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Diversifying operations

Diversifying Finance

Matching currency cash flows

Currency Clauses: Risk Sharing

Back-to-back Loans

Cross –Currency Swaps

Contractual Strategies

Expected changes in foreign exchange rates should be incorporated in all financial plans of an MNE, including both operating and financial budgets.

Expected exchange rate change should not be a surprise requiring alteration of existing plans and procedures.

Unexpected exchange rate changes are those that could not have been anticipated or built into existing plans.

Hence a reevaluation of existing plans and procedures must be considered.

One must note that because budgets are built around expected exchange rate changes, the unexpected exchange rate is the deviation from the expected exchange rate, rather than the deviation from the actual exchange rate at the time a budget was prepared.

Operating exposure is inevitably subjective because it depends on estimates of future cash flow changes over an arbitrary time horizon. Thus it does not spring from the accounting process, but rather from operating analysis.

Planning for operating exposure is a total management responsibility that depends upon the interaction of strategies in finance, marketing, purchasing, and production.

• Diversifying...
• Sales
• Location of production facilities
• Raw material sources

(Worldwide diversification in effect pre-positions a firm to make a quick response to any loss from operating exposure.

The firm’s own internal cost control system and the alertness of its foreign staff should give the firm an edge in anticipating which countries will have weak currency.

Recognising a weak currency is different from being able to predict the time or amount of a devaluation, but it does allow for some defensive planning.

If the firm is already diversified, it should be able to shift sourcing, production, or sales efforts from one country/currency to another in order to benefit from the change in the post-devaluation economic situation. Such shifts could be marginal or major.)

• Raising funds in more than one capital market
• Raising funds in more than one currency

May lower a firm's cost of capital and increase availability of capital.

(Unexpected devaluations change the cost of the several components of capital—in particular, the cost of debt in one market relative to another.

If a firm has already diversified its sources of financing, it can quickly move to take advantage of any temporary deviations from the international Fisher effect by changing the country or currency where borrowings are made.)

Create operating or financial foreign currency cash outflows to match equivalent foreign currency inflows.

- Debt

Contracts, including sales and purchasing contracts, between parties operating in different currency areas can be written such that any gain or loss caused by a change in the exchange rate will be shared by the two parties.

Two firms in different countries lend their home currency to each other and agree to repay each other the same amount at a later date.

This can be viewed as a loan between two companies (independent entities or subsidiaries in the same corporate family) with each participant both making a loan and receiving 100% collateral in the other’s currency.

A back-to-back loan appears as both a debt (liability side of the balance sheet) and an amount to be received (asset side of the balance sheet) on the financial statements of each firm.

The firm’s future cash flows; and the predictability of the firm’s competitor’s responses to exchange rate changes.

Short Run (12 months) - gain/loss depends on the currency of denomination of expected CFs.

Medium Run (2-5 years) Equilibrium - Firm should be able to adjust prices and factor costs over time to maintain the expected level of CFs.

Medium Run Disequilibrium - Firm may not be able to adjust prices and costs to reflect new competitive realities caused by a change in exchange rates.

Long Run (5+ years) - CFs influenced by existing and potential competitors, possible new entrants and to exchange rate changes under disequilibrium conditions.

Matching currency cash flows

Risk-sharing agreements

Back-to-back (parallel) loans

Cross-currency swaps