When conducting business aboard, cash inflows are affected when a variety of currencies are involved. In the case of Nike’s proposal to expand in India, there are ways to migrate exchange rate risks by exposing the possible risks before they affect the company’s profit margin. One method is the transaction exposure. Transaction exposure is the degree to which the value of future cash transactions that are affected by exchange rate fluctuations. According to Madura,
“Transaction exposure can have a substantial impact on a firm’s earnings. It is not unusual for a currency to change by as much as 10 percent in a given year. If an exporter denominates its exports in a foreign currency, a 10 percent decline in that currency will reduce the dollar value of its receivables by 10 percent. This effect could possibly eliminate any profits from exporting” (Thomson South-Western 2006).
To assess transaction exposure, Nike will ...view middle of the document...
It helps to identify currencies whose values are most likely to be stable or highly variable in the future. The equation for a portfolio’s standard deviation suggests that positive cash flows in highly correlated currencies result in higher exchange rate risk for the MNC.
The best technique to eliminate transaction exposure is through the money market. A money market hedge involves taking a money market position to cover a future payables or receivables position. In the case of Nike, a money market hedge is best because the company will payables and receivables if they expand into India. Nike is already a successfully stable company, so they could invest a deposit into purchasing foreign currency for payables to future employees. As far as receivables go, Nike could hedge their position by borrowing the currency now and converting it to dollars. The receivables will be used to pay off any loans.
Politics are very influential when it comes to conducting business aboard. Politics can either make or break a business proposal. When it comes to Nike and their proposal to expand into India, politics are very important to consider during the decision making process. India is a poverty stricken country that needs business investments to survive. According to Daniel,
“India's economy is set for its worst performance in a decade after three consecutive quarters of growth near 5.5 percent. High government spending has led to a fiscal deficit that economist say is likely to hit 5.6 percent this year, exacerbated worse by a fall in revenues” (Daniel, F.,2012).
The decision making process for Nike must consider all political events that exist within the country of interest. Religion, economy, governmental positions, all these factors will affect the overall profit of the business. In this case, hedging in the currency call options would be the best decision because if the economy doesn’t recover, then Nike could let any contracts pending expire.
Daniel, F. (2012). Key political risk to watch in India. FACTBOX . Retrieved from http://in.reuters.com/article/2012/12/05/india-political-risks-idINDEE8B401Q20121205
Madura, J. (2006). International financial management (8th ed.). Mason, OH: Thomson/South-Western