Table of Contents
Executive Summary 3
Net Exposure 4
Offsetting Exchange Rate Effects 4
The Canadian Dollar 5
Risk of Hedging Net Inflows 5
A Subsidiary as a Solution? 5
Summary of Recommendations 6
The U.S. firm, Vogl Company, has global import and export operations that can significantly impact its financial position. The firm both imports and exports to Canada, New Zealand, Mexico, and Singapore, although it does not have any foreign subsidiaries. Canada is by far Vogl’s largest market, accounting for 79% of its $36.4 million in 2010 exports. New Zealand and Singapore are closely tied as purveyors of Vogl products, with the ...view middle of the document...
MXN 11,000,000 | 0.18 | $1,980,000 | 5.4% | | MXN 10,000,000 | 0.18 | $1,800,000 | 19.1% |
SGD 4,000,000.00 | 0.65 | $2,600,000 | 7.1% | | SGD 8,000,000 | 0.65 | $5,200,000 | 55.3% |
TOTAL VOLUME | | $36,380,000 | | | TOTAL VOLUME | | $9,400,000 | |
Vogl’s Foreign Currency Net Exposure |
Net Transactions (Local Currency) | Spot Rate | Exposure in USD |
CAD 30,000,000 | 0.9 | $27,000,000 |
NZD 4,000,000 | 0.6 | $2,400,000 |
MXN 1,000,000 | 0.18 | $180,000 |
-SGD 4,000,000 | 0.65 | $(2,600,000) |
TOTAL EXPOSURE | | $26,980,000 |
Offsetting Exchange Rate Effects
The New Zealand dollar, Mexican peso, and Singapore dollar all tend to be inversely correlated with the US dollar, creating exchange rate risks. The Canadian dollar, Vogl’s biggest source of cash inflows (about 90%), has no correlation to the US dollar and does not pose an exchange rate risk that could be mitigated. Therefore, the firm’s limited exchange rate risks can be easily mitigated since its outflows of Singapore dollars nearly match its inflows of New Zealand dollars and Mexican pesos. From an exchange rate perspective, Vogl should continue doing business in New Zealand dollars, Mexican pesos, and Singapore dollars as long as the trends do not change and inflow to outflow ratios closely correlate.
The Canadian Dollar
Given the Canadian dollar forward rate of 1 CAD to $0.93 USD, Vogl could see a yield of $900,000 by hedging the net cash flows in Canadian dollars. There is significant enough benefit for the risk/cost for Vogl to pursue this strategy. However, it may choose to only hedge 50 – 66% to mitigate unnecessary exposure should the firm’s exports to Canada be less than anticipated
Risk of Hedging Net Inflows
Because Vogl estimates significant range (+/- up to 33%) in its export revenues, it should only hedge its guaranteed sales of CAD 20,000,000 to mitigate its overall risks. While this strategy leaves Vogl partially exposed to exchange rate risk, it saves the firm from having to borrow Canadian dollars at a loss in order to fulfill a forward contract. Conversely, this strategy requires the tradeoff of additional yields should the Vogl’s export revenue exceed CAD 20,000,000.
A Subsidiary as a Solution?
While Vogl is considering establishing a subsidiary in Canada to avoid year-to-year hedging decisions, the firm has not eliminated its long-term exchange rate risks because it remains perpetually invested in the Canadian dollar. Additionally, a Canadian subsidiary would still need to repatriate profits in US dollars to its parent company. The bottom line is that a Canadian subsidiary would decrease Vogl’s short-term exchange rate exposure while increasing its exposure over time as it is reinvesting and compounding the Canadian dollar. This strategy, however, adds one important benefit. Long-term transaction exposure can be mitigated if the parent company has flexibility in subsidiary remittances and can time them to transfer only...