Effects of Changes in Exchange Rates on a Firm
Fluctuations in the currency exchange rates have varying effects on the firms in a country. An exchange rate refers to the price of one currency when expressed in another currency. The rate advertently determines how much of one currency can be used to purchase a certain amount of the other currency. The changes usually have significant effects on the profit margins of the businesses affected as well as on the quantity produced and prices of the products (Lopez, 2011). Firms that are most likely going to directly affected by such fluctuations include international businesses, importers, and exporters.
Our firm, DeLiss Manufacturers, is one of the country’s largest exporters of automobiles. The company is also one of the leading importers of car parts and other associated raw materials in the country. The company relies on its imports to produce goods that it can export to other countries. Therefore, the company is adversely affected by changes in global currency exchange rates because it buys from other countries and sells to other countries.
There are several occasions when the dollar has appreciated and depreciated during the course of the company’s business. For most of 2014, the dollar had appreciated against some of the major currencies in the world including the pound and the euro. The appreciation was attributed to the country’s rapid economic recovery after the 2008 financial crisis.
Throughout the company’s history, it has had to exchange US dollars for pounds in order to purchase raw materials from Britain. The company exports a quarter of its final products to Britain and sells the rest in the domestic market. The British consumers would have to exchange pounds for US dollars in order to purchase the final goods from the company.
In such a scenario, it means that the company would need fewer dollars to import raw materials from Britain. The depreciation of the pound means that purchasing goods from Britain will be less expensive. As a result, the profit margin of the company will increase due to the reduction in costs associated with production, specifically the purchase of raw materials. Furthermore, due to the reduction in production costs, the company would have the incentive to reduce the price of the goods it sold to the domestic and foreign markets.
On the other hand, the company’s profits also suffered due to its decreased competitiveness in international markets. Once the dollar appreciates, foreign consumers will look for cheaper alternatives to the goods sold in the United States. The appreciation of the dollar makes it more expensive for other countries to purchase goods from the US. This is the reason the company’s revenues fell during this period. It sold less finished cars to its British clientele who usually account for a quarter of the company’s sales annually. The company’s output reduced and there was a consequent drop in employment during the said period.
When the dollar appreciated, two main elements of the company’s business were affected. The elements were the price and the quantity of goods sold. Since imports were cheaper, the company had the luxury to order for more raw materials from Britain. However, more raw materials would mean additional finished goods. The British were reluctant to purchase more goods from the company during this time owing to the relatively higher cost of importation on their side.
The company had to re-strategize and focus more on the domestic market. The domestic market would be able to absorb the extra units that the company had produced. Goods sold in the domestic market were cheaper owing to the low costs of inputs. The decline in price resulted in an increase in the company’s goods. The company was able to continue making profits despite the fact that its international sales to Britain had significantly reduced. The increased quantity of the cars also had an effect on the lowering of the price and the increase in demand.
In the future, the company aims at profiting from changes in exchange rates by using a currency option, also referred to as hedging. In this regard, the company buys and sells currency at a fixed and previously determined exchanged rate on a future date. The benefit of this strategy is that the company will know exactly how much it will have to pay to import goods from Britain and exactly how much it will get by selling its cars to Britain. The maneuver is meant to protect the company when fluctuations in the exchange rate are not favorable.
The company is also looking towards setting up a foreign-currency account. According to Cook (2014), foreign-currency accounts are created in different currencies, and will be helpful in reducing currency transactions for both the company and the international clients. The accounts also help offset the adverse effects of currency movements for both the clients and the company.
The best way to predict future changes in the exchange rate is to monitor the changes in the global currency exchange rate for an extensive period. Monitoring of this sort will reveal a trend and some of the causative factors of fluctuations in exchange rates. The company can use this information to predict when the exchange rate will fluctuate and adjust its business practices accordingly.
Cook, J.A. (2014). The effect of firm-level productivity on exchange rate pass-through. Economic Letters, 122(1): 27-30.
Lopez, R. (2011). Prices and exchange rates: a theory of disconnect. Review of Economic Studies, 78 (3): 1135-1177.