Blueberry Ltd is a UK fashion company with a Chinese subsidiary that produces cl

Question

Blueberry Ltd is a UK fashion company with a Chinese subsidiary that produces clothes in China and sells them in Japan. This subsidiary pays its wages and its rent in Chinese yuan, which is presently tied to a basket of major currencies. The clothes sold to Japan are denominated in Japanese yen. Assume that Blueberry expects that the Chinese yuan will continue to keep its value against the dollar. The subsidiary’s main goal is to generate profits for itself and it reinvests the profits. It does not plan to remit any funds to the UK parent.

Required:

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? (7 marks)

b) If Blueberry Ltd 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? Why? (7 marks)

c) Identify the reasons that Blueberry ltd established the subsidiary in China instead of Japan. Assume no major country risk barriers. (8 marks)

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? Explain.

Explanation / Answer

Let's say $1=10 yuan and $1= 2 yen then 1 yuan = 0.2yen

a) Now it strengthens and becomes $1=1yen then 1 yuan = 0.1 yen. So where earlier Chinese subsidiary was earning 0.2 yen per yuan now it just earns 0.1 yen. As a result, its profits decline.

b) If Blueberry Ltd had established its subsidiary in Tokyo, Japan instead of China, its subsidiary’s profits would be less exposed to exchange rate risk as now the earnings gets affected due to only 2 exchange rates. Earlier it was getting affected due to 3 exchange rates. In cas something goes wrong in China, Japan or US, company may have to bear losses.

c)

d) If Chinese subsidiary has to take domestic loas, it should borrow in Chinese Yuan as it would minimize the subsidiary's exchange rate risks. But if the subsidiary has to borrow from international market then it would be better to borrow US dollars. US dollars is a stabe currency. There might be risks associated with other exchange rates but least is with dollars.

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