How Globalization affects U.S. Companies

The notion of a global marketplace is no longer a trend of the future – it's here now. No longer are corporate behemoths such as Coca-Cola, Ford or Sony the only global enterprises. Today, companies that operate with just a few employees and an Internet presence can, and do, compete effectively on the global stage. As such, even individuals who choose not to invest in security instruments denominated in currencies other than their own reference currency must still be aware of how the fluctuation of currency values will affect the performance of their investments. To illustrate this point, let's consider the possibilities of how American investors who purchase stock in domestic companies are affected by foreign exchange (or FX) risks if the companies that they invest in either import, export, have overseas operations, or have foreign competitors.

U.S. companies that import raw materials or goods from overseas are exposed to the risk that the U.S. dollar will decline. If it does, the cost of the imported goods will rise when valued in terms of the dollar.

U.S. companies that export raw materials or goods overseas are exposed to the risk that the dollar may increase in value. If the dollar gets stronger, the revenue that the company generates in other currencies will, in turn, buy fewer dollars.

U.S. companies that have overseas operations are exposed to the risk that either the dollar will strengthen or weaken, depending upon whether they're making overseas investments or bringing profits back home. If the company is investing overseas, the risk is that of a declining dollar. If repatriating its profits, the company would prefer not to see a strengthening dollar. Take a look at the following situation:

An American company enters into a contract to build a new manufacturing plant in France. It will take a full three years to complete the plant, bring it online, and have it become profitable. During those three years, the U.S. company will be converting dollars into francs, and will be exposed to the risk that the dollar will decline, thereby buying fewer francs. After the plant becomes profitable, the company will be converting francs into dollars and the risk will be that the dollar will get stronger (less dollars bought by the francs).

Even United States companies that don't import, export, or have overseas operations – but only have foreign competitors – are often exposed to FX risk. Let's examine the scenario of an American company that is not engaged nor has any interest in importing or exporting goods; all of their products are sold in the U.S. A foreign competitor, however, does have an interest in doing business internationally. For instance, if the dollar were to rise sharply against the foreign company's home currency, it would be able to charge less dollars for its goods sold in America while still maintaining its profit margin. This is because the company's expenses are denominated in its reference currency – which the strengthened dollar would now buy more of. As such, the viability of the U.S. company could be threatened by the FX risk.

The changing value of the United States dollar affects virtually every American company to one degree or another. Therefore, even U.S. investors who restrict themselves to buying only domestic investments need to be aware of how changing FX rates affect their portfolios. In order to do this, investors should understand some of the reasons that foreign exchange rates change.

 

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