It is becoming increasingly difficult to ignore the fact that fluctuations of exchange rate produce an adverse impact on the national economy and business performance of companies, especially those that trade internationally at a large scale. A considerable difference between values of two currencies poses a strong obstacle for many companies. Exchange rate volatility is never recognized as a prominence of a certain currency because absence of balance and diversity at the global market lead to a respective crisis. This problem is usually present in the global context, which is why a business entity should be always aware of potential threats. Fluctuations of exchange rates contain multiple implications so that chief executive officers attempt to adopt strategies aimed at making an adequate response to a change in value of a national currency towards a foreign one. Theoretical foundation is surely essential for a relevant response to exchange rate volatility, but methodology of implementation of a chosen strategy is also important. That is why addressing the issue of exchange rate fluctuations in regards to a present context is the key factor. Thus, the following paper gives an account of discussion and explanation of strategies aimed at leveraging corporate finance for Japanese companies in regards to Japanese Yen/U.S. dollar exchange rate volatility.
Specifically, the following study draws a theoretical framework in order to select and describe the most applicable theories and models. Initially, however, the study presents a brief overview of the context and general insight on the exchange rate between Japanese Yen and U.S. dollar. The paper also discusses selected theories and models in relation to the given context. As a result, the study suggests solutions for addressing the issue and associated methodology for their implementation. Once the thesis and key terms of the study are outlined, it is appropriate to proceed to the next section.
To begin with, a context of the issue should be provided. Japanese Yen is the 3rd worldwide currency after Euro and U.S. dollar (Pottorff n.d.). Besides, Yen is a reserve currency of Japan so that this country still relies on it as the source of cash flows. Yen is one of the most stable currencies owing to low interest rates, which is why Japanese business is especially concerned about its stability in relation to the national economy. It is becoming increasingly apparent that Yen is a vulnerable target for crude oil price volatility as long as Japan does not obtain sufficient resources of oil (Pottorff n.d.). Hence, increase in its prices reflects on costs for transportation, delivery, and other logistic operations. In such cases, Yen becomes extremely receptive with respect to foreign currencies.
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Nevertheless, Yen is also recognized as a so-called carry trade. Since it has a low interest rate, it is cheaper to convert it in other foreign currencies so that a trader can make profit from the difference (Pottorff n.d.). The source of Yen is internal reserve of Japanese Yen Holders as well as foreign customers and investors who need this currency for operating at Japanese markets. Beyond a doubt, Japan exports a lot, especially to Western countries, which is why its relation with U.S. dollar is obvious. In spite of the fact that Japan offers top-scale products and services, they are recognized as low-cost ones because of dollar dominance over yen (Pottorff n.d.). This phenomenon can be justified with multiple factors, but the most prominent one suggests that the United States control a considerable part of the crude oil global market and it leverages Japanese products value with implied expenditures on export even though initial value of a product is higher.
Taking these points into account, it is fair to admit that the current crisis of crude oil market in Russia gives the U.S. an opportunity to obtain the leading position. That is why relation between Yen and U.S. dollar have become more positive for U.S. dollar. This tendency could be observed during the entire previous year when the exchange rate was swinging multiple times. An average change in price was up to 10 yen so that the price for one U.S. dollar was 115 125 Yen. It is hard to argue that PPP of Yen was decreasing. For now, Japanese PPP is still unsatisfactory even though Yen value has embarked on a gradual growth. This tendency is a distinct evidence of Yen being a carry trade, which is why its value becomes more significant. Traders need to purchase U.S. dollar at a more beneficial price so that they exchange Yen into other currencies at a reasonable interest rate.
The situation normalized in February, but a possibility of adverse changes is still present. That is why Japanese CEOs feel concerned about financial future of their organizations and seek for ways for leveraging outcomes of exchange rate fluctuations. The main objective, however, is not to leverage the exchange rate itself, but to find a reasonable reaction to the event (Pottorff n.d.). That may involve fixing prices, changes in supply chain management, and new positioning of key corporate assets. The growth of Yen is observable as long as prices almost return to the level, which was in the beginning of the previous year. Therefore, Japanese business entities have a perfect opportunity to establish their financial stability in regards to recent outcomes of exchange rate volatility. This process is obviously long and complicated, which is why involvement of a distinct theoretical foundation and implementation framework is needed.
Among a wide range of theories relating to an adequate response to exchange market fluctuations, volatility and exchange rate model (VAR) is one of the most appropriate choices for leveraging financial performance of an organization (Zhou 2011). First of all, this model enables a company to address an error in adjustment to changes so that its response to exchange rate fluctuation becomes more valid. The model does not indicate the error, but corrects it by suggesting a more relevant adjustment in pricing and trade. VAR model, however, requires an initial positive reaction to exchange rate fluctuations (Zhou 2011). A company is expected to initially accept decrease in value of a national currency. This aspect is especially applicable to fluctuations caused by respective volatility of crude oil prices. Thus, a company has to add this difference to delivery and distribution expenses (Zhou 2011). Determination of this difference can be invalid, which is why VEC model is used as a supplementary tool for identifying a gap in co-integration of foreign currency value and value of to-be-traded goods or services (Zhou 2011).
