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Executive Summary

This report extensively analysis the issues of exchange rate fluctuation that encumber the performance and profitability of STMicro. Primarily, the report profoundly examines the various factors in the U.S economy that influenced the depreciation of the dollar against the euro during the period of 2003 - 2006. Subsequently, the extent to which the dollar fluctuation has been consistent with the theories of exchange rate determination is discussed. Secondarily, the report examines the various types of exchange risk exposure encountered by firm and scrutinizes the reasons to why STMicro did not majorly involve in currency hedging. The validity of these reasons for firms to abstain from hedging against exchange rate fluctuations is examined. Finally, the efficacy of the current strategy adopted by STMicro to minimize its exchange rate exposure is discussed in details. Following the analysis of the firm’s strategy is a detailed set of recommendation that provides alternative measures for STMicro to protect itself against exchange rate fluctuations for an extended period of time.  

Contents:
Page
1.Introduction

1.1.Case Background………………………………………………………………... 4 1.2.Scope of report……………………………………………………………………5

2.Could the fall in Dollar against Euro have been predicted? What were the fundamental reasons for decline in 2003 to 2006?

2.1The American economy………………………………………………………………5

3.Extent to which the decline in exchange rate was consistent with theories of exchange rate?

3.1 Theories of exchange rate determination……………………………………………..6 3.1.1. Theory of Purchasing Power Parity………………………………………..6 3.1.2. Theory of International fisher effect
3.2 Conclusion…………………………………………………………………………….8

4.Reasons for STMicro to do little currency hedging?

4.1.Types of exposures……………………………………………………………….9

4.1.1.Transaction exposure………………………………………………………....9

4.1.2.Economic exposure…………………………………………………………..9

4.2Currency hedging………………………………………………………………...10 4.3Other reasons for firms to Hedge?.........................................................................10
Page
4.4Why Firms don’t hedge?..................................................................................10 4.5Conclusion……………………………………………………………………11

5.Is STMicro’s current strategy appropriate to deal with exchange rate fluctuation?

5.1.STMicro’s strategy……………………………………………………………12 5.2 Conclusion & Recommendation………………………………………………12

6.Conclusion…………………………………………………………………………….13

7. List of reference………………………………………………………………………14

1.Introduction:

1.1 Case Background:

STMicro is the world’s sixth largest semiconductor chip manufacturer, with major companies like Nokia to its client profile. This Europe based manufacturer had 70 percent of its costs denominated in Euro, while their semiconductors were priced in Dollars. In 2000, combination of a weak euro and a strong dollar gave STMicro a competitive edge and translated to the company’s healthy profits. However in 2003 the euro rose against the dollar and continued to rise until 2006. Primarily, this was accounted to the fact that the U.S trade deficit reached historic heights and the U.S government officially stated that they would prefer a weaker dollar to improve its export competitiveness. Following this was the concern over the acute U.S budget deficit in 2003 – 2006, which piloted the foreigners to conclude that this would result in the U.S government to increase its money supply and thereby resulting in inflation, which would further depreciate the value of the dollar. STMicro did very little currency hedging and its profits was adversely affect by the depreciation of the dollar. The CEO of STMicro decided to execute cost cutting measures and decided to move production from Europe to Asia. He describes this strategy as ‘real hedging’ and in order to avoid shifts in exchange rate risks...
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