Sunday, October 5, 2014

Sometimes Appreciation is not appreciated at all: The currency edtion

Companies that do business internationally care about movements in currency exchange rates.  They can affect the bottom line in a way the corporation has little control.

Latest Threat to Corporate Earnings: The Almighty Dollar
"While U.S. executives must be pleased with encouraging news about the economy—including Friday’s strong jobs report—it may prove a mixed blessing for their bottom lines. That is because American corporations, as represented by the S&P 500, aren’t that American. Over 40% of sales come from outside the country. 
The problem isn’t only the absence of similar momentum abroad, but that the U.S. increasingly looks like it will soon be on the road to higher interest rates. 
That makes the dollar relatively attractive. In just the past three months, the greenback has gained 8.4% against the euro and 7.5% against the yen, big moves in the foreign-exchange market." (Emphasis mine)
 A simple example to illustrate this.

Assume the US dollar and the Euro are trading at parity:  $1.00 exchanges for 1.00 Euro, 1.00 Euro exchanges for $1.00 (they are not, but go with it).

So, profits of 1,000,000 Euros will exchange back into $1,000,000US dollars.

The Dollar "gains" or appreciates 8.4% as the excerpt above suggests.  This means that $1.00US will exchange for 1.084 Euros and 1.00 Euro will exchange for $.923 US cents ($1.00/1.084 Euros--a simple reciprocal).

So, our 1,000,000 in profits in Euros will exchange into $923,000US dollars (1M Euros X $.923)---a loss through the exchange rate change of $77,000 US dollars.

However, there is a flip side for a European firm making profits in the US.

If they take profits of $1,000,000 US dollars and exchange it back into Euros they will receive 1,084,000 Euros---a gain of 84,000 Euros as a result of the currency change.

Exchange rate swings can be a blessing or a curse for a corporation expatriating profits. It just depends on which side of the fence you are standing on as to how you will be affected.
View My Stats