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August 22, 2012

Essay Paper on International Revenues and Costs

This report has been written to show that how the multinational company is affected with the volatility. How the cost and revenue is affected because of change in exchange rates of the currencies. What are the methods to price the products? Concept of hedging is also discussed and the how the companies involved in international business use its means to avoid volatility.
Practical example of the multinational company has been set up. When company have the different activities in other countries, how does cost and revenue affected. Two activities have been mentioned in this report. How do the activities affected by the change in currency rates?

 Johnson & Johnson
Johnson & Johnson is a global American company which is a manufacturer of pharmaceutical, medical devices and consumer packaged. It was founded in 1886. Headquarter is in New Brunswick, New Jersey, USA and company is
Operating in 57 countries, selling products in more than 175 countries. Company is involved in different activities in all over the world. Millions of people from different countries enjoy the benefits of the products from Johnson & Johnson.
There are several products which are manufactured by the Johnson &  Johnson like consumer goods, medical devices and diagnostics and prescription products.
There are several activities, in which company is involved like,
  • own projects
  • sponsoring/philanthropy
  • research
  • volunteering & cooperation with partners
·         Affinity Groups
·         Mentoring Programs
We could take two of them to see what could be the effect of exchange rate on the company revenue and cost.
1)      Own New Projects:
As a family of companies Johnson and Johnson tries to own new projects for the company. Company focuses on decentralization. It has family of companies in different regions of the world like Africa,
  and North  America.
2)      Environment
Johnson & Johnson engages in a variety of programmes and partnerships with different companies and organizations as part of its commitment to the environment and sustainable growth. Johnson & Johnson have the  partnerships with many  organizations, including the American College of Occupational and Environmental Medicine, The Business for Social Responsibility and The World Business Council for Sustainable Development.
Among other programmes, the company has established the "Next Generation Goals", a proactive pollution prevention programme aimed at improving environmental performance and the integration of environmental management into business decisions. These goals have been achieved and new targets have been established.
PRICING               QUALITY                          LOW                                   HIGH

P      LOW
Pricing Strategies Metrics
Company uses the foreign currency to pay the employees and to price the products. Normally firm that owns a fixed capacity of a resource that is consumed in the production or delivery of multiple products. The firm tries to increase its expected revenue by a dynamic pricing strategy for each product (Carbaugh, 2010). There is no single recipe to determine pricing, however multinational companies uses the geographical pricing for their products. In geographical pricing, there are variations in price in different parts of the world.
Exchange Rate Risk
See this table showing how exchange rates are Volatile
This table displays the change (trend) in currency exchange rates for the top most traded currencies.
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How to read this table: Each line shows the percentage change in the value of the currency exchange rate relative to the value of the day before, 7 days before, 30 days before, and 365 days before, respectively.
Currency Rate shows the exchange rate for selling the currency pair. For example EUR/USD=0.972 means 1 EUR = 0.972 USD.
Arrows indicate the direction of the change.
When the multinational company works in the different countries, they always have the exchange rate risk because of the volatility. Mostly payment is made in foreign currency than there is no guaranty that the currency rate would remain same.
There are both possibilities that the foreign currency will appreciate or depreciate as compare to a dollar.
Multinational companies with commercial ties to countries could experience major changes in their economies are even more vulnerable to currency rate risk. An example of a risky currency is the Japanese Yen. A rocky economic recovery in Japan and Japanese restrictions on capital outflow makes the dollar-yen rate very volatile (Levi, 2009).
 If an export or import oriented company runs the business in a market which is very much volatile, it is expected a higher degree of currency rate risk. Sudden changes in the exchange rate could be disastrous for a company that does not plan to avoid the volatility.
The exchange rate expresses the national currency's quotation in respect to foreign ones. If the exchange rate of the Japan improves then it will reduce the profit of   the company as company will get will less revenue in terms of dollar, production cost of the company would increase too.
Means of Hedging from exchange rate risk
Forward and futures markets are used to accomplish the objectives of hedging, speculation, and trading. Forward contracts are signed between large entities, while futures contracts involve any size entity (for example, individuals, small firms, or large firms). Forward market trading occurs over the counter or via the telephone, whereas futures trading take place on a physical exchange, such as the International Monetary Market in Chicago.
Dates and delivery time is quoted in the contract and the exchange rate is fixed so there is no affect of the volatility. Companies use four options to avoid the exchange risk. They are given below
1)      Do not hedge
2)      Hedging using forward or future contracts
3)      Hedge using money market contracts
4)      Hedge using option contracts
If the firms decide to hedge then the choice is among forward and future contracts, money market contracts, or option contracts. Each of the hedges will accomplish the goal of removing the exchange rate risk. Forward/Future contracts and money market contracts lock you in so that you cannot take an advantage for good changes in the spot market.
For example, if a company hedged accounts payable using a forward contract and the currency which is applicable depreciates in value, the company could not take an advantage of it. They are locked into the forward contract. The benefit of the option contract is that it does not require that you exercise the option. Depending on changes in the spot rate that the company can either exercise the option or let it expire, and then take advantage of favorable movements in the spot market.
Hedging Against Currency Risk to Avoid the Volatility Trap:
There are some measures which could be taken to avoid the volatility;
One way is to avoid the risk by minimizing their commercial involvement with countries that have volatile currencies like the Japanese Yen. This is however not a practical solution. Another way is to hedge in the spot currency market by taking a position that effectively neutralizes the volatility in the pair. For example: an American importer is expecting a shipment of 380,000 pounds sterling worth of British goods in four months. To pay his supplier, he will need to convert dollars to pounds (Hallwood and Ronald, 2000).

Because he will not be making payment until the goods are delivered, there is a risk that the dollar may decline and make purchase more expensive. There is also a chance that it would appreciate and make the transaction cheaper, but the importer prefers to enter a hedge to avoid the risk of having to pay more in the future.
To hedge his risk, he buys 380,000 pounds in the currency market. If the pound appreciates (and consequently the dollar depreciates), he will profit in his trading account-and completely offset any losses he would have incurred by converting at the end of the four months.

Additional source of revenue
We have been talking about the cost increase because of changes in exchange rates but of course, movements of exchange rates can also provide opportunities to make revenue by taking position in the currency market. The market volatility that makes hedging necessary when doing business can be used to get back lost revenue when currency prices make your product less expensive in the other countries.
Affects of exchange rate on the activities of Johnson & Johnson 

Activity One
Own New Projects:
If the Johnson and Johnson family of companies have new projects in the other countries, then every change in exchange rate would affect the cost or revenue of the company.
Depreciation in the currency value of the country would cause increase in the cost of the products because company will have to invest more in that country to buy new projects. If Johnson & Johnson want to buy new projects in the United Kingdom and the value of pound is improving as compare to the dollar, company cost for the new project would increase as well.
Let’s assume the exchange rate for the pound to dollar was I.45 last week and it is now 1.547 means has increased the cost of the company and decrease in the revenue. When cost increases then revenue decreases. Higher exchange rate would increase the number of dollars.
Activity Two
Johnson & Johnson is committed for the sustainable environment growth. Company have the partnership with different organization in different countries. The amount company contribute with the partner organisations would increase if the exchange rate of the foreign currency appreciates. It could also depreciate and can generate revenue as cost decreases. Payments are made in foreign currency in above mentioned examples.
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