Local currency is US dollar and foreign currency is EURO dollar
Exposure to local currency appreciation:
Local sales (in the firm’s home country) are expected to decrease if the home currency appreciates because the firm will face increased foreign competition. Local customers will be able to obtain foreign products cheaply with their strengthened currency. That is, local customers will be able to obtain foreign substitute products cheaply with their strengthened currency. Cash inflow form 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. With regard to the firm’s cash outflow, the cost of imported supplies denominated in local currency will not be directly affected by changes in exchange rate. If the local currency appreciates, however, then the cost of imported supplies denominated in the foreign currencies will be reduced if the local currency appreciates because the strengthened local currency will be exchanged for the foreign currency to make the interest payment. Thus, appreciation in the firm’s local currency cause a reduction in both cash inflow and outflow. The impact on a firm’s net cash flows will depend on which transaction type, outflow or inflow, is more affected by the appreciation. For example, the firm is in the exporting business but obtains its supplies and borrows funds locally, then the value of its inflow transaction will be reduced to a greater extent than will the value of its outflow transactions. In this case, net cash flows will be reduced. Conversely, cash inflows of firm concentrating its sales locally with little foreign competition will not be severely reduced by appreciation of the local currency. If such a firm obtains supplies and borrows fund overseas, its outflow will be reduced. Overall, this firm’s net cash flow will be enhanced by the appreciation of its local currency.
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