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Managing Exchange Rate Risk for Yum!Brands and Wal-Mart: Chinese Yuan

The artificially low value of the Yuan makes US manufactured exports unattractively priced in China. And the undervalued Yuan leads to excessive US imports of Chinese made goods, which in turn, leads to an unwelcome trade balance in China's favor. For example, the trade deficit with China was roughly $20 billion for the month of May, 2007. The total trade deficit for the US for 2008 was roughly $700 billion. These numbers shrunk during 2009 as recession hit the global economy. But now they are growing again. In the month of May, 2010 the trade balance was -222 billion and for all of 2010 roughly -273 billion.

China chose to change their 'floating' arrangement and pegged the Yuan to the USD at a rate they selected. The US continued to complain so China recently allowed the Yuan to 'float' again. China holds such a large investment in US Treasuries as a result of the continuing US trade surpluses that the US does not have a great deal of leverage. If China sold those Treasuries the US dollar would fall significantly in value.

Please write a report for the financial managers of Yum!Brands and Wal-Mart by responding to following tasks:

1) Suppose China suddenly decided to change its mind. Overnight, instead of increasing its value China decided to devalue downwards the Yuan by 20% in order to increase the attractiveness of its exports.

What would be the impact of the devalue of Yuan on the two US companies: i) Yum!Brands - whose 2010 profits were $1.16 billion coming from their Chinese operations and ii) Wal-Mart - where the great majority of the products sold in its US stores are made in China.

2) Based on your analysis, how big the risk is for Yum!Brands and Wal-Mart? How can both companies protect themselves from such a major change in currency values? What are your recommendations to these companies?

Solution Preview

1) Suppose China suddenly decided to change its mind. Overnight, instead of increasing its value China decided to devalue downwards the Yuan by 20% in order to increase the attractiveness of its exports.

This would be great for Wal-Mart who buys products from China and sells them in the US market. Wal-Mart could realize a greater profit or lower their prices and put further pressure on competitors that do not buy the bulk of their products from China. If the Yuan devalued by 20%, the US dollar would buy 20% more products in China, or realize a 20% greater profit on US sales. So, for Wal-Mart a devaluation of the Yuan would be beneficial in the ...

Solution Summary

The expert examines managing exchange rate risks for the Yum! brands and Wal-Mart for the Chinese Yuan.

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