In addition, Granger Casualty Test is an effective supplementary method of avoiding leveraging errors (Zhou 2011). It is informative to note that this test is also applicable to cases of fluctuations because of crude oil price volatility. This test requires involvement of three statistical events within a long-term performance of an organization. In order to speak about the test in a more detailed way, its comparative feature should be indicated (Zhou 2011). The test compares potential scenarios of taking each of three exchange rate adjustments. A choice of any scenario is a matter of a companys decision-making, especially under circumstances of a one-way scenario when a company is unable to manage advanced adjustment and a less difficult alternative is an option (Zhou 2011). This is a drastic limitation to Granger Casualty Test, which is why it is recommended as a supplementary tool.
The other effective response strategy is operational hedging. A company needs to settle a preliminary price with manufacturers, logistic services, and other supply chain members in beforehand for a long run. As a consequence, a company trades its goods or services at prices that do not differ from value of the national currency before fluctuations in the exchange rate (Dohring 2008). This strategy is cost-effective, but inappropriate appliance of hedged prices may result in under- as well as over-hedging (Dohring 2008). The former term implies a situation when a company has hedged its expenses below the initial value of currency so that it still loses cash flows in a long run. As for latter term, over-hedging means excessive hedging of expenses so that trade is unprofitable for the final customer and supply chain members. That is why operational hedging is recommended for well-matured companies and their products once their demand is always secured (Dohring 2008).
By the same token, hedging of trading expenditures is possible through offshoring. Delivery of products to an intermediate market will leverage the difference in exchange rates and then the goods are shipped to a destination market at a desired price and value (Dohring 2008). Offshoring, however, is applicable to cases when a company needs to establish or preserve its large presence at a particular market, meanwhile fluctuations in exchange rates pose a considerable obstacle for that (Dohring 2008). Hence, offshoring strategy is reasonable in the event of a profit-generating opportunity at a target market or accessing a specific benchmark advantage. Moreover, offshoring is the safest approach of trading internationally under volatility in exchange rates. Again, this strategy presents a limitation for companies, which can easily adjust to any other market (Dohring 2008). Otherwise, a company is expected to seek new ways of creating and rendering value to its products in order to leverage its finance according to exchange rates.
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In addition, initiatives directed at evaluation and reallocation of capital investments are a sufficient assistance tool for a company in terms of exchange rate fluctuations (Verbeke 2013). This incentive is especially important to companies, which trade at the largest scale, so that numerous opportunities are still available for them even under such external pressure. A company has to create a new value for its products or services in order to leverage its cash flows with a new exchange rate (Verbeke 2013). Beyond a doubt, foreign customers will not purchase the same product for a higher price, especially if a product is not unique. Therefore, a market competitive advantage should be transformed into a distinct selling point that has not been previously available to customers (Verbeke 2013). In such a way, customers will purchase the product at a higher price and correlation between the two currencies becomes acceptable for a firm, while customers are satisfied with a new product feature.
Likewise, a corporate strategy can be attached to international financial management trends so that a company will always perform with a financial relevance to exchange rates. Since the majority of exchange rate volatilities emerge owing to a respective instability at the market of crude oil, it is reasonable to leverage financial performance of a company with account for that (Verbeke 2013). As a matter of fact, possession of a more autonomous supply chain protects a company from expenses associated with increased prices for transportation, delivery, and distribution. That is why fixing related prices in a long run is an effective solution. This strategy is similar to operational hedging, but this approach does not require amending a total price of a product or service (Verbeke 2013). Nevertheless, this strategy does not make an impact on demand as long as customers receive the product at the same price even though some supply chain member would prefer to operate more profitable deliveries.
In regards to presented theories, it is appropriate to outline an integrated approach and methodology for their implementation in the Japanese context of exchange rate fluctuations. First of all, companies are recommended to conduct a regular accounting reporting and observation. These data will be a reliable source for deployed VAC model. Accounting data and VAC model can be implemented throughout general financial analytic systems (Valinurova 2013). It is becoming abundantly clear that a significant involvement of information technologies is necessary in this case. Likewise, supplementary VEC tool can be incorporated via traditional and linear probability models. Facilitation of this solution is possible with deployment of Cloud technologies, especially Cloud Business Intelligence, which will be able to create interactive and hierarchy-free probability calculation (Valinurova 2013). Exchange rates can change numerous times within a single day, which is why average managers have to make decisions instantly without involvement of senior employees. It is not typical of Japanese organizational behavior, but provision of a respective standard will enable companies to react to exchange rate volatilities with a maximal confidence in the relevance of decision-making.
