Exchange Rate Risk & Hedging Strategy

Introducing Multinational corporation or MNC is a firm that engages in foreign direct investment that directly investing, controlling and managing value-added activities in other countries “Walmart”. Why does business go multinational? In order to cut the cost or tap into a new market. Different ways can be adapted to increase the business to go on a global scale. It can be vertical in which they undertake various stages of production in different countries for the core business, Horizontal in which it can be the same product sold in a different country, or Conglomerate multinational which is producing range of products in different countries.

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There are multiple advantages for MNC to enter the developing countries and to exploit those opportunities like the foreign exchange gap and the public finance gap. While the corporation seek to maximize their values by making financial decision or investment, they require comprehensive business and financial information. The foreign exchange gap can be a double-edged weapon in case the risk is not measured adequately, as we need to study the exchange rate relation ship that is derived into four main theories. IRP – Interest rate parity theory which is a financial theory that links the interest rate differentials to future exchange rate, Expectation theory that suggests the current expectations that shapes the future exchange rate. Considering the purchasing power parity theory which propose the identical goods should cost the same across currencies in the long run and finally IFE – International fisher effect that relates interest rate differences to expected currency appreciation or depreciation.

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Hedging is when the companies are making international transactions in different countries in different currencies then exchange rate can have significant impact on profit that is resulted from delays in payment of international contracts or globalization of supply chain. The remedies for those risks to be mitigated can be through forward contracts in which they can lock the exchange rate for a future transaction, currency derivatives as it is a financial instrument whose value is derived from exchange rate forecasting or they can take a loan in foreign currency that can also be a hedging strategy. ?

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Unilever annual report 2015 stated that loss in the foreign exchange net increase significantly, from Rp 198 million to Rp 3.188 million. we can see that currency risk always happen every year and company can made gain or loss from foreign exchange transaction. Almost every year company suffered loss on foreign exchange. This increasing loss causes by depreciation of Rupiah against USD and low government spending. The damage from this risk makes the price from raw materials increasing significantly and so did the cost of production. Fluctuate in currency rates has been described as “Changes to the relative value of a currency can fluctuate widely and could have a significant impact on business results. Currency rates, if not stable, can also result in significant swings in the prices of the raw materials needed to produce company goods.” And it is categorized as medium risk. As a result, they adapted:

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·???????? Currency exposure is managed within pre-scribed limits and by the use of forward foreign exchange contracts.

·???????? Hedge some exposures through the use of foreign currency borrowing or forward exchange contracts.

After going through all the above we can understand that mitigating the risk is crucial to the success of global business and the followed strategies plays a pivotal role in the profit generated by the corporations, however it is still important to keep in considerations other factors like the political risk and the country stability with certain frequent unchanged laws governing the corruption that arises. Sovereign risk and economic stability also can be an indicator which is the company ability to honor its debt obligation and if there are signs of recession like a rise in unemployment and inflation. Considering all the above factors will reduce the risk while thinking globally.

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Reference

Sinulingga, R.A. (2019) ‘Risk Management System in PT. Unilever Indonesia, Tbk’, TIJAB (The International Journal of Applied Business), 3(1), pp. 38-58.

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