Question

DFI Location Decision Decko Co. is a U.S. firm with a Chinese subsidiary that produces smartphones 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 smartphones 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 Decko, the U.S. parent.

A) Assume that the Japanese yen strengthens against the U.S. 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 in China, would the 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 U.S. dollars, Chinese yuan, or Japanese yen?

Answer 1

Ans:-

A: Here one currency is getting strengthier than another currency. In this scenerio Japanese Yen becomes more strength than U.S dollar ,which implies that U.S will get less japanese Yen and gives more U.S dollar to Japan. In this way Chinese yuan also remains stable with U.S dollar. Which clearly signifies that as like U.S dollar Chinese Yuan is weaker as compare to Japanese Yen . So in transaction matter China will get less Japanese Yen and gives more chinese Yuan to Japan. Here Chinese subsidiary face loss thereby reduces its profit significantly.Sell takes place in Japan.

B: The subsidiary's profit would be more exposed to exchange rate risk, if Deckco Ltd had established its subsidiary in Tokyo ,Japan. Here Japanese Yen and U.S dollar will be two currencies to be affected by exchange rate risk. Japanese Yen has strengthened against U.S dollar. Japanese Yen will be appreciated .

C: In general Companies establishes its manufacturing units in low exchange rate risk volatility region, which let it comfortable in producing units and sell these to other countries to generate more revenue. And another thing is that stable currency also matter more in this situation. It is location base problem for every companies which have global presence.So assuming no country risk barriers, Decko ltd should establish its subsidiary unit in stable currency region like china.

D:Chinese subsidiary should borrow money from chinese Yuan. Because transaction done in local or domestic currency elliminates the exchange rate risk and make stable transaction in operation.