China Noah Corporation
The reason why companies hedge against foreign currency risks is to protect themselves against loss of business value. China Noah has a different form of foreign currency exposure due to transactions involved when dealing with international customers and suppliers. This exposure arises when China Noah has entered into international financial obligations that are exposed to currency rate fluctuation. Moffett (2015) noted that companies are exposed to substantial foreign currency risk as they endeavor to boost sales revenues or obtain raw materials (p. 34). The foreign exchange risk is critical because it can reduce business value. Therefore, McDonald must hedge to protect against loss of business value.
When China Noah applies the forecast spot-rate model, profitability declines significantly due to the foreign exchange losses. However, when the company applies a forward rate quote, sales revenues increases significantly. If the company uses fix rate baseline assumption, the result will be unclear since the exchange rate cannot be predicted with precision over the next five years.
The schedule of the foreign currency exposure will be based on the exchange rate at the time of purchasing the raw material. Since China Noah intends to buy raw materials from Indonesia today, the foreign currency exposure will be determined by the exchange rate today unless payment is discounted on monthly bases (David, Arthur & Michael, 2015, p. 46).
The outlook of both currencies is imperative when making a decision on the best hedging strategy to be implemented since it determines foreign exchange losses. For instance, if the Indonesian Rupiah is expected to appreciate over the next five years, China Noah must hedge its business against foreign exchange transactions exposure.
The best hedging model is spot rate forecast since it minimizes exposure against rising Indonesian Rupiah over the next five years.
McDonald’s
The three major exposures facing British McDonald subsidiary can be successfully hedged using cross-currency swap. These risks are caused by the fact that the equity capital is highly dependent on the value of a pound. Secondly, the subsidiary is exposed to Intra Company 4 year L125 million debts at an interest rate of 5.3%. McDonald has effectively been able to alter the denomination of cash flow in debts that affect interest rate structure. McDonald can be able to hedge against these foreign exchange exposures by swapping the fixed rate to decrease interest rate payable whenever they expect floatation rate to decrease.
McDonald subsidiary in the UK has been able to hedge its business against foreign exchange risk by employing a seven-year swap strategy. This model allows the company to hedge against foreign exchange fluctuations when the company receives payment in pounds. Moreover, the model allows the company to settle its obligations in pounds without incurring foreign exchange losses while they receive principal payments at the end of the swap agreement. McDonald lock-in its regular payments in dollars against any rising costs as a result of appreciating pound.
The most critical decision is for a parent company to determine whether the inter-company loan should be permanent or not. When the parent company decided the loan is permanent, foreign gains and losses are absorbed by the parent company and are reflected in the profit and loss account. Therefore, Anka should pay attention to OCI because it has a direct impact on shareholders equity.
References
David, K., Arthur, I., & Michael, H. (2015). Fundamentals of Multinational Finance. City: Pearson Education Limited.
Moffett, M. (2015). Fundamentals of Multinational Finance. City: Pearson Education Limited.