This paper examines financial risk management strategies related to currency exchange rate fluctuations and interest rate exposure, with reference to Deere and Company and Walmart. The paper discusses how a strong home currency can undermine a firm's international competitiveness and outlines key risk mitigation tools, including hedging through futures, forwards, and options. It also analyzes Walmart's annual report disclosures on interest rate risk management, including fixed-rate loans, variable-rate debt, and interest rate swaps. The paper concludes that hedging remains the most widely accepted and practical approach to managing exposure across currency and interest rate risks in global operations.
Deere and Company is facing challenges as a strong dollar negatively impacts its sales in the Eurozone. The firm is suffering not only due to unfavorable exchange rates, but also because of intense competition from European firms that operate and price in euros.
When companies operate across international borders, they face risks associated with exchange rate movements. In the case of a strong home currency, goods priced in that currency become more expensive for foreign buyers. Pricing in dollars — even when converted to euros at the point of sale — effectively passes the exchange rate risk to the purchaser. The practical consequence is that the price may become uncompetitive, particularly when rival firms base their pricing on the same currency as their customers.
The firm may address this issue by implementing strategies that allow it to price in euros. Several such strategies are available. The most common approach is hedging — a tool specifically designed to manage exchange rate risks. Hedging is used where a firm has exposure to changes in the price of commodities. It involves the purchase or sale of a derivative contract to buy or sell a set amount of a commodity at a predetermined price at a specific point in the future (Howells & Bain, 2007). The derivative will typically be a future or a forward, where the transaction is binding and will take place at the agreed price, or alternatively an option (Howells & Bain, 2007).
Options give the purchaser of the contract the right — but not the obligation — to purchase the commodity at the set price. With an option, the purchaser can compare the prevailing spot rate with the contract rate and use whichever is more advantageous (Howells & Bain, 2007). In the case of Deere, the firm could price its equipment in euros and then use hedging to cover the risks associated with exchange rate fluctuations.
Other potential strategies include pricing in euros and retaining those euros until the firm judges the exchange rate to be favorable for repatriating revenues. If the European market is sufficiently large, an alternative approach would be to establish operations within the Eurozone itself, where manufacturing and input costs are incurred in euros and sales are made in euros. Under this model, exchange rate risk is reduced to the repatriation of profits only.
Of all these options, hedging is likely to be seen as the most viable. It is a widely used and well-established tool for managing financial risk across international markets.
Walmart includes information within its annual report on how risk is managed. The company is exposed to a number of different market risks, including interest rate changes and foreign currency risk. Walmart carries both long-term and short-term debt, which may be affected by changes in interest rates, and it manages these risks in several ways.
Some debt has been structured using fixed-rate loans (Walmart, 2014). Fixed rates carry certain risks — particularly if interest rates fall — and are also more likely to involve setup fees and other higher costs associated with the loan (Howells & Bain, 2007). At the current time, with interest rates remaining low, the risks associated with interest rate changes on fixed-rate loans are relatively low for the borrower. However, they are higher for the lender, and as a result, fixed-rate loans are likely to carry a premium (Howells & Bain, 2007).
For its variable-rate loans, Walmart also uses derivatives to reduce risk, specifically interest rate swaps. These were estimated to have a fair market value of $107 million in 2014. Approximately 18% of the company's debt was held in variable-rate loans, and it was estimated that if interest rates increased by 100 basis points, the additional cost would be $78 million (Walmart, 2014).
"Currency swaps used to offset $2.8 billion loss"
Of all the options available to firms facing exchange rate exposure, hedging is widely regarded as the most viable and practical risk management tool. As demonstrated by both Deere and Company's pricing challenge in the Eurozone and Walmart's disclosed use of interest rate and currency swaps, derivatives play a central role in how multinational firms protect themselves against the financial volatility inherent in global operations.
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