You are the CFO of a U.S. firm whose wholly owned subsidiary in Mexico manufactures component parts for your U.S. assembly operations. The subsidiary has been financed by bank borrowings in the United States. One of your analysts told you that the Mexican peso is expected to depreciate by 30 percent against the dollar on the foreign exchange markets over the next year. What actions, if any, should you take?
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When the analysts predicted that peso would depreciate by 30 percent, it would mean that all the assets purchased in peso depreciate by 30 percent in their value correspondingly.
If the peso depreciates by 30 percent as expected, relatively, the dollar value of the Mexican subsidiary would decrease as well. With the depreciation of peso, the demand for peso would increase and more consumers would start to buy goods in peso because the same amount of money paid to buy a good carries a lesser value. In contrast, the demand for goods in U.S dollar would decrease. This would result in the decreasing value of the company’s Mexican subsidiary in U.S dollars.
With the expected depreciation in mind, the company would want to protect the company by collecting the foreign receivables before the depreciation takes place, so that it would not lose its value. Furthermore, by avoiding major peso-denominated costs until after devaluation, would likely cut down costs for the company. In contrast, U.S dollar-denominated purchases should be made before the devaluation and change peso-denominated major accounts into dollars if it is possible. By doing this, it prevents the drop in values of peso accounts.