Managing Exchange Rate Risk

Managing Exchange Rate Risk

For a number of multinational corporations, currency fluctuations can pose an extreme risk for them. This is because of sudden changes and dramatic amounts of volatility inside the marketplace can have a negative effect on their bottom line results. When this happens, there is a realistic possibility that these challenges could negatively impact their financial position and ability to compete inside many different markets. (Berger, 2011)

In the case of Fed Ex, the company has operations around the globe and is one the larger overnight package delivery services. This means that sudden shifts in the currency could negatively impact their earnings. To fully understand the overall scope and the way they are able to deal with these challenges requires focusing on how this impacts their operations, options financial managers can use to manage it and the benefits / drawbacks of these strategies. Together, these elements will highlight how the company is able to deal with these issues, make adjustments for unexpected changes and the lasting impact it is having on their financial position. ("Fed Ex," 2013)

Exchange rate risks can have a dramatic impact on Fed Ex's bottom line results. This is because the company is constantly shipping millions of packages every single year across international borders. The way that most customers will pay them for their services is in the form of the local currency where they live. When there are sudden changes in value, it will have an effect on their ability to control costs from the added amounts of volatility. (Berger, 2011) ("Fed Ex First Quarter Results," 2012)

A good example of this occurred during the third quarter of 2012. In this period, the company reported that earnings fell by 4%. The reason why is from increased amounts of volatility in the Euro. This had ripple effects on customer demand. As they became, more hesitant to send their packages to other locations using Fed Ex. At the same time, the firm was realizing an increase in operating costs based upon these unexpected transformations. This is illustrating how exchange rate risks can have a negative impact on the business operations of Fed Ex. ("Fed Ex First Quarter Results," 2012)

When this happens, it will add to the overall financial pressures impacting the firm. This will take place with them realizing rising costs and it will lead to a loss in demand for their services (from consumers who are more hesitant about the state of the economy in their own country). It is at this point when Fed Ex will have negative impacts on their business operations. (Berger, 2011) ("Fed Ex First Quarter Results," 2012)

The biggest advantage that Fed Ex can use to minimize these risks is to purchase calls or puts, on forward options contracts (through a strategy known as hedging). Under this approach, the company could use them to protect themselves from sudden changes in the currency by purchasing these contracts in advance. Once there is a sudden decrease in the value of the currency, is when the put options can be sold in the open market or exercised. This will prevent the company from taking large losses at times when there are increased amounts of volatility. (Berger, 2011) (Grady, 2010)

Another option that Fed Ex has available is a currency swap. This is when there is an exchange for the principle and interest in one currency with another. The basic idea is to use this as way to effectively negotiate a predetermined rate in the future with the other party they are working with. It is at this point, when the company will have more stability and can help to mitigate the negative impacts of unexpected shifts. (Berger, 2011) (Grady, 2010)

The biggest advantages of hedging are it will allow Fed Ex to offset any kind of losses they are experiencing from volatile currencies. The major drawback of this strategy; is there will be a certain amount of losses they will write off from purchasing the put option (during times of stability). This could negatively impact their bottom line results to a certain extent from purchasing of added amounts of insurance. (Berger, 2011) (Grady, 2010)

The advantages of currency swaps are that it will reduce the underlying levels of volatility from sudden changes in the markets. At the same time, the transaction occurs on the international stage, which means that it does not have to be reported in the annual report. This will have a positive impact on their operations by reducing any kind of accounting related charges they will experience in the process. However, there is a possibility that the company could face increased scrutiny of their practices from not reporting the transaction on their balance sheet. This means that regulators (such as: the SEC) could make claims that they are trying to go around U.S. securities laws. (Berger, 2011) (Grady, 2010)