The Importance of Considering Foreign Exchange

Any multinational firm must consider foreign exchange since it significantly influences how well the business performs. It is a factor that determines profitability since it can either cause a successful firm to fail or to thrive (Brown, 2017). This memo estimates how variations in foreign exchange rates may upset the cost-effectiveness of the company’s international business sector. Additionally, it aims to assess if the firm should buy raw materials abroad and highlights the need to consider currency exchange rates while conducting international commerce. According to the first scenario, the corporation’s revenues will be $(1/3.52)*1.25 million MYR, or $355113.64, grounded on the spot rate on April 1st of 3.52 MYR/1 USD. As a result, given that the business must make $360000 (90*4000) in revenue to break even, it will incur a loss of $355113.64 minus $360,000 = $4866.36.

In the second scenario, the business will convert its revenue into US dollars using the frontward rate of 0.317 US dollars/MYR. The income from the forward rate is $0.317 * 1.25 million MYR, or $396250. The business will thus make a profit of $396250-$360000=$36250. Thirdly, because the firm is a manufacturer, it can use its 1.25 million MYR in sales to buy raw materials in Malaysia. However, it is crucial to consider the Malaysian ringgit’s currency fluctuation before buying raw materials with money. To minimize further losses, purchasing raw materials with the revenue is advisable rather than turning it into US dollars or vice versa if the currency is very volatile. In conclusion, the study above demonstrates that exposure to foreign exchange risks can lead to losses. Therefore, a business must reduce the risks by hedging to prevent losses brought on by changes in foreign exchange rates.

Reference

Brown, G. W. (2017). Managing foreign exchange risk with derivatives. Journal of Financial Economics, 60(2-3), 401-448.