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Exchange Rates: Developing Strategies to Protect Profits in a Global Economy

In today's global economy, exchange rates are a factor that needs to be considered by everyone: the world's economy has become so interconnected that exchange rate fluctuations can now create a substantial impact on not only multinational corporations, but also on small businesses and even entirely domestic enterprises. As a result, a savvy businessperson will want to pay just as much attention to his company's balance sheet as he/she does to international exchange rates; after all, the two are far more closely related than it may initially seem.

Honda: Example of Exchange Rates Affecting Profits

A prime example of how exchange rates can substantially affect a business' profits can be seen by examining the Honda Motor Corporation. Honda's 2004 first quarter net income fell an astounding 36.5% from its previous quarter – a fact resulting primarily from the fact that the Japanese yen rose substantially in value against the US dollar. Because of the yen's relative rise in value against the US dollar, it became substantially more expensive for US companies to purchase Honda automobiles. As a result, Honda was left decreased profits, and US retailers were left with a shorter automobile inventory.

The chart below visualizes the decline of the dollar against the yen.

The chart above tracks the US dollar's value against the yen since September of 2003 to April of 2004. Note the steady decline. This naturally created trouble for Japanese companies that relied on a weak yen in order to sell mass amounts to US-based companies.

By participating in the foreign exchange market, Honda executives could have countered their losses resulting in exchange rate movement by simply selling the USD/JPY exchange rate pair. Selling the USD/JPY pair is essentially the same as selling an instrument in a traded market (stocks, for example). By selling USD/JPY, Honda would be selling, or borrowing, US dollars, and buying Japanese yen with the proceeds. In this way, they would have profited from the FX trade --- something that would have been quite useful in offsetting the substantial loss of profits they incurred due to decreased sales.

What Businesses Can Do

Honda is by no means an isolated example; the number of companies participating in an international environment continues to grow at an exponential rate. Accordingly, more and more companies will need to be watchful of exchange rate movements in order to understand how it will affect their bottom line. For companies in danger of losing money, or for companies looking to protect profits, the foreign exchange market offers the perfect solution.