Consider a big U.S. multinational with operations in numerous countries around the world. The company’s biggest export markets are Europe and Japan, which together offer 40% of the company’s annual revenues.
The company’s management had factored in an average slump of 3% for the dollar against the Euro and Japanese Yen for the running and the next two years. The management expected that the Dollar will be bearish due to the recurring U.S. budget deadlock, and growing fiscal and current account deficits, which they expected would affect the exchange rate.
However, the rapidly improving U.S. economy has triggered speculation that the Fed will tighten monetary policy very soon. The Dollar is rallying, and in the last few months, it has gained about 5% against the Euro and the Yen. The outlook suggests further gains, as the monetary policy in Japan is stimulative and the European economy is coming out of recession.
The U.S. company is now facing not just transaction exposure (as its large export sales) and translation exposure (as it has subsidiaries worldwide), but also economic exposure. The Dollar was expected to decline about 3% annually against the Euro and the Yen, but it has already gained 5% versus these currencies, which is a variance of 8 percentage points at hand. This will have a negative effect on sales and cash flows. The investors have already taken into account the currency fluctuations and the stock of the company fell 7%.
