PART II Now suppose that ABC establishes a Chinese subsidiary that produces cell
ID: 2757798 • Letter: P
Question
PART II Now suppose that ABC establishes 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 dollar. The cell phones sold to Japan are denominated in Japanese yen. Assume that ABC expects that the Chinese yuan will remain stable against the dollar. The subsidiary’s main goal is to generate profits for itself, and it reinvests those profits. It does not plan to remit any funds to 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 ABC had established its subsidiary in Tokyo, Japan, instead of in China, would its subsidiary’s profits be more exposed or less exposed to exchange rate risk? c. Why do you think that ABC established the subsidiary in China instead of in 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?
Explanation / Answer
A) If the Japanese Yen strengthens agains the U.S. dollar, the profits for the company will depreciate as Chinese Yuan is stable against the dollar.
B) If ABC had established its subsidiary in Tokyo, Japan, its profits would be less exposed to exchange rate as the company doesn't intent to remit the profits. So, the company won't need to exchange the currency.
C) To answer this question, we need the full case. However, just to give an idea, generally a company prefers a country over the other due to lower labour cost & other expenses, if the country risk barriers are equal. So, please go through the case & answer it in your own words.
D) The company should borrow Chinese yuan as the investment needs to be done in China only and with Chinese yuan, there will be no exchange risk.
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