On a separate note, an event of positive Granger Casualty Test suggests that a company can perform in terms of the most apt scenario. Measurement of financial performance in relation to exchange rate volatility can be performed with standard accounting metrics such as EBIT and CAPEX (Valinurova 2013). A calculation of EBIT follows a formula EBIT = Revenue Operating Expenses or EBIT = Interest + Taxes + Net Income. As for CAPEX, it can be calculated as CAPEX = Cash flow from operations/Capital Expenditures. In such a way, positive data from these calculations and forecasts determine relevance of a chosen scenario within terms of Granger Casualty Test. In any case, each potential scenario should be provided with required calculations (Valinurova 2013).
A managerial perspective suggests that initiatives aimed at reallocation of capital investments should be taken in a sequence in order to have an opportunity for changing priorities in case of exchange rate volatility. Additionally, a choice of new capital investment priorities is recommended to follow a national economy framework as long as fluctuations of exchange rates are an event that is applicable to the entire national business (The World Bank 2012). Hence, companies are also recommended to start building internal productivity and liquidity capacity. In such a way, they will be able to add value to their products and services so that a difference in currency values will be leveraged (The World Bank 2012). Japanese business has a particular advantage in that regard because organizational structure of all business entities is mainly institutionalized (The World Bank 2012). Thus, facilitation of new capital investments will be controlled by chief executive teams, which are usually the most experienced workers within the field of a companys performance.
As a matter of fact, new capital investments during a period of exchange rate fluctuations are usually focused on creation of gradually developing incentives. These incentives result in launching value-added projects and ensuring horizontal growth of an organization (The World Bank 2012). Building a favorable environment for such incentives presupposes a considerate risk management since a probability of loss is especially explicit during the period of exchange rate volatility (The World Bank 2012). Besides, methodology of implementing these incentives should be aligned with the overall corporate strategy of a company. However, a company does not have to change entirely as it just needs to add value to its selling points in order to respond to an increase in the difference between Yen and U.S. dollar values. Generally speaking, a company should meet the same objectives, but through different means in order to preserve its financial value. That is why exchange rate fluctuations may even serve a function of a productivity facilitator for some organizations.
In order to speak about hedging, it is worth saying that it should be conducted each month as amendments to exchange rates usually take place prior to the end of the month. Therefore, planning of hedging according to constituent weightings is reasonable in such cases (Somanath 2011). A constituent weighting is calculated with a formula, which is the following: Wi= (Rate difference)i/Voli + Index value (Somanath 2011). The hedge does not have to be higher or lower than a rate of exchange at the moment of close, which is why constituent weighting is a ratio that determines the most optimal hedge extent (Somanath 2011). This way of implementing operational hedge is the most accurate and it does not require additional data. A company can react to fluctuations in exchange rate with a maximal flexibility, which is essential for any business entity.
Japan, however, is not a flexible country in that regard so that companies are unlikely to change their prices every single month. That is why an average use of hedge funds as a primary corporate asset is a much more applicable framework for the Japanese business (Somanath 2011). Still, a concept of monthly hedging should not be neglected, which is why a development of an integrated model is needed. A company may integrate calculation of constituent weighting in its accounting IT-infrastructure so that all accounting and financial data are presented with account for a present constituent weighting (Somanath 2011). A response to an adverse situation caused by a Western currency should comply with the Western trend in business. That is why a company needs to integrate its data into IT-infrastructure in order to optimize its hedging (Somanath 2011). In general, a principle of doing more with less effort is especially applicable to cases of exchange rate volatilities in Japan. This methodology is cost-effective and risk-free, as well as renders a maximal accuracy owing to the constituent weighting-based accounting model.
All in all, this paper has presented discussion and explanation of strategies focused on leveraging business performance in terms of exchange rate fluctuations between Japanese Yen and U.S. dollar. Initially, the study has provided a brief context of the issue and depicted insights into reasons for exchange rate volatility in Japan. Subsequently, the paper has introduced a theoretical framework relating to the issue. As a consequence, the study has also suggested an explained methodology for implementing discussed strategies in the context of Japanese fluctuations of exchange rates. The study has revealed primary insights into how to develop a response strategy and determined several tendencies that should be considered. That is why the primary purpose of the study has been fulfilled, while findings of and remarks to the study are the following.
It is appropriate to make a general comment on the fact that Japanese business entities should primarily leverage their expenditures in relation to transportation, delivery, and distribution since a change in crude oil prices adversely affects exchange rates of Yen to U.S. dollar. Still, Japanese products and services are popular worldwide, which is why creation of value-added product lines is a distinct way of escaping exchange rate difference in currencies. Moreover, such events even stimulate companies to develop new products and obtain new market niches. Hedging and initial fixing of prices are evidently the most effective methods, but they should be supported with VAR and VEC models in order to ensure relevance of taken initiatives. For some specific occasions, a choice of a certain scenario of Granger Casualty is also possible. The main requirement to Japanese companies in case of exchange rate fluctuations is to follow a common business sense and ensure alignment of all incentives with their overall corporate strategies.