Sunday, 25 December 2016

Reasons of Forecasting Exchange Rates For MNC's

Virtually every operation of an MNC can be influenced by changes in exchange rates. Several corporate functions for which exchange rate forecasts are necessary follow:

  • Hedging decision: 
MNCs are constantly confronted with the decision of whether to hedge future payables and receivables in foreign currencies. Whether a firm hedges may be determined by its forecasts of foreign currency values. As a simple example, consider an Indian firm that plans to pay for imports from Mexico in 90 days. If the forecasted value of the peso in 90 days is sufficiently below the 90-day forward rate, the MNC may decide not to hedge.
  • Short-term financing decision: 

When large corporations borrow, they have access to several different currencies. The currency they borrow will ideally  (1) exhibit a low interest rate and  (2) weaken in value over
the financing period. If, for example, a U.S. firm borrowed Japanese yen, and the yen depreciated against the U.S. dollar over the financing period, the firm could pay back the loan with fewer dollars (when converting those dollars in exchange for the amount owed in yen). This financing decision should therefore, be influenced by exchange rate forecasts of any currencies available for financing.

  • Short-term investment decision:

Corporations sometimes have a substantial amount of excess cash available for a short time period. Large deposits can be established in several currencies. The ideal currency for deposits would (1) exhibit a high interest rate and (2) strengthen in value over the investment period. Consider, for example, a Japanese corporation that has excess cash deposited into a British bank account, and assume the British pound has appreciated against the yen by the end of the deposit period. As the British pound are withdrawn and exchanged for yen, more yens will be received, due to the pound’s appreciation against the yen. Exchange rate forecasts of the currencies denominating available deposit accounts should therefore be considered when determining where to invest the short-term cash.

  • Capital budgeting decision: 

When an MNC attempts to determine whether to establish a subsidiary in a given country, a capital budgeting analysis is conducted. Forecasts of the future cash flows used within the capital budgeting process will be dependent on future currency values. Accurate forecasts of currency values will improve the estimates of the cash flows and therefore enhance the MNC’s decision-making abilities.

  • Long-term financing decision: 

Corporations that issue bonds to secure long-term funds may consider denominating the bonds in foreign currencies. As with short-term financing, corporations would prefer the currency borrowed (denominating the debt) to depreciate over time against the currency they are receiving from sale. To estimate the cost of issuing bonds denominated in a foreign currency, forecasts of exchange rates are required.

  • Earnings assessment: 

When earnings of an MNC are reported, subsidiary earnings are consolidated and translated into the currency representing the parent firm’s home country. Forecasts of exchange rates play an important role in the overall forecast of an MNCs consolidated earnings.

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