In 2003, Asp’s foreign exchange losses amounted to Rum 60 million (6 507 592 Euros at a spot price of Rum 9. 22/Euro) (after Rum 15 million of the Rum 75 million was pushed into 2004 and absorbed as inventory) fortunately for JP, they had earned an extraordinary Rum 70 million profit from a housing fund which mitigated the large losses JP faced and turned a deficit into a 2003 operating profit of Rum 10 million (1 084 598 Euros (Rum 9. 22/Euro)). My suggestion to JP would be to try and source their raw materials from China to reduce their transactional exposure.
All European purchases were priced and invoiced in Euros, the Euro had been rising against the Rum (considering the Rum was fixed to the dollar and the dollar had been falling against the Euro, the falling Rum was unavoidable). JP is constrained with the restrictions Chinese law has put on investment so they are restricted to buying forward contracts for commercial purposes only, corporate policy to hedge a minimum 80% of its anticipated currency exposures, and the reluctance to bear any risk associated with currency exposure leaving JP vulnerable.
J has roughly 200 reign subsidiaries worldwide.
It has always pursued a highly decentralized organizational structure, in which the individual units are responsible for their own performance from the top to the bottom line of the income statement. How is this reflected in the situation in which JP finds itself? It is obvious each individual firm makes its own decisions towards foreign exchange and there are no set guidelines for each of the subsidiaries to follow. Is considered a multinational organization that employs individuals that possess the skillets required to analyses the foreign exchange market and advise management where they see fit.
Paul Young and his associates might not have the knowledge required to make sound business decisions involving the foreign exchange market. By allowing JP to operate exclusively they face the peaks and troughs of the foreign exchange market which means that while trading in Rum (which is fixed to the $USED) they are exposed to the appreciating Euro. What is the relationship between the actual spot exchange rate, the budgeted spot exchange rate, the forward rate, and the expectations of the Chinese subsidiary’s financial results by the US parent company?
Considering the anticipated revenue growth for 2004 is 20%, Paul Young and JP have a lot of work to do. The only event that can possibly save JP from suffering another financial disaster is a depreciation of the Euro against the $USED. All the market factors are working against JP. With the appreciating Euro against the $USED and the Rum fixed against the $USED, Asp’s internal costs are rising and their financial results are looking weaker as a result. Asp’s forecast for the Euro remains strong, leading to increased costs.
All the information so far has indicated that due to the high price of the Euro against the $USED, JP has faced significant losses. This does not look like changing in the foreseeable future especially considering JP budgeted (Army. 22-Army. 60) = Army. 62 out of the forward rate of all of 2003. If you were Paul Young what would you do? Would choose the outcome that was certainly as opposed to an uncertain outcome. With the anticipated further appreciation of the Euro, I would choose to hedge.
Even with the downside of the associated costs of hedging and running the risk of not meeting the company’s sales expectations, hedging is a far more appropriate choice than the unknown risk related to adverse exchange rate fluctuations – which could result in unlimited losses. Hedging is ultimately about reducing risk not maximizing profits. Another possible solution could be to see if JP could source their products from America. This has the advantage of no exchange rate fluctuations due to the Rum being pegged against the $USED.
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