Foreign Exchange Exposure Management
Due to significant appreciation of the U.S dollar against the Irish punt in recent years, it has come to our attention that the profit margins of our Irish operation are extremely sensitive to fluctuations in the value of the U.S dollar. With already high interest rates, steadying rates of inflation, and flat economic growth in the United States, it appears that the time has come to worry about the possibility of a large devaluation of the dollar. Such depreciation could have the effect of wiping out the existing benefit of lower Irish operating costs relative to our American operations, which we have come to enjoy in recent years due to the dollars large increase in value. One solution to this looming problem is to allow the controller of our Irish subsidiary to buy the punt forward, thereby eliminating the downside risk of any dollar depreciation. However, this option completely negates the fact that there is currently a hedge already in place our Irish operations managers have every incentive to cut operating costs given a large downward swing in the dollar. Despite management's philosophy that speculation should be of no interest to those in the manufacturing business, the Irish controller's concerns are of substance, and deserve the right to be addressed.
Argument for weakness of Dollar
From 1980 to 1984 the dollar appreciated against the punt by 50%. Between 1980 and 1984 the dollar had high interest rates, between 11.3% and 13.7%. The high interest rates were to combat high inflation in the US economy, the interest rates also caused the dollar to appreciate against other currencies. Over the last 2 years inflation has fallen to 5%, much lower than the 10% rate in 1981. A lower inflation rate could result in the US government lowering interest rates, which could cause the US dollar to decline. Other warning signs of a possible weakening dollar is are the rising deficit and low...