Exchange Rate Issues for Deere

Finance

Managing Financial Risk including Currency Exchange Rate Risks

Deere and Company are suffering as the string dollar is impacting negative on sales in the Euro zone. The firm is suffering not only due to the exchange rate, but also the high level of competition from other European firms that are operating in the Euro.

If companies operate across international boarders they will face risks associated with exchange rate movement. In the case of a strong home currency, this will make the goods more expensive to purchase if the pricing is based in the home currency. The basing of the price on the dollar, even if it is converted to Euro's effectively passes the risk to the purchaser. The impact can be the price becoming uncompetitive, especially when there are firms that are basing their pricing structure on the same currency as the purchasers.

The firm may deal with the issue by implementing strategies that will allow for the firm to base the pricing on Euros. There are several strategies which may be implemented. The most common approach is to use hedging as a tool to deal with the exchange rate risks. Hedging is used where a firm has exposure to changes in the process of commodities. Hedging involves the purchase (sale) of a derivative contract to buy (or sell) a set amount of that commodity at a set price at a specific point in the future (Howells & Bain, 2007). The derivative will usually be a future or forward, where the transaction is binding and will take place at the set price, or an option (Howells & Bain, 2007). Options give the purchaser of the contract the option to purchase the commodity at the set price, without an obligation to make the purchase. With an option the purchaser of the contract would be able to compare the spot rate with the contract rate and used the most advantageous (Howells & Bain, 2007). In the case of Deere, the firm would be able to price the equipment in Euros, and then use hedging to cover the risks associated with exchange rate fluctuations.

Other potential strategies may include pricing in Euro's and then holding the Euro's until the firm deems the exchange rate to be favorable for repatriating revenues. If the European market is large, an alternate approach may be to set up in the Euro zone, where manufacturing and input costs are incurred in Euros, and sales can be made in Euros, so the exchange rate risk is reduced to the reparation of profits only.

Of all these options, it is likely that hedging will be seen as the most viable, it is a tool that is used widely and accepted as a way of managing risk.

Question 2

WalMart include information within their annual report in the way risk is managed. WalMart manage a number of different market risk. These risks include interest rate changes and foreign currency risk. WalMart are exposed to long-term and short-term debt, which may be impacted by changes in interest rates. The firm manages risk for these debts in a number o f ways. Some debt has been taken out using fixed rate loans (WalMart, 2014). Fixed rates have some potential risks, especially if there is the potential for interest rates to decrease, they are also more likely to have set up fees and other higher costs associated with the loan (Howells & Bain, 2007). At the current time, with low interest rates, it may be argued the risks associated interest rate changes on fixed rate loans are low for the borrower; however, they are higher for the lender, and as such the rates offered on fixed rates are likely to have a premium attached (Howells & Bain, 2007).