Multinational Companies and Currency Fluctuations

Multinational corporations face adverse risks due to the fluctuation of the exchange rates. Currency fluctuations cause currency shocks that affect financial institutions and financial markets.  The value of currencies gives the value of property, goods and services.  Most of the multinational organizations tend to export products to foreign countries or import supplies from foreign manufacturers. The exchange rate is essential in the global economy because the effect of the currency fluctuations affects all the organizations and the whole economy.  The impact of the exchange rate fluctuation may lead to changes in the asset price, profit margin, and the financial structure of the company (Tille, 2014). The hedging strategies adopted by the multinational companies are different depending on the company and the fluctuations of the exchange rates. The multinational organizations also lead to challenges of the balance of payments.

McDonald Company

McDonald is an international company that is expected through the management to make decisions that will maximize profits, stock prices, and also maximizes shareholder wealth (Grant, 2016). Also, changes in the exchange rates will affect McDonald’s cash flow through translation risks, transaction, and economic exposure risk. Stability of the exchange rate stability explains why McDonald can face economic problems in the current economy. The company has experienced fluctuations in its profits. The company deals with currency fluctuations in different ways with an aim to reduce the instability of its cash flow as well as to reduce foreign exchange losses. The changes in the exchange rate can be either expected or the unexpected. The unexpected fluctuation measures the positive effect of the change in the company while the predicted change measures the negative impacts on the company.

McDonald Company experiences various risks which affect the cash flow of the company. The risks include economic exposure risk, translation risks and transaction risks. The transaction risk refers to the company’s cash flow risks that result from the different region's currencies. The exposure to the risk is anticipated when the exchange rate fluctuations affect the firm’s future cash transactions. Transaction risk can be named as the most precise form of exchange rate risk. The company can hedge against this kind of threat by converting foreign currencies to domestic currencies. McDonald Company faces three major tasks when dealing with transaction risk. The company identifies the level of the risk, decides whether to hedge against this exposure, and whether to hedge all or parts of the exposure. When the decision is made to hedge, the company uses one of the available techniques (Mun, 2012).

Economic exposure refers to the other risks that the company faces. The threat involves a complete change of the company’s financial performance due to exchange rate fluctuation. The company can be said to be suffering an economic exposure risk when its future cash flows are affected. The exchange rate movements can affect the cash flows indirectly unlike the associated foreign transactions. The company can hedge this type of risk by determining the extent to which the cash flows are affected by the exchange rate fluctuations. Multinational enterprises present challenges to balance of payments accounts. The companies, therefore, allocate resources, bill transactions, and price intra-company transactions to maximize company-wide global net profits. The transactions and the accounting activities may not always align well with the economic behavior. The accounting issues become a challenge because of the growing number of multinational companies.

Hedging Techniques

Fluctuation of the foreign currencies is one of the many risks that McDonalds Company faces. The other types of threats include changes in interest rates, commodity prices and equity prices. The company uses derivative instruments and foreign currency denominated debt to mitigate the impact of the changes. For instance, the values of the derivative instruments that McDonald's used in the year 2013 are shown below on the consolidated balance sheet.

Figure 1 (Luo, 2013).

Also, the company uses the cash flow hedges to reduce its exposure to the risks and the expected future cash flows. A cross-currency swap is used to hedge the risk of cash flows associated with the foreign currency. McDonald's also uses new investment hedges in certain foreign outlets and affiliates (Shapiro, 2016).

The finance department at the McDonalds develops a strategy that helps hedge the foreign exchange risks. One of the methods that a company uses is borrowing money locally and uses it to buy local assets. For instance, McDonald's has over eight billion dollars in debt, which is over 50 percent of the foreign currency debt. The company can, therefore, use, the local currency to pay the debt and avoid the impact of the fluctuation foreign currency. However, the remaining debt can be paid by use of forwarding options contracted on a basket of currencies. McDonald's uses a natural way of hedging against the fluctuations of the currencies by use of local currencies to fund local operations. The primary concern is the Chinese currency, Yuan, because it is the only currency that remains pegged to the US$ even with its significantly small gain. One example of the company’s subsidiary in India showed the effectiveness of the natural way of hedging against the risks. Correctly, the group identified cultural differences and used the challenges to devise a way around and address the cultural challenges. The deliberate attempts to understand and utilize the cultural differences enabled the company to adapt to the local conditions.

McDonalds uses various strategies and instruments to manage the current risks. For instance, the company uses external methods such as the financial derivatives whose values are derived from the underlying asset. External hedging strategies include currency forwards, currency options, currency swaps, currency futures, and contracts for difference. McDonald's uses currency swaps to trade part of the foreign currency and offset the same amount at a later date. The currency swap allows the McDonalds to borrow in markets that give a more significant advantage and then at a later date swap to obtain the desired payment. McDonald's also uses contracts for difference to trade currencies during fluctuations because the trading is not associated with other costs.

McDonald Company uses operational and financial hedging methods to protect itself from adverse financial loss.  The hedging methods include using geographic distribution, the company’s location, and the number of countries in which the company operates. The firm considers factors like its exchange rate index and its stock rate of return. When the company decides to use a geographical location to hedge against economic risks, then the high exposure of the risk goes to the more prominent operation regions. An increase in foreign revenue leads to higher exposure to risks. Operational and financial hedging methods are complementary to reduce the impact of the exchange rate risks. McDonald Company also hedges against the exposure to its fixed assets by focusing on the threat on cash flows. Fixed assets in a foreign country may result in high exchange rate risk (Eichengreen, 2015).

Recommendations

McDonald Company should use the internal and external method to manage the foreign currency rate fluctuation risk. The internal process involves the use of the company’s internal financial statements. The domestic arrangements include leading, netting and lagging, pricing policies and balance sheet hedging.  Also, the company can diversify internationally and use sound financing decisions in the long-term cash flows. The external method involves using contractual relationships with other firms to hedge against the losses. The external means involve the derivatives and contracts such as currency exchange, currency options and currency futures which will have a positive impact on the domestic balance of payments.

References

Eichengreen, B. (2015). Exchange rates and financial fragility (No. w7418). National bureau of economic research.

Grant, R. M. (2016). Contemporary strategy analysis: Text and cases edition. John Wiley & Sons.

Luo, Y. (2013). Entry and cooperative strategies in international business expansion. Greenwood Publishing Group.

Mun, J. (2012). Real options analysis: Tools and techniques for valuing strategic investments and decisions (Vol. 137). John Wiley & Sons.

Shapiro, A. C. (2016). Multinational financial management. John Wiley & Sons.

Tille, C. (2014). Financial integration and the wealth effect of exchange rate fluctuations. Journal of International Economics, 75(2), 283-294.