Blueberry Ltd is a UK fashion company with a Chinese subsidiary that produces clothes in China and sells them in Japan. This subsidiary pays its wages and its rent in Chinese yuan, which is presently tied to a basket of major currencies. The clothes sold to Japan are denominated in Japanese yen. Assume that Blueberry expects that the Chinese yuan will continue to keep its value against the dollar. The subsidiary’s main goal is to generate profits for itself and it reinvests the profits. It does not plan to remit any funds to the UK parent.
Required:
a) Assume that the Japanese yen strengthens against the US dollar over time. How would this be expected to affect the profits earned by the Chinese subsidiary?
b) If Blueberry Ltd had established its subsidiary in Tokyo, Japan instead of China, would its subsidiary’s profits be more exposed or less exposed to exchange rate risk? Why?
c) Identify the reasons that Blueberry ltd established the subsidiary in China instead of Japan. Assume no major country risk barriers.
d) If the Chinese subsidiary needs to borrow money to finance its expansion and wants to reduce its exchange rate risk, should it borrow US dollars, Chinese yuan, or Japanese yen? Explain.