MNC and its risks

Topics: Foreign exchange market, Futures contract, Derivative Pages: 5 (1363 words) Published: March 7, 2014

1)An MNC or a multinational corporation has business entities (wiseGEEK, 2013) operating in many countries. It has its main headquarter in its home country while having offices, factories in other countries (Investopedia, 2013). These companies set up branches in other countries to take the relative comparative advantages those countries may offer(International Finance Study Guide, 2013)

2)Currency exchange risks occur as the exchange rates fluctuate every second throughout the day. MNCs often deal with large transactions in which they may need to pay or receive large sums of money within certain period of time, exchange rate fluctuations are crucial as they may affect the company’s earning greatly(Ayse, 2013).

a)Transaction Risks
This is the most common type of risks faced by the MNCs. MNCs deals with account receivables, account payables and dividends. There will be a time frame between the transaction date and the actual receive or pay out date. In between these dates there can be fluctuations in exchange rates which will contribute to company’s profit or loss (studymode, 2002). For example, if a Singapore company strikes a deal with an American company today which results in one million United States dollars to be received in a month’s time. Come to the actual paying date the following can occur:

Transaction DateUSD/SGDPayment DateUSD/SGD
1st Jan 20131.2500 Scenario One : 1st Feb 20131.2600 (USD strengthens against SGD)

Scenario Two : 1st Feb 20131.2400 (USD weakens against SGD)

Scenario One: With the strengthening of USD by 100 points against SIN, the company profits: SGD 1,000,000 x 0.01 = SGD 10,000
Scenario Two: With the weakening of USD by 100 points against SIN, the company loses: SGD 1,000,000 x 0.01 = SGD 10,000

b)Translation Risks
This risk is basically involves exchange rate risks with balance sheets relating to subsidiary companies in foreign countries. This will in turn affect the “consolidation of a foreign subsidiary to the parent company’s balance sheet” (Michael, 2006). As a result, exchange rate for balance sheets is used at the time of consolidation.

c)Economic Risks
It pertains to the present value of company’s future cash flow. As mentioned above, cash flows for the company are always in future timeframe of a month or even months later, be it the parent company or the foreign company. Thus economic trends need to be closely observed in order to implement strategy or plans to prevent losses. It also affects the price of imports and exports which will either make the company’s products less competitive in the foreign market or cause the price increase of raw materials imported to increase which result in higher cost of production (Michael, 2006).

3)There are three foreign exchange instruments that can be used to hedge the company’s exposure:

i)Forward contracts
It is a deferred cash market transaction where either the purchase price or the selling price of a commodity or asset has been pre agreed by a contract but will only make delivery in the future(Investopedia, 2013)(Wikinvest, 2012). “Forward is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed upon today” (Wikipedia, 2013).

ii)Future contracts
It is similar to forward contract but is a more standardised and is done on trading floors and future exchange markets (wikipedia, 2013) (investopedia, 2013). Examples are Chicago Mercantile Exchange and London International Financial Futures & Options Exchange (International Finance Study Guide, 2013)

iii)Options contracts
An option contract gives you the right to buy and sell an asset, or in this case, currency (Investopedia, 2013). It is not an obligation to carry out the option if is it not to your benefit. An option usually has a strike price and an expiry date. Upon maturity, the purchaser can choose whether to exercise the option or let is lapse. Once it expires it no...
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