Also known as currency risk, FX risk and exchange-rate risk, it describes the possibility that an investment’s value may decrease due to changes in the relative value of the involved currencies. Investors may experience jurisdiction risk in the form of foreign exchange risk.

  Currency depreciation has the largest impact on companies that import the majority of their raw materials because that means that the value of their currency is falling meaning that foreign suppliers require the company to pay them more for the same product. It is equivalent to a price increase to the buyer even though the supplier still gets the same amount of their own currency. The impact the exchange rate will have on an organization will be determined by various factors. For instance, if a company imports the majority of its raw materials and only sells their finished product to the domestic market, they will lose money due to currency depreciation. However, if they sell a large enough percentage of their finished products overseas, it is possible that they will make money from the depreciation.

Transaction exposure is the level of uncertainty businesses involved in international trade face. Specifically, it is the risk that currency exchange rates will fluctuate after a firm has already undertaken a financial obligation. A high level of vulnerability to shifting exchange rates can lead to major capital losses for these international businesses.Economic exposure is the risk that a company's cash flow, foreign investments, and earnings may suffer as a result of fluctuating foreign currency exchange rates. Translations explore is the risk of loss that might arise due to changes in value of the stock, revenue, assets or liabilities of a business due to foreign exchange rate movements. A business has translation exposure when some of its stock, revenue, assets or liabilities are denominated in a foreign currency and need to be translated back to its base currency for accounting purposes. Translations,transaction and economic explore will affect the business, if they deal with foreign currency.

There are various advantages of choosing a subsidiary as the business vehicle for your company set up or expansion internationally. The main aspect is the control and support of the parent company. The already established parent company will have the resources and employees to staff the subsidiary so the subsidiary receives a ready made network of people with experience in the business.

The main disadvantage of setting a subsidiary abroad is the cost. Acquiring a local company may be a quicker way to establish the company in its new surroundings but it will also be a more expensive option. It may be difficult for the parent company not to overpay for the local company’s assets and the price will be bumped up further if there is a bidding war.