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Exchange rate risk

DFI Location Decision.

Decko Co. is a US firm with a Chinese subsidiary that produces cell phones in China and sells them in Japan. This subsidiary pays its wages and its rent in Chinese yuan, which is stable relative to the dollar. The cell phones sold to Japan are denominated in Japanese yen. Assume that Decko Co. expects that the Chinese yuan will continue to stay stable against the dollar. The subsidiary's main goal is to generate profits for itself and reinvest the profits. It does not plan to remit any funds to the US parent.

a) Assume that the Japanese yen strengthens against the US dollar over time. How would this be expected to affect the profits earned by the Chinese subsidiary.
b) If Decko Co. had established its subsidiary in Tokyo, Japan, instead of China, would its subsidiary's profits be more exposed or less exposed to exchange rate risk?
c) Why do you think that Decko Co. established the subsidiary in China instead of Japan? Assume no major country risk barriers.
d) If the Chinese subsidiary needs to borrow money to finance its expansion and wants to reduce its exchange rate risk, should it borrow US dollars, Chinese yuan, or Japanese yen?

Solution Preview

a. If Yen strengthens against the dollar, it would also strengthen against the Yuan. Therefore the cash flow from sales when converted to Yuan from Yen would be higher. Thus the profits of the firm would increase since it would get more Yuan for the same ...

Solution Summary

The solution explains various questions relating to exchange rate risk

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