Explain the competitive and conversion effects of exchange rate changes on the firms operating cash flow?

Answer 1

1. Explain the competitive and conversion effects of exchange rate changes on the firm's operating cash flow.

Due to random change in the exchange rate a company's competitive position in the market place changes. For example if the Yen depreciates against US dollars then a Car manufacturer in USA will be adversely effected, as the Japanese imported cards become cheaper due to change in the exchange rate of Japanese Yen.

On the other hand if a Japanese owned car is being produced in USA than that too will be adversely effected , however if its components are being imported from Japan, they may cost lower thus they will gain some advantage over the US manufacturer which makes all the components in US. In this case the US car manufacturer like Ford or GM will lose their competitive position to the Japanese subsidiary in US, thus effecting their cash flows adversely.

The Competitive Effect is a change in the firm's competitive position in the market which may arise due to change in cost or price. The US car manufacturer's cash flow will decline due to the unfavourable change in the competitive position in the US markets.

The Conversion Effect is evident when a parent company's balance sheet reflects the foreign subsidiary cash flows by converting in the domestic currency. For the Parent company the Domestic currency appreciation results in smaller domestic currency receipts and Domestic currency depreciation results in larger domestic currency receipts. If Yen depreciates then the Japanese parent company will value the receipts from a US subsidiary at a higher rate in Yen showing a larger domestic currency receipt.