Sharma Co. is a U.K. firm with a Chinese subsidiary that produces cell phones in

Question

Sharma Co. is a U.K. 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 against the pound. The cell phones sold to Japan are denominated in Japanese yen. Assume that Sharma Co. expects that the Chinese yuan will continue to stay stable against the pound. 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 Sharma, the U.K. parent.

a.       Assume that the Japanese yen strengthens against the U.K. pound over time. How would this be expected to affect the profits earned by the Chinese subsidiary?

b.      If Sharma 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 Sharma 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.K. pounds, Chinese yuan, or Japanese yen?

Explanation / Answer

a.) It wont make any difference if japanese yen remains stable against chinese yuan. Since it is chinese subsidiary which is billing the goods & is not rewuired to remitt funds to UK.

b) It would result to less exchang erate risk since subsidiary is not required to remitt funds to UK & there wont be any kind of exchange risk.

c) It is due to cheap production cost in china as compare to Japan after taking into consideration the possible exchange differences.

d) It is best to borrow in Japanese yen as that money borrowed can be repaid from the revenue generated in japanese yen so there wont be any excahange risk.

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