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IMPACT OF CHANGES IN THE LOCAL CURRENCY

The exchange rate is the price of one currency in terms of another currency. For
example, 1 US$ = 1,151 Korean Won. A currency has appreciated in value if more of
a foreign currency is needed to buy it. A currency has depreciated in value if more
of it is needed to buy a foreign currency. For example, a change in the exchange
rate from 1 US$ = 1,151 Won to 1 US$ = 1,200 Won means that more Korean Won
are needed to buy 1 US$, and the US dollar has appreciated. And because less
dollars are needed to buy 1 Korean Won, the Won has depreciated.
Depreciation in a nations currency makes foreign goods and products more
expensive. Consider a Korean coat that is priced at 10,000 Won when the exchange
rate is 1 US$ = 1,151 Won. To buy this coat, an American has to pay $8.69
(=10,000/1,151). Now suppose the US dollar depreciates to 1 US$ = 1,000 Won. The
American now has to pay $10 (=10,000/1,000) for the same coat.
This process is symmetrical, so an appreciation in a nations currency makes foreign
goods cheaper. For example, if the exchange rate goes from 1 US$ = 1,151 Won to
1 US$ = 1,250 Won, the Korean coat will cost the American $8 (=10,000/1,250).
The value of a firms cash flows can be affected by exchange rate movements if it
executes transactions in foreign currencies, receives revenues from foreign
customers, or is subject to foreign competition. For example, Intel invoices 65% of
its chip exports in US dollars. If the Euro weakened against the dollar, then
European importers would need more Euros to pay for them and so might decide to
purchase chips from European manufactures instead. So even though Intels exports
are invoiced in US dollars, its cash flows to be received from exports may decline
because of a weakened Euro. The table below provides some more examples of how
a firm can be subject to changes in foreign currencies. In this table, I am taking the
perspective from a Korean firm.
A KOREAN FIRM
Exporting products to a European
country in which it agreed to accept
Euros.
Importing products from a Mexican firm
that are priced in Mexican pesos
Exports products to the UK that are
priced in Korean Won
Sells products to local customers in
Korea, and its main competitor is based
in Belgium

ITS CASH FLOWS ARE ADVERSELY


AFFECTED IF
The Euro depreciates

The Peso appreciates


The Pound depreciates (causing some
customers to switch to the competitors)
The Euro depreciates (causing some
customers to switch to the competitors)

From the above discussion, it should be clear that local sales (in the firms home
country) are expected to decrease if the local (home) currency appreciates because
the firm will face increased foreign competition. That is, local customers will be able
to obtain foreign substitute products cheaply with their strengthened currency. Cash
inflows from exports denominated in the local currency will also likely be reduced as
a result of appreciation in that currency because foreign importers will need more of
their own currency to pay for these products.
On the other hand, if the firms local currency depreciates, then its transactions will
be affected in a manner opposite to how they are influenced by appreciation. Local
sales should increase due to reduced foreign competition because prices
denominated in strong foreign currencies will seem high to the local customers. The
firms exports denominated in the local currency will appear cheap to importers,
thereby increasing foreign demand for these products. Even exports denominated in
the foreign currency can increase cash flows because a given amount in foreign
currency inflows to the firm will convert to a large amount of local currency.