ABSTRACT This paper is written with a purpose to give a strategic advice to 3M’s current CFO D.W. Meline how to manage 3M’s future exposure of the foreign exchange rate risk. In doing so, the overall profile of the company is discussed; the current foreign exchange risk management instruments are described; and conclusions are drawn, followed by recommendations.
ABSTRACT This paper is written ...view middle of the document...
In this paper, the focus lies on the foreign exchange rate risk, which is of high importance, since the company generates more than 60% of its profits from abroad. Therefore, we investigated two possible scenarios: U.S. dollar depreciation and appreciation, with incentive to give a strategic advice to Mr. Meline- 3M’s current CFO- which hedging instruments need to be used to acquire the best outcome for the company, while weighting costs and benefits.
The biggest problem in 3M’s risk management strategy is an inaccurate forecasting. This causes the company’s derivatives to incur losses. Especially, as the company is risk-averse, meaning it prefers to hedge most of the currency exposure, even though sometimes those hedging activities are unnecessary. Therefore, post contract costs do not overcome the benefit.
There are few possible solutions to 3M’s hedging problems. First of all, best would be to change the way of forecasting of future exchange rates and do it more frequently. In case of dollar appreciation, we suggest not to hedge at all (assuming forecasts were correct) and future contracts (assuming forecasts were incorrect), and in case of depreciation (assuming forecasts were correct), the best solution would be forward contracting and enter in future contracts (assuming forecasts were incorrect).
We believe, if Mr. Meline follows those suggestions, company could avoid risks and financial stability would be improved furthermore.
In this paper, we are focusing on the exchange rate risks 3M encounters in their daily economic activities. More specifically, we will look at how the company is affected by its domestic currency fluctuations, meaning appreciation and depreciation of U.S. dollar, and how it copes with it. The main findings were that 3M is more negatively affected by U.S. dollar depreciation, as it operates mainly overseas. The exact findings and suggestions how to manage such fluctuations are described in detail in the following sections.
To begin with, the company was founded in 1902; it is fundamentally a science-based multinational company with sales from six major business segments. The most important segment is Industrial and Transportation Business with 34.6% of consolidated sales, and was responsible for more than $10.3billion in sales and generated over $2.2billion in operating income in the year 2012. Other important segments are: Health Care Business (17.3%), Consumer and Office Business (14.4%) and Safety, security and Protection Services Business (12.75%). While looking at some of 3M’s key financial statistics, we benchmarked 3M to one of their major competitors- Johnson & Johnson (J&J). In Figure 1 and 2 we see their revenues and net profit margins respectively.
Figure1: 3M and J&J Revenues over 2009-2013
Source: Annual Reports 3M and Johnson & Johnson 2013
When looking at the revenue of both companies, we can conclude that J&J reports higher revenues of $71.31...