MNCs are coming up in huge numbers nowadays. To earn the profits with minimal amount of risk has been a matter of concern for the investors. For this purpose management of risk is a very crucial factor. Pertaining to this context, this project has been undertaken with an objective to study the risk management strategies that can be used by MNCs. The various risks faced by the MNCs have been mentioned and the ways to manage them have been depicted in the project. Exchange Rate Risk is one of the Major risks faced by MNCs. A Multinational Corporation is a large business organization whose operations extend across international boundaries.Location-specific advantages include location-specific natural resources, manmade resources, low taxes; low wage costs, high labor productivity, or state supported monopolies Location-specific advantages can lead to sustainable competitive advantages. Ownership-specific and location-specific advantages by themselves are not sufficient to ensure the success of the multinational corporation over local firms. Market internalization (I) advantages accrue to the multinational corporation as it exploits its ownership- specific advantages in local and international markets.
[...] Characteristic Economic Effect of Exchange Rate Changes on MNC's Cash Flow Relevant Economic Devaluation Revaluation Categories Factors impact impact Revenue Parent company Parent company revenue impact revenue impact Export Sales Price Sensitive Increase Decrease Demand Price insensitive Slight increase Slight demand decrease Local Sales Weak prior import Sharp decline Increase competition Strong prior import Decrease Slight competition decrease Costs Parent company Parent company cost impact cost impact Domestic Inputs Low Import Content Decrease Increase High Import content/ Slight decrease Slight Inputs used in Increase export or import competing sectors Imported Inputs Small local market Remain the same Remain the same Large local market Slight decrease Slight increase Depreciation Cash flow impact Cash flow impact Fixed assets No asset valuation Decrease by Increase by adjustment devaluation % revaluation % Financial Management of Exchange Risk The one attribute that all the strategic marketing and [...]
[...] A money market hedge involves simultaneous borrowing and lending activities in two different currencies to lock in the rupee value of a future currency cash flow Risk Shifting: A company can avoid its transaction exposure altogether if the other company allows its price of the sale to be in the home currency. This practice does not however eliminate the risk; it simply shifts the risk from the seller to the buyer. Despite the fact that this form of risk shifting is a zero sum game, it is common in international business. [...]
[...] domestic) foreign sales branches and subsidiaries Contract-based entry Licensing and franchising Investment-based entry Foreign direct investments Cross-border mergers and acquisitions Joint ventures Exporting Through Agents and Distributors: Advantages quick and easy low resource commitment low cultural costs and risks control over production Disadvantages relatively low sales potential must overcome quotas and tariffs high political risk no control over market & distribution channels Exporting Through Foreign Branches and Subsidiaries Advantages higher sales potential than agent/distributor retains control over production achieves control over marketing & distribution Disadvantages higher resource commitment slower entry than agent/distributor still must overcome quotas and tariffs high political risk higher cultural costs and risks than agent/distributor Contract Based Entry Advantages quick and easy low resource commitment low cultural costs and risks avoids import and investment barriers Disadvantages limited fees/royalties on license agreements loss of control over production technology potential creation of competitors Investment Based Entry Advantages high sales potential potential for lower costs diversifies manufacturing base and matches foreign currency costs to revenues avoids import quotas and tariffs Disadvantages high resource commitment high exit costs must overcome cultural differences must overcome investment barriers Foreign direct investment relatively slow entry initially but doing very well now maintains control over production, distribution, and intellectual property Cross-border mergers and acquisitions relatively rapid entry price of entry (acquisition premium) can be high Cross-border joint ventures may avoid investment restrictions less exposure to political/cultural risks risk losing control of intellectual properties risk creating a competitor THE CONCEPT OF RISK What is Risk? [...]
[...] Specifically, if PV is the present value of the firm, then the firm is exposed to a currency risk if: Change in PV/ Change in Exchange Risk is not equal to Zero Where, Exchange risk is defined as the variability in the firm's value that is caused by uncertain exchange rate changes. Thus, exchange risk is viewed as the possibility that currency fluctuations can alter the expected amounts or variability of the firm's future cash flow. Economic exposure can be separated into two components: Transaction Exposure Operating Exposure Transaction exposure stems from the exchange gains or losses on foreign currency denominated contractual obligations. [...]
[...] The neutral zone represents the currency range in which the risk is not shared Foreign Currency Options: In many circumstances a firm is uncertain whether the hedged foreign currency inflow or outflow will materialize. This uncertainty has important consequences for the appropriate hedging strategy. Taking the above example, GE would like to guarantee that the exchange rate does not move against it between the time it bids and the time it gets paid, should it win the contract. The danger of not hedging is that its bid will be selected and the Deutschemark will decline in value, possibly wiping out GE's anticipated profit margin. [...]
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