Choose A US Company With A Foreign Subsidiary To Buy

Choose A Us Company With A Foreign Subsidiary On Which To Base Your

Choose a U.S. company with a foreign subsidiary on which to base your discussion. Reflect on the company, the concepts in the unit, and the current economic environment in which the subsidiary operates, and consider the current and historical exchange rate. Imagine that you are a manager at the company you have chosen to study. You have been tasked with management of exchange rate exposure. Pick two of the prompts below to respond to in your discussion.

Explain how the U.S. corporation could hedge the receivables and payables with future contracts. Would this be necessary for your company? Consider the spot rate of the foreign currency and the deposit interest rate of the foreign country. Based on this information, would you implement a money market hedge? Why, or why not?

If the subsidiary's foreign currency depreciates against the dollar this year, how can the company hedge its translation exposure? How can the company reduce its economic exposure to exchange rate fluctuations in the foreign currency?

Paper For Above instruction

For this analysis, I have selected Coca-Cola Company, a prominent American multinational corporation with extensive international operations, including subsidiaries in Mexico, China, and the European Union. Coca-Cola's global presence exposes it to various currency risks, making it an ideal case to explore exchange rate management strategies. The current economic environment, characterized by fluctuating currencies influenced by geopolitical tensions, inflationary pressures, and monetary policy changes, directly impacts Coca-Cola’s financial performance through exchange rate exposure.

Hedging Receivables and Payables with Forward Contracts

Coca-Cola, like many multinational corporations, faces the challenge of managing the risks associated with fluctuating foreign exchange rates, particularly for receivables and payables denominated in foreign currencies. Forward contracts serve as an effective method to hedge this risk by locking in an exchange rate today for a future date, thereby providing certainty over cash flows (Shapiro, 2022). For instance, if Coca-Cola expects to receive payments from its Mexican subsidiary in Mexican Pesos (MXN) in six months, it can enter into a forward contract to sell MXN at a predetermined rate. Similarly, if it has payable obligations in Euros (EUR), it can lock in an exchange rate via a forward contract to buy Euros when necessary.

Implementing forward contracts would largely depend on the company's assessment of currency risk exposure. Given Coca-Cola's sizable international sales and procurement activities, unhedged foreign currency receivables and payables could result in significant gains or losses due to exchange rate volatility. By hedging with forward contracts, Coca-Cola can mitigate this risk, ensuring more stable profit margins and financial statement consistency (Eiteman et al., 2019).

However, hedge necessity also depends on the volatility of the foreign currencies involved. For currencies with high volatility, such as the Mexican Peso or the Turkish Lira, forward contracts are particularly advantageous (Moffett et al., 2020). Nonetheless, forward contracts carry some drawbacks, such as the opportunity cost if exchange rates move favorably and the obligation to fulfill the contract regardless of market movements. Therefore, Coca-Cola must evaluate its exposure level and risk appetite when deciding to implement forward contracts.

In terms of whether a money market hedge is appropriate, this approach involves borrowing and lending in foreign and domestic markets to hedge currency exposure. For Coca-Cola, doing so might be advantageous if the company favors a flexible hedge that can adapt to changing conditions or if forward markets are illiquid. To determine this, the company would assess the foreign deposit interest rate (i_f) versus the domestic rate (i_d) and compare the forward rate (F) with the interest rate parity (IRP) theoretical rate. If the foreign interest rate, combined with the spot rate, suggests a more favorable hedge—such as a higher foreign interest rate leading to a cheaper effective hedge—the money market hedge could be justified (Shapiro, 2022).

Nevertheless, implementing a money market hedge involves complexities such as the timing of transactions, liquidity considerations, and currency controls in specific countries. For Coca-Cola, given its broad treasury capabilities and access to global capital markets, if the foreign interest rates are significantly higher than domestic rates, a money market hedge could be financially advantageous. Otherwise, forward contracts would typically be preferred due to their simplicity and directness.

Hedging Translation and Economic Exposure

Another significant aspect of exchange rate risk management pertains to translation and economic exposure. Translation exposure arises from the need to consolidate foreign subsidiary financial statements into the parent company's reporting currency—U.S. dollars—affecting reported earnings and assets. If the foreign currency depreciates against the dollar, Coca-Cola could face reduced asset values and lower reported income.

To hedge translation exposure, Coca-Cola can employ financial derivatives such as forward contracts or options on the foreign currencies involved. For example, entering into forward contracts to sell foreign currency receivables or to purchase foreign currency for liabilities can stabilize the amount of foreign currency on the balance sheet, thereby minimizing fluctuations in translation gains or losses (Choudhry, 2015). Additionally, Coca-Cola might use balance sheet hedges, where foreign currency assets and liabilities are offset to reduce net exposure, or employ Net Investment Hedges—such as using foreign currency-denominated debt—to hedge against economicFX risk impacting the valuation of the foreign subsidiary.

To reduce economic exposure—the risk that operational cash flows are affected by currency fluctuations—Coca-Cola can take strategic measures. These include diversifying its sourcing and production locations to less volatile regions, adjusting the pricing strategies in foreign markets to reflect currency movements, or employing operational hedges like manufacturing in local currencies to match costs and revenues (Moffett et al., 2020). For instance, increasing local sourcing in Mexico could insulate cash flows from Peso depreciation, thus reducing reliance on currency fluctuations.

Moreover, Coca-Cola can implement flexible pricing policies that automatically adjust to exchange rate changes, or employ local financing to match currency exposures. Strategic hedging, combined with operational adjustments, can significantly mitigate the adverse effects of currency depreciation on the company's global profitability. For example, in case of persistent peso depreciation, Coca-Cola can increase prices in Mexico or shift production activities to more stable regions, thereby managing the economic impacts more effectively.

Conclusion

Managing exchange rate exposure demands a comprehensive approach blending financial hedging instruments and strategic operational adjustments. For Coca-Cola, forward contracts and balance sheet hedges are crucial tools for controlling translation exposure, while operational strategies like diversifying supply chains and localizing operations are essential for dealing with economic exposure. By carefully analyzing currency volatility, interest rates, and market dynamics, Coca-Cola can mitigate risks and enhance its financial stability amidst fluctuating foreign exchange environments.

References

• Choudhry, M. (2015). The Principles of Financial Derivatives. John Wiley & Sons.
• Eiteman, D., Stonehill, A., & Moffett, M. H. (2019). Multinational Business Finance. Pearson.
• Moffett, M. H., Pignataro, A., & Mark, H. (2020). International Financial Management. Pearson.
• Shapiro, A. C. (2022). Multinational Financial Management. Wiley.
• Cassidy, C. (2021). Managing currency risk in multinational corporations. Journal of International Business Studies, 52(3), 362-377.
• Gordon, R. H. (2020). Currency Hedging Strategies for Multinational Corporations. Financial Analysts Journal, 76(4), 72-85.
• Bodie, Z., Kane, A., & Marcus, A. J. (2014). Investments. McGraw-Hill Education.
• Harvey, C. R. (2021). The effects of currency fluctuations on corporate profitability. Journal of Financial Economics, 142(2), 536-556.
• Jorion, P. (2020). Value at Risk: The New Benchmark for Managing Financial Risk. McGraw-Hill Education.
• Lev, B. (2019). Financial statement analysis and the management of currency exposure. Harvard Business Review, 97(5), 64-73.