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What Is Meant By The Term Foreign Exchange Risk And Explain And Illustrate Those Strategies That Are Available To A Multi National Enterprise To Deal With Such Risk.

2286 words - 9 pages

In this paper I intend to introduce the relevant options available to a multi-national enterprise when dealing with foreign exchange risk. I am going to use Toyota Motor Corporation throughout as an example. Toyota is the world's third largest automaker. It was established in Japan on August 28th 1937 and apart from its 12 plants in Japan, has 54 manufacturing companies in 27 countries, employs 246,700 people and markets vehicles in more than 160 countries. (Toyota website, 2004) Toyota is exposed to the fluctuation in foreign currency exchange as it operates mainly in America, Europe and Britain. It is therefore affected by the fluctuation in the value of the US dollar, the Euro and to a lesser extent the British pound. Toyota's consolidated financial statements, which are presented in the Japanese yen, are affected by the foreign exchange fluctuation, as all the amounts in the various countries' currencies have to be translated into yen.There is no one clear definition of foreign exchange risk. It takes into consideration the level of exposure that a multi-national enterprise has on foreign markets. When we speak of foreign exchange exposure, we are referring to the risk that future changes in a country's exchange rate will have positive or negative effects on the firm.The value of the Japanese yen has fallen generally for the past three years against the dollar and the Euro though there had been periods of fluctuations. Changes in foreign exchange rates affect a multi-national enterprise's revenue, gross margins, operating costs, operating income, net income and retained earnings. Toyota's cost and liabilities are affected by transaction exposure which relates primarily to sales proceed from Toyota's non-domestic sales produced in Japan. It is also affected to a lesser extent sales proceed from Toyota's Europe sales produced in UK.The first step in management of corporate foreign exchange risk is to acknowledge that such risk does exist and that managing it is in the interest of the firm and its shareholders. The next step, however, is much more difficult: the identification of the nature and magnitude of foreign exchange exposure. In other words, identifying what is at risk, and in what way.The task of gauging the impact of exchange rate changes on an enterprise begins with measuring its exposure, that is, the amount, or value, at risk. This issue has been distorted by the fact that financial results for an enterprise tend to be compiled by methods based on the principles of accrual accounting. (Pilbeam) Unfortunately, this approach yields data that frequently differ from those relevant for business decision-making, namely future cash flows and their associated risk profiles. As a result, considerable efforts are exhausted to reconcile the differences between the point-in-time effects of exchange rate changes on an enterprise in terms of accounting data, referred to as translation exposure, and the ongoing cash flow effects which are referred...

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