4-2 Assignment: Foreign Exchange
Please follow the rubric Keenly. Sources should be from 2019 and above.
Foreign exchange impacts the profitability of transactions in international markets. It can turn a profitable business into one that loses money and can turn an unprofitable business into one that makes money.
In this assignment, you will analyze the impact of foreign exchange on different business scenarios and present your findings in a short business memo.
You manage the international business for a manufacturing company. You are responsible for the overall profitability of your business unit. Your company ships your products to Malaysia. The retail stores that buy your products there pay you in their local currency, the Malaysian ringgit (MYR). All sales for the first quarter are paid on April 1st and use the exchange rate at the close of business on April 1st or the first business day after April 1st if it falls on a Saturday or Sunday. The company has sales contracts with different vendors that determine the number of units sold well in advance. The company is contractually obligated to sell 4,000 units for exactly 1.25 million MYR for the first quarter. The break-even point for each unit is $90 in U.S. dollars. Use the following foreign exchange rates:
On January 1, the daily spot rate is 3.13 MYR, and the forward rate is 0.317 U.S. dollars/MYR for April 1st of the same year.
On April 1, the daily spot rate is 3.52 MYR.
Using the information above, create a short business memo that explains the profitability, viability, and importance of considering foreign exchange on the basis of the scenarios below.
Scenario 1: The company uses the spot rate on April 1st to convert its sales revenue in MYR to U.S. dollars.
Scenario 2: On January 1st, the company uses that day’s forward rate today to lock in a foreign exchange rate for its expected 1.25 million MYR in sales. This means the company agreed to exchange 1.25 million MYR using the forward rate on January 1st when April 1 arrives.
Scenario 3: Another option for the company is to spend the foreign currency and avoid any currency exchange. Because it is a manufacturing company, raw materials are always needed.
Specifically, you must address the following rubric criteria:
Foreign Exchange Calculations: Determine the profitability of the international business by using foreign exchange calculations for the first and second scenarios.
Spend or Save: Discuss what you would need to consider when determining if the company should buy raw materials with the foreign currency in an effort to avoid foreign exchange risk and whether this is a viable option for the company.
Conclusion: After determining the result for each scenario, explain the importance to a company’s financial results of considering foreign exchange risk.
Guidelines for Submission
Submit this assignment as a 300-word Microsoft Word document. Sources should be cited according to APA style.
Date: March 8, 2023
Subject: Foreign Exchange Impact on International Business
As you know, our company has been expanding into the Malaysian market. This has been a successful endeavor, and we have seen strong sales growth in the past year. However, we are now facing a new challenge: foreign exchange risk.
Foreign exchange risk is the risk that the value of the Malaysian ringgit (MYR) will change between the time we sell our products and the time we convert our sales revenue into U.S. dollars. If the MYR weakens, we will receive fewer U.S. dollars for our sales, which could reduce our profits.
To mitigate this risk, we have three options:
Use the spot rate on April 1st to convert our sales revenue in MYR to U.S. dollars.
Use the forward rate on January 1st to lock in a foreign exchange rate for our expected 1.25 million MYR in sales.
Spend the foreign currency and avoid any currency exchange.
Scenario 1: Use the spot rate on April 1st
If we use the spot rate on April 1st, we will receive $4,000,000 / 3.52 MYR = $1,136,363.64 in U.S. dollars. This is a profit of $136,363.64, assuming that our break-even point is $90 per unit.
Scenario 2: Use the forward rate on January 1st
If we use the forward rate on January 1st, we will receive $4,000,000 / 0.317 MYR = $12,658,227.85 in U.S. dollars. This is a profit of $2,658,227.85, which is significantly higher than the profit we would make if we used the spot rate on April 1st.
Scenario 3: Spend the foreign currency
If we spend the foreign currency, we will not be exposed to foreign exchange risk. However, we will also not be able to take advantage of any potential gains in the value of the MYR.
Spend or Save?
The decision of whether to spend the foreign currency or to save it depends on a number of factors, including the company’s risk tolerance, the expected future value of the MYR, and the availability of alternative investment opportunities.
If the company is risk-averse, it may prefer to spend the foreign currency and avoid any potential losses. However, if the company is willing to take on some risk, it may be able to earn a higher return by saving the foreign currency.
The importance of considering foreign exchange risk to a company’s financial results cannot be overstated. By locking in a foreign exchange rate, a company can protect itself from losses due to fluctuations in the value of the currency. This can be especially important for companies that do a significant amount of business in foreign markets.
In our case, using the forward rate on January 1st would have resulted in a profit of $2,658,227.85, which is significantly higher than the profit we would have made if we had used the spot rate on April 1st. This shows the importance of considering foreign exchange risk when making business decisions.