INTERNATIONAL PRODUCTION LOCATION AND PRO FORMA FINANCIAL HEDGING OF EXCHANGE RATE RISK

There are many considerations in a firm's choice of where to locate a production facility. One of the least understood is the implication of foreign exchange risk. The issue is complex because, in addition to the concept of operational hedging, managers must also consider economic exposure and, in cases with foreign competitors, competitive exposure. As shown in this article, a firm's competitive exposure to exchange rate changes depends upon the location of its competitors' plants as well as its own.
The currency exposures of various international production strategies are demonstrated using hypothetical scenarios. The scenarios can also be used to perform a pro forma financial hedging analysis of currency exposure in simple three-outcome cases. By implicitly accounting for the market's pricing of exchange rate risk, the financial hedging analysis provides a straightforward way for managers to evaluate various international production possibilities.