Question

using BMW as the company describe the nature of business of the selected organisation and explain the impact of fluctuations of the exchange rate on business performance. Identify and explain three factors that may have contributed to exchange rate volatility in your country during the last 12 months and three approaches that can be adopted by the business to minimise the negative impact of exchange rate volatility. [25 Marks]

Answer 1

BMW is a well-known automobile manufacturer. The company sells its products nearly in all the countries in the world. As a result, the global economic changes are extremely crucial for the company’s business performance.

One of the key global phenomenon that often impacts such multi-national companies is the fluctuation of exchange rate. While BMW is a German company by origin, currently it has manufacturing facilities across several locations to help cater to the global audience. This means fluctuation in exchange rate impacts the business prominently. For example, in case the local currency of the manufacturing hub weakens, importing parts would become expensive. This in turn increases the price of the produced vehicles and causes rise in price in the market. Similarly if the currency strengthens, the goods that are imported becomes easier (or cheaper) to obtain but makes it difficult for the end product (cars) to be exported to other countries. For such reasons, a company like BMW needs to continuously find balance in its global operation to keep a consistent pricing and cost structure for their production.

There are many factors that impact exchange rate of a country. Three of the key factors are

• Inflation: With increase in inflation, the local currency becomes weaker. This means that in the global market, the demand for local currency reduces and increases the foreign exchange rate.
• Interest rate change: When a central (or federal) bank decides to change interest rate, it prompts increase or decrease in demand for the local currency. Increase in interest rate slows down growth of investment and infrastructures. However, this also results in strengthening the currency. Which in turn reduces the exchange rate.
• Foreign currency reserve: When the foreign currency reserve of a country depletes there is major risk associated with foreign trade. Reduction in foreign currency reserve impacts most countries in the world. With depletion of foreign currency the demand for the foreign currency increase, this leads to weakening of local currency and increase in exchange rate.

Businesses can take measures to tackle exchange rate fluctuation by several means. Some of them are

• Forward contract: Through this method, businesses and subsidiaries can have a futuristic contract that determines pricing for purchase and sale of goods. This way, any impact of exchange rate fluctuation can be avoided. This helps businesses to hedge against unfavorable currency.
• Currency swap: This is a cash flow management system where businesses experience a lot of foreign currency inflow and outflow. Through currency swap, businesses can resolve problems of matching currency valuation at a specific time and date.
• Option strategies: This is a speculative method of hedging oneself against unfavorable currency. Through various currency option strategies businesses can recover their loss through currency derivative or options.