McDonald Corporation is a multinational company that operates in the fast food sector in 119 countries. The company has 32,737 restaurants and operates 19,276 franchises. McDonald runs its business in the six geographical regions such as the United States, Europe and Pacific, Middle East and Africa (APMEA). In the U.S. segment, McDonald could boast of 34% from its total revenue. The company also records 40% of the total revenue in the European segment. In the APMEA, the company records 21% from its total revenue. McDonald continues to focus on restaurant business to achieve long-term growth, and "McDonald's customer-focused Plan to Win-which concentrates on being better." (McDonald Annual Report, 2010 P10). The performances of McDonald are attributed to the core menu that the company serves to its customers. The core menu such as Chicken McNuggets and burgers, McCafe beverage, and McRib sandwich. At the end of 2010 fiscal year, McDonald recorded 5% increase in the total sales and 11% growth rate in the earning per share. The success of McDonald is attributed to the constant flow of customers. Presently, McDonald serves average of 64 millions customers per day, and as company continues gaining market shares, its operating income grew by 9% in 2010. Typically, the company enjoys comparable success around the world. In the U.S., McDonald records sale increase by 3.8%, and there is sale increase by 4.4% in Europe. The company continues to make a strong improvement in sales with the increase in sales count.
Despite the McDonald's success in the U.S. And the international markets, the company still faces many risks. One of the risks that McDonald faces in its foreign operations is the foreign exchange risks.
The objective of this paper is to assess the foreign currency exposure of McDonald in Europe.
Market Operation of McDonald in Europe
McDonald operates in different countries in Europe. Among the countries that McDonald operates are the UK, France, German, Spain, etc. Since European countries use currency other than U.S. dollar, McDonald faces the foreign currency exchange risks in its global operations. Since the integration of European Union (EU), many European countries use Euro as their official currency, and since McDonald operates in the UK and other countries in Europe, the company faces foreign exchange risks in Europe. Typically, McDonald has the most exposure to foreign currency risks among the U.S. restaurant companies. Foreign exchange rate risks are the varying exchange rates between two currencies. During the time the contract is negotiated and concluded, exchange rates movement could adversely affect the net income of a company. Since the collapse of Breton Woods system of fixed exchange rates, there is a dramatic increase in the exchange volatility. Since McDonald operates in multiple countries, the company is vulnerable to foreign exchange risks because short-term movement in exchange rates could not offset change in the prices of goods. (Chowdhry, & Howe, 1999).
Essentially, with 35% sales in Europe, McDonald is exposed to the 35% of foreign exchange risks, and McDonald business operations are challenged with managing of these risks. Foreign exchange risks are the biggest risks that McDonald is facing. Approximately 65% of the company debt is in foreign denominated currency, and the company has greatest exposure to Euro and UK pounds. Typically, McDonald generates a significant part of its operating income in foreign currency and 40% of the company total debt is denominated in foreign currency. With the fluctuation in foreign currency, the company earning is being affected by the changes in the foreign currency exchange rates. The fluctuation of the U.S. dollars against Euro and Pounds always affect the company foreign operations. The 10% fluctuation of the Euro and UK pounds against U.S. dollars affects the diluted earning of McDonald by 20 cents, and in 2011, McDonald faces the increase in the currency exchanges rates by approximately 7%. It is essentially to realize that changes in 10% of Euro and Pound against dollar will change the company net income, and the weak dollar against Euro and Pounds will negatively affect the earning of McDonald.
In the recent years, the U.S. has recorded recession that weakens the U.S. dollars. In 2007, there was a decline of U.S. dollar against Euro and the UK pounds. In addition, the United Kingdom that does not participate in the Euro experienced weakness of its currency against Euro, which made the pound to decline against Euro. Baertlein (2010) argues that McDonald has been exposed to the 10% move in Euro in the first quarter of 2010, and the effect leads to the decline of earning per share of McDonald by 6 cents. Typically, foreign exchange translation has impact on the earning of McDonald. In 2009, the foreign exchange translation has negative impact on the consolidating operating results of McDonald. For example, strong Euro and British pounds against U.S. Dollars primarily drove the negative impacts of 2009. Generally, McDonald borrows long-term debts in Euro and UK pounds, and the company is exposed to the fluctuation in the foreign currencies. For example, the company debt obligations was totalled $11.5 billions at the end of the December 2010 compared with the debt $10.6 billions at the end of 2009 making the company to record the net issuance of $787 millions. The different in debt between 2009 and 2010 was due to the foreign currency fluctuation.
McDonald uses various strategies to mitigate the foreign exchange risks in order to achieve competitive market advantages in the international business environment.
Strategies McDonald uses to Mitigate Foreign Exchange Risks
McDonald uses many strategies to mitigate the foreign exchange risks. One of the strategies employed is hedging activities. The company also uses derivative instrument to mitigate the impact of foreign exchange risks. The company derivative instruments are designed towards hedging instruments. In addition, the company uses forward foreign exchange agreement to mitigate the foreign currency risks. (Moosa, 2006). The company also enters into derivatives not associated with hedging instruments. "The Company has also entered into equity derivative contracts to hedge market-driven changes in certain of its supplemental benefit plan liabilities." (McDonald Annual Report, 2010 P. 32).
Moreover, McDonald enters into fair value hedging strategy to reduce the company exposure to certain liabilities. For example, the company enters into the exchange agreement to mitigate foreign exchange risks because of the company underlying debts that are denominated in currencies such as Euro and UK pounds.
In addition, the company uses cash flow hedging to reduce the volatility of the foreign exchange. The company cash flow hedge includes forward foreign currency agreement to protect itself against reduction in the value of the foreign exchange cash flow. (Stapleton & Subrahmanyam, 2009). Typically,
"When the U.S. dollar strengthens against foreign currencies, the decline in present value of future foreign denominated royalties is offset by gains in the fair value of the forward foreign currency exchange agreements and/or foreign currency options. Conversely, when the U.S. dollar weakens, the increase in the present value of future foreign denominated royalties is offset by losses in the fair value of the forward foreign currency exchange agreements and/or foreign currency options." (McDonald Annual Report, 2010 P. 34).
Using the upfront contract strategy, the company total loss is limited due to the foreign currency fluctuations.
To possess sufficient liquidity for its business process and finance its global operations, McDonald makes use of money, bond, and equity through the operation of international banking system.
Functions of International banking system and financial markets
International banking system has been an important component of international financial operations, and it performs the key functions in business of Multinational Corporation. The development of international banking has been contributed to the increase in the international economic activities, and the international banking is closely related to the international financial market. International banking system is very important for the capital flow in and out of the United States. The role of international bank is to lend or accept deposit in currencies in foreign currencies. Many international banks are also offering range of sophisticated financial products to U.S. firms abroad. One of the functions of the international banking operations is to facilitate Eurodollar deposit in the banking offices outside United States.
There are several functions that international banking provides to facilitate global business operations. First, international banks provide cross-border lending. For example, a bank having an headquarter in the UK could offer loan to a multinational corporation located in the United States. Essentially, international banking activity is essential component of financial integration. The international banking system facilitates the international financial stability and it has contributed to welfare gain across the countries. International banking system has been a key player in the global integration. Presently, there is a growing demand for the international banking by the multinational companies because international banks promote cross-boarder transfers.
Despite the contribution of international banking in promoting the international financial integration, there is a criticism levied against the international banking activities. For example, in the last decade, it has been noted that cross-boarder lending has outpaced the international trade.…