International Market and Exchange rate fluctuations

Currency Rate Swings and their Impact

Currency rate swings, such as the one anticipated in this situation, can be costly or lucrative depending on how they are hedged and managed.

Impact on Mexican Subsidiary

For example, if the Mexican subsidiary’s expenditure is not going to come from abroad markets, the influence of the fluctuation on the production cost will be less than if the resources that the product uses are sourced from the United States, which is an example of a foreign market. In the latter arrangement, the final cost of the product by the Mexican Company will increase significantly, and this will not be good for the business.

Other than the predicted increase in the cost of production, the financing cost of the Mexican subsidiaries will rise by about 30% because of the increased value of exchange of a dollar than peso. As a result, the Mexican company will be forced to spend more pesos for every owned dollar due to the decreased peso value compared to the dollar (Sercu, & Vanhulle, 1992).

Impact on American Company

Moreover, the American company might be influenced positively or negatively by the fluctuation in the rates of exchange. On one hand, the cost of production of its products might go down because of the reduced input costs from Mexico. However, on the other hand, its products in Mexico may increase in price, which can affect the total sales of the exports. Therefore, proper management must be put in place to ensure that the fluctuation in the exchange rate does not affect the business.

Since the market fluctuation has been predicted, the companies need to hedge against it to ensure maximum profitability of the American company and proper minimization of the damage of the Mexican subsidiary. As a CFO, this calls for minimization of any associated costs while maximizing the potential gains from the fluctuation.

Protecting the Company’s Value and Leverage

The dollar value of the Mexican subsidiary will decrease notably, thereby reducing the total dollar value of the equity of the firm that is reported in the consolidated balance sheet. As a result, the firm’s leverage will go up and increase its borrowing cost, thereby limiting its access to the capital market. Therefore, the company needs to explore the utilization of forward contracts as well as swaps with the aim of protecting itself from the movement of currency for transactions. Moreover, the company needs to start engaging in a lead approach to gain its overseas receivables in time (Allayannis, Ihrig, & Weston, 2001).

References

Allayannis, G., Ihrig, J., & Weston, J. P. (2001). Exchange-rate hedging: Financial versus operational strategies. The American Economic Review, 91(2), 391-395.

Sercu, P., & Vanhulle, C. (1992). Exchange rate volatility, international trade, and the value of exporting firms. Journal of banking & finance, 16(1), 155-182.