Multinational / International Corporation is the popular form of business in the world when globalization becomes a common trend on 21th Century. That requires businesses improving themselves both product and service quality and risk management strategies to adapt with market trend and increase profitability. As a multinational corporation (MNC), we know that foreign exchange risk is the most important risk not only because it is the biggest financial market but also it directly affects to a company’s profitability. The MNC operates its business more than one country, so the fluctuation of foreign exchange among countries is always the most interesting matter, which has brought both advantages and disadvantages for business.

This report is going to discuss about the foreign exchange risk management, the most interesting story for each MNC or who have been involving in financial market. This will mention the instruments used to hedge foreign exchange risk and the case study of 3M Corporation to illustrate for FX strategies.

Foreign exchange (FX) market

Foreign exchange market is the largest financial market, which created by sellers and buyers in different countries when they exchange their currencies to trade to each others. For example, a Vietnamese buyer wants to order some perfumes from America, so the thing she can do after choosing products is exchange Vietnam Dong into US Dollar to purchase with American sellers. Lots of international trade processes like that have created foreign exchange market. When the currencies go through among different countries, they are governed by many factors such as interest rate, country law, supply and demand. those are all of the factors a MNC must consider during their international trade.

Foreign exchange risk is one of the major risks for a MNC business, which make it thinking carefully before choosing a hedging instrument to reduce risk as low as possible. The spread between two currency’s values may cause loss or gain profits for business. In order to protect profitability on the foreign exchange market, there are two common methods are financial hedging such as: forward contract, future contract, swap and option and operational hedge.

Financial hedge

First of all, I want to mention about the forward contract, which is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed today. It is the most direct and popular way of hedging transaction. When the buyers believe that the interest rate of currency will increase or decrease in the future, they can make forward contract with today price. They will set up the price, the date and the amount of currency they trade at the specific of time in the future. For example, America is a major export market for Chinese company and the Yuan- Chinese currency depreciates drastically again US Dollar. If the US importers predict that Yuan continue depreciate in next some month when the payment will be paid for Chinese exporters, it means the import products increase price, so they can use the forward contracts now to prevent the risk of foreign exchange rate between US Dollar and Yuan. Today one US Dollar equals 6.741 Yuan, when the US customers want to buy shoes cost 6.741 Yuan; it means they pay $1 for each couple of shoes. In case, they order large amount of shoes in next three month and exchange rate of that time will be 7.741 Yuan per Dollar. It will cost more for US buyers. Therefore, forward contract is used as a tool to protect US buyers in this example to ensure that US buyers will not lose their money in case Yuan depreciates against US Dollar. In addition, another contract US buyers can use is future contract. It’s almost similar to forward contract to set up specific price, date, amount for transaction in the future. However, future contract is standardized on the specific day such as 15th or 30th, not 12th or 18th. And the volume of currencies or price parties want to trade must be even quantity. The function and benefits future contract can give to buyers or sellers the same with forward contract. For example, we can assume that there is a $4,000 margin. Buy S&P 500 at 1400 Value of the contract = $50 x price of the S&P 500 = $50 x 1400 = $70,000. Value of client’s position is $4,000. The next day, the S&P 500 price falls. The margin reduces by the change in the value of the contract. Current price S&P 500 is 1380 Value of the contract = $50 x price of the S&P 500 = $50 x 1380 = $69,000. Value of client’s position = $3,000. After a few days, the S&P 500 rises. Client closes his/her position. Sell S&P 500 at 1420 Value of the contract = $50 x price of the S&P 500 = $50 x 1420 = $71,000.Value of client’s position is $5,000. This client’s profit, less commissions and fees, is $1,000. Consider that this profit was earned using $4,000 rather than $70,000.

In addition, there are two more financial instruments such as: swap and option. People use swap as a financial contract that obligate each party to the contract to exchange (swap) a set of payment its own for another set of payments owned by another party. And the last one is option, which gives the purchaser the right to buy or sell the underlying financial instrument at a specified price. On the maturity if the purchaser does not want to act the contract, they must pay the fees depends on the rules of both parties.

Operational strategies:

Each MNC has its own operational strategy to face with foreign exchange risk. Each country has own factors to affect the marketing, production. Nowadays, MNCs have many factories in other countries to reduce cost of production. They focus on which countries have high inflation and low cost of raw material or labor cost, especially developing countries such as Viet Nam, China or Philippine. In case, which countries have the sign of appreciate of domestic currency, they will move their production to countries I have told above as the tool to maximize the profitability and minimize the operation expense.

The case study

3M Company is formerly known as the Minnesota Mining and Manufacturing Company, which is an American multinational conglomerate corporation based in Maplewood, Minnesota, a suburb of St. Paul by Henry S. Bryan, Herman W. Cable, John Dwan, William A. McGonagle, and Dr. J. Danley Budd. With over 76,000 employees, they produce over 55,000 products, including: adhesives, abrasives, laminates, passive fire protection, dental products, electronic materials, electronic circuits and optical films.[6] 3M has operations in more than 60 countries – 29 international companies with manufacturing operations, and 35 with laboratories. 3M products are available for purchase through distributors and retailers in more than 200 countries, and many 3M products are available online directly from the company.

When 3M faced to strong US Dollar at Asian financial crisis on 1997 to a half of 1998, the profit was changed by spot price at the time they combine the consolidated financial statement. As a MNC, they had a lot of factories and offices in many countries in the world, so when all of financial statements are converted to US Dollar at the end of the year, they lost a lot of amount of money. They tried to solve the problem by financial through forward contract, options and swaps and operational strategy. Unfortunately, the fund of the farther company located in US have not enough to buy financial hedge and another reason is Janet Yeomans wanted to focus more on operational strategies than financial strategy. She considered that spending money for those financial hedges were not good for the company’s situation at the point of time of strong US Dollar. At the end of the article, the author said “Even though 3M has a policy of using operating hedges instead of financial hedges for its overseas operations, it still uses financial instruments to hedge intercompany transactions and specifics cash flows. However, it does not hedge the possibility that the dollar equivalent of local currency revenues might fall.”

In case of 3M, i think the company should be decentralized their business. The managers of each country are familiar with the working environment, and harmful economic or financial factors in local country. They have deep knowledge about the countries where 3M put the office, so believe them to give them the right to completely control the office or factory is the best way to reduce the risk in this case.

Conclusion

In my opinion, each MNC has own advantages and disadvantages in choosing the available strategies for itself. The right strategy can help the business remove or make it get out foreign exchange risk. Operational hedge focuses on more how to control their business in other countries to adapt with the current financial situation. MNCs can move or set up the new factories or offices in which countries have better financial condition. Instead of using operational hedge, business can use financial hedge depend on the ability they analyze the problem and other ability about finance or human resource…

REFERNCES

Frederic S. Mishkin and Stanley G.Eakins, “Financial Markets and instituation”, 2006,Pearson, New Jersey, New York

en.wikipedia.org/wiki/Forward_contract

en.wikipedia.org/wiki/3M

www.saga.vn/dictview.aspx?id=1117

en.wikipedia.org/wiki/Option_(finance)

John D. Daniels, Lee H. Radebaugh, Daniel P. Sullivan, 2007, 2004, 2001 “ International Business”. Pearson, New Jersey- “3M and its foreign exchange risk management stategy”

John D. Daniels, Lee H. Radebaugh, Daniel P. Sullivan, 2007, 2004, 2001 “ International Business”. Pearson, New Jersey- “3M and its foreign exchange risk management stategy”