Full Answer Section

Contribution of Foreign Operations to Parent Firm’s Profits

Microsoft has two of its largest foreign operations in China and the European Union. In 2022, China accounted for 19% of Microsoft’s total revenue, and the European Union accounted for 22% of Microsoft’s total revenue.

Microsoft’s foreign operations make a significant contribution to the company’s profits. In 2022, Microsoft’s foreign operations generated $123 billion in revenue, which was 62% of the company’s total revenue. Microsoft’s foreign operations also generated $55 billion in net income, which was 65% of the company’s total net income.

Hedging Against Exchange Rate Risk

Microsoft uses a variety of means to hedge against exchange rate risk. One common hedging strategy is to use forward contracts. A forward contract is an agreement to buy or sell a currency at a predetermined price on a future date. Microsoft can use forward contracts to lock in the exchange rate for its future revenues and costs.

Another common hedging strategy is to use currency options. A currency option gives the holder the right, but not the obligation, to buy or sell a currency at a predetermined price on or before a certain date. Microsoft can use currency options to protect itself against unfavorable movements in exchange rates.

Effect of Changes in the Dollar’s Exchange Value on the Firm’s Profitability

Increases in the dollar’s exchange value can have a negative impact on Microsoft’s profitability. When the dollar rises in value, Microsoft’s foreign-currency denominated revenues are worth less in US dollars. This can lead to a decrease in Microsoft’s revenue and profits.

Decreases in the dollar’s exchange value can have a positive impact on Microsoft’s profitability. When the dollar falls in value, Microsoft’s foreign-currency denominated revenues are worth more in US dollars. This can lead to an increase in Microsoft’s revenue and profits.

Additional Thoughts

In addition to the obstacles mentioned above, there are a number of other challenges that Microsoft faces in managing its currency exposures. One challenge is the volatility of exchange rates. Exchange rates can fluctuate wildly, making it difficult for Microsoft to predict the future value of its foreign-currency denominated revenues and costs.

Another challenge is the complexity of the global financial system. Microsoft has operations in over 190 countries, each with its own currency and financial system. Managing currency exposures across such a complex landscape is a daunting task.

Despite these challenges, Microsoft has been successful in managing its currency exposures. The company has a team of experienced currency risk managers who use a variety of hedging strategies to protect the company from unfavorable movements in exchange rates.

Example of Microsoft’s Hedging Strategies

In 2020, Microsoft used a combination of forward contracts and currency options to hedge against its exposure to the Chinese yuan. The company entered into forward contracts to sell Chinese yuan at a predetermined price in the future. The company also purchased currency options that gave it the right to sell Chinese yuan at a predetermined price on or before a certain date.

These hedging strategies helped Microsoft to protect its profits from the decline in the value of the Chinese yuan in 2020. As a result, the company’s revenue and profits from China were relatively stable despite the volatility in the exchange rate.

Conclusion

Microsoft is a global company that faces a number of challenges in managing its currency exposures. However, the company has a team of experienced currency risk managers who use a variety of hedging strategies to protect the company from unfavorable movements in exchange rates.

The effect of changes in the dollar’s exchange value on Microsoft’s profitability will depend on the extent to which the company’s foreign operations are hedged. If the company’s foreign operations are fully hedged, then changes in the dollar’s exchange value will have a minimal impact on profitability. However, if the company’s foreign operations are not hedged, or only partially hedged, then changes in the dollar’s exchange value can have a significant impact on profitability.

Overall, Microsoft is well-positioned to manage its currency exposures. The company has a strong track record of profitability, and it has a team of experienced currency risk managers who use a variety of hedging strategies to protect the company from unfavorable movements in exchange rates.