Case Study: Xian-Janssen Pharmaceutical (China) and the Euro

1) How significant an impact do foreign exchange gains and losses have on corporate performance at Xian-Janssen Pharmaceutical? What is your opinion of how they structure and manage their currency exposures?

Foreign exchange exposure is a measure of the potential for a firm's profitability, net cash flow, and market value to change because of a change in exchange rates. With the dollar closing on 51.3o/f in December (Rmb10.75/€), the go-day forward rate was also moving up. Paul Young knew that he would have to use a budget rate for 2004 (forecast for the average spot exchange rate for the year) of somewhere between Rmbg.8/€ and Rmbio.o/E. But given the rough forward premium he had been forced to pay in 2003, his after-hedging effective rate could rise to Rmbio.5oif in 2004. Paul stared at the numbers-specifically his estimate of earnings for 2004-and wondered how in the world he was going to reach corporate's earnings objectives of Rmb 1.205 billion.

According to my opinion Foreign exchange transaction exposure can be managed by contractual, operating, and financial hedges. The main contractual hedges employ the forward, money, futures, and options markets. (Gregory, pp. 45)Operating and financial hedges employ the use of risk-sharing agreements, leads and lags in payment terms, swaps, and other strategies. The term natural hedge refers to an off-setting operating cash flow, a payable arising from the conduct of business.

A financial hedge refers to either an off-setting debt obligation (such as a loan) or some type of financial derivative such as an interest rate swap. In some situations, funds to fulfill the forward exchange contract are not already available or due to be received later, but must be purchased in the spot market at some future date.

The firm seeking the money market hedge borrows in one currency and exchanges the proceeds for another currency. Funds to fulfill the contract - to repay the loan - may be generated from business operations, in which case the money market hedge is covered. The manager needs to choose an appropriate interest rate for the calculation of money market hedge. Hedging with options allows for participation in any upside potential associated with the position while limiting downside risk. The choice of option strike prices is a very important aspect of utilizing options as option premiums, and payoff patterns will differ accordingly. (Yuanjia, pp. 63)

2) Johnson & Johnson has roughly 200 foreign subsidiaries worldwide. It has always pursued a high decentralized organizational structure, in which the individual units are responsible for much of their own performance from the top to the bottom line of the income statement. How is this reflected in the situation XJP finds itself?

A decentralised system, on the other hand put the power to make many strategic decisions at the local level giving individual divisional companies power to almost run the company as a separate entity. As a correlation, Xian-Janssen Pharmaceutical is likely to run on less rigid policies and wider spans of control among each officer of the ...