For a multinational corporation, foreign exchange rates matter as the earnings from the subsidiaries in different countries are translated into the earnings in the home country which is impacted by foreign exchange rates and its fluctuations.
For example, a company in USA having subsidiary in Britain and India will have its consolidated earnings affected by the currency exchange rates between USD and British Pound and Indian Rupee. Also if the company is exporting or importing from these countries, the value of exports and imports would change based on the prevailing exchange rates, and this would determine the cost of production or market demand as well.
It also comes into play when appraising different projects as the cash flows of the projects have to be translated into the home currency and appropriate discount rates applied to find out NPV in case of equity funded project. The companies can use the forward market judiciously to buy forward contracts to hedge its foreign currency exposure and in this way build predictability in its cash flow. The use of forwarding contracts obviously comes at a premium which the company has to pay to fix the currency exchange rate it will use for transactions in future. However, this cost removes the risk from the cash flow due to currency fluctuations.
How do you think the company gains an appreciation for what their best approach to managing the risk? Is this equivalent to gambling? I think it is to a degree but the consistent rate adjustments for future periods can be largely depended upon unless some major change in the property of a nation (or nations) occurs. Are we seeking much change with current natural disasters?
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