Unit 5 - Individual Project (250 points)
Select a U.S. multinational company, and respond to the following questions:
In terms of currency denomination, describe how the firm prices its revenues and costs.
For multinational enterprises (MNEs) with multiple foreign operations, consider any 2 of those operations and the contribution they are making to the parent firm's profits.
What means do they use to hedge against exchange rate risk?
Using this information, what do you think would be the effect of increases or decreases in the dollar’s exchange value on the firm’s profitability?
Be sure to show all applicable work.
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In order to answer these questions, let's consider the multinational company General Electric (GE) as an example.
1. Currency Denomination:
GE is a U.S. multinational company that operates in several countries worldwide. In terms of currency denomination, GE prices its revenues and costs in the local currency of the countries where it operates. For example, if GE sells a product in Germany, it will invoice the sale in Euros, while if it incurs manufacturing costs in Mexico, those costs will be denominated in Mexican Pesos.
2. Contribution to Parent Firm's Profits:
Let's consider two of GE's foreign operations, one in China and one in Brazil, and their contributions to the parent firm's profits.
a) China:
GE has a significant presence in China and operates in various industries including healthcare, power, and aviation. The Chinese market represents a large customer base for GE, and the country's economic growth and industrialization present several growth opportunities. Therefore, the contribution of GE's operations in China to the parent firm's profits is likely substantial.
b) Brazil:
GE also has a presence in Brazil, where it operates in sectors such as energy, healthcare, and transportation. Brazil is the largest economy in Latin America and offers potential growth prospects. However, Brazil has faced economic challenges in recent years, including currency devaluations and political uncertainties. Therefore, GE's operations in Brazil may have a more volatile contribution to the parent firm's profits compared to its operations in China.
3. Hedging Against Exchange Rate Risk:
To hedge against exchange rate risk, GE may utilize various means, including:
a) Natural Hedging: GE may establish a natural hedge by matching its revenues and costs in the same currency. For example, if GE generates revenue in Euros and also incurs manufacturing costs in Euros, it reduces its exposure to exchange rate fluctuations between the Euro and other currencies.
b) Financial Hedging: GE may also use financial instruments such as currency forwards, options, or futures contracts to hedge against exchange rate risk. These instruments allow GE to lock in certain exchange rates for future transactions, reducing uncertainty and protecting against currency fluctuations.
4. Effect of Exchange Rate Fluctuations on Profitability:
Increases or decreases in the dollar's exchange value can have both positive and negative effects on GE's profitability, depending on the specific circumstances. Here are a few scenarios:
a) Positive Effect: If the dollar depreciates against other currencies, the value of GE's foreign revenues denominated in those currencies will increase when converted back into dollars. This can boost GE's profitability as its earnings from foreign operations will appear higher in dollar terms.
b) Negative Effect: Conversely, if the dollar appreciates against other currencies, the value of GE's foreign revenues when converted back into dollars will decrease. This can negatively impact GE's profitability as its earnings from foreign operations will appear lower in dollar terms.
It is worth noting that the impact of exchange rate fluctuations on profitability can also be influenced by various other factors, such as the competitiveness of GE's products and services, its ability to manage costs, and the overall economic conditions in the countries where it operates.
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