Financing and Exchange Rate Risk
Solve the following problem:
Compton Co. has a subsidiary in Thailand that produces computer components. The subsidiary sells the components to manufacturers in the United States. The components are invoiced in U.S. dollars. Compton pays employees of the subsidiary in Thai baht and makes a large monthly lease payment in Thai baht. Compton financed the investment in the Thai subsidiary by borrowing dollars from a U.S. bank. Compton has no other international business.
a. Given the conditions, is Compton affected favorably, unfavorably, or not at all by depreciation of the Thai baht? Briefly explain.
b. Assume that interest rates in Thailand declined recently, so the Compton subsidiary considers obtaining a new loan in Thai baht. Compton would use the proceeds to pay off its existing loan from a U.S. bank. Will this form of financing increase, reduce, or have no impact on its economic exposure to exchange rate movements? Briefly explain.