1.You are the CFO of a U.S. firm whose wholly owned subsidiary in Mexico manufactures component parts for your U.S. assembly operations. The subsidiary has been financed by bank borrowings in the United States. One of your analysts told you that the Mexican peso is expected to depreciate by 30 percent against the dollar on the foreign exchange markets over the next year. What actions, if any, should you take? “
When a foreign currency depreciates against the U.S. Dollar, in this case the Mexican peso, the peso’s value falls, and the US dollars demand increases as its value rises. A foreign currency fluctuation can significantly affect sales and profit of a firm. In the given scenario, one any USD denominated costs related to assembly operations will be more expensive as it will require more peso to buy USD to spend on input materials, shipping, manufacturing and selling of the firm’s products in the foreign market. On the flip side, any peso-denominated costs will be cheaper as these costs will require less dollars to convert to peso. Also, repayment of the borrowings financed in the US will also more expensive to pay back as it will also require more peso to convert in order for the firm to afford payments and interests in dollars. As the CFO, several actions that I can take include:
· Settle any USD denominated account payables before the peso depreciates.
· Collect foreign receivables before the expected depreciation to minimize loss in value.
· Restock USD-denominated inventory before depreciation occurs. Buy peso-denominated inventory after depreciation.
· Convert or invest using operating peso accounts to USD prior to depreciation to minimize loss in value and also for the purpose of setting aside for future payments to US financed borrowings.
· Enter into forward exchange contracts in order to protect the firm from exposure to foreign exchange fluctuations.
2. “You are the CFO of a U.S. firm whose wholly-owned subsidiary in Mexico manufactures component parts for your U.S. assembly operations. The subsidiary has been financed by bank borrowings in the United States. One of your analysts told you that the Mexican peso is expected to depreciate by 30 percent against the dollar on the foreign exchange markets over the next year. What actions, if any, should you take? “
When businesses deal with the threat of changes in exchange rates, rapid decisions must take place in the inefficient market. This is exposing our business exchange rate and that is a risk if we don’t do anything. If the Mexican peso depreciates against the dollar on the foreign exchange markets, then the dollar value of the Mexican subsidiary would devalue significantly. This will limit our access to the market and reduce the total dollar value of our firm’s equity. I think the best way to handle this financial crisis is to do a lead strategy to collect all our foreign receivables before they are due. I would collect them within the next two to three months. This is because it would be smart to collect the money while we can get it while it is at its current value. When this plan is implemented, the primary rate variability will have only slight negative effects on our company’s future.
Also, I would suggest issuing contracts immediately to protect the company from moving any money for any transactions dealing with the risks of our subsidiary in Mexico. This contract will outline with measures that our firm can have a fixed exchange rate to protect against it decreasing in value. Therefore, when the peso depreciates by almost 30 percent against the dollar, our firm saves money on the production costs of our products. Without having the foresight of the depreciation of the peso in Mexico, it would have been very costly to continue business as normal. This also avoids the risk of economical exposure and losses. The opportunity about this situation is that next year, the parent company can benefit from bank borrowing and get pesos at a cheaper rate. Being cost-effective, it helps our company with minimization of any costs associated with the depreciation of the peso while maximizing any possible gains.