Question

On March 11, 2011 a devastating earthquake and subsequent tsunami struck Japan, causing widespread destruction. Very often, people associate “bad event = currency depreciation”. This is not always logical. Immediately following the earthquake, the value of the Yen spiked up to 75 ($0.0133 / ¥). A suggested primary reason was the repatriation of insurance proceeds. In order to pay insurance claims, insurers had to sell off assets held abroad and bring the proceeds to Japan. In late 2011, you are approached by the HP Inc CFO. He is asking you to assist with a negotiation with Canon. HP stands to lose quite a bit of printer profitability with the Yen at 75. He suggests that HP Inc. renegotiate the contract with Canon to be dollar-based.   How would you like to respond? Your response should consider both your expectations of the future relative values of the Yen and Dollar, as well as HP’s exposures and abilities to manage those exposures.

Answer 1

Canon is a Japanese firm, while HP is an American multinational company. With the appreciation of Japanese yen, HP might lose its profit, since it will get lesser yen for each dollar it exchanges. Therefore, it might be a better idea for HP if the contract with canon is dollar-based. This will not only allow to avoid the shocks (like the earthquake) that Japan is facing, but will also bring stability for HP as it will then be less affected by the external factors.

However, expectations play a major role in the value of currency. Post-earthquake, people start expecting depreciation of the currency. Even though Japanese yen appreciates due to various factors like repatriation of insurance proceeds, still, this is where people's expectations come into the light. Due to the devastation, people will demand more money and due to the shortage of goods, the price in the economy might increase. This will lead to the inflation and therefore, depreciation of currency. Therefore, there will be instability in the economy as currency will appreciate because of repatriation, and simultaneously will depreciate due to the inflation.

In such a situation, I stand with the advice of HP Inc CFO and would suggest to renegotiate the contract with Canon to be dollar-based.