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Caterpillar Tractor and the foreign exchange market

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veronica lai

on 26 September 2014

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Transcript of Caterpillar Tractor and the foreign exchange market

1980s
US$ appreciated
against ¥
2008
¥ depreciated
against US$
Pricing advantage
of KOMATSU
Caterpillar's revenue
Depreciation
in other currencies
Pricing advantage
of foreign competitors
LOSS
GAIN
Bridget, Rosemary & Veronica
Caterpillar Tractor
Through
diversified strategy
Transaction Exposure
"The extent to which income from individual transactions is affected by fluctuations in foreign exchange values"
A) How did Caterpillar use strategy as a "real hedge" to reduce its exposure to foreign exchange risk?

B) What is the downside of its approach?
Translation Exposure
"The extent to which consolidated financial results of a corporation are affected by movements in exchange rates."
Caterpillar's revenue
LOSS
"Real" Hedging...
When a company takes position to alter exposure to risk.

hedging based on "real and viable options"

Globalisation
Caterpillar's Global Footprint
“From Calgary to Cairo and from Sydney to Salt Lake City, Caterpillar operates hundreds of offices and facilities across the world. Caterpillar's global presence, product breadth and financial strength enable us to win in today's competitive marketplaces” (Caterpillar.com).
Globalisation
In a nutshell
Question One
In the 1980s a stronger dollar hurt Caterpillar’s competitive position,
but in 2008 a stronger dollar did not seem to have the same effect.
What had changed?
Decentralization:
Question Two
Appreciation in
US$
reduce costs,
achieve massive profit margins
Global dealer network:
(elaborated in question 2 'hedging')
Negative situation in the 1980s...
prompted CAT to revise its strategy

In two decades...
global dealer network; decentralisation; new product line

By 2008...
CAT was in better competitive position to reduce the negative impacts of a stronger $

Therefore...
While appreciation in the US $ would still adversely impact Caterpillar's revenues,
a stronger $ in 2008 did not seem to have the same effect as in the 1980s
CHANGES
more internally focused
American leading exporter
decision rights (pricing) were based on forces in US market, where headquarters were located

limited strategy to mitigate any form of foreign exchange risk
Japanese company
undercut Caterpillar's pices by up to 30%
gained market share
GREAT LOSS
(Neilson, Martin & Powers 2008)
In 1982, CAT posted the first annual loss in almost-60-year history.
In 1983 and 1984, it lost $1 million each day.
By the end of 1984, Caterpillar had lost a billion dollars
(Obstfeld 2009)
(Levenick 2014)
Result:
reorganised into global business units
decisions were made much further down the organization
New product line (P2000)
(Rao, Scheller-Wolf & Tayur 2000)
introduced in 1999
And the Foreign Exchange Market
Traditional product line
large
low-volume
high-margin
customised
costing $500,000
small
high-volume
standardized
costing $20,000
New product line
Result
In 2008,
The strong $ started to negatively impact Caterpillar’s revenues again.
However, situation has changed.

Explain the difference between transaction exposure and translation exposure using the material in the Caterpillar case to illustrate your answer.

Question 3
(Hill, 2011)
(Hill, 2011)
(Kelleher 2008)
LOSS
GAIN
Export prices were rising,
Revenues generated by foreign operations declined when converted back to US dollars.
Since foreign operation costs were priced in their local currencies,
a stronger $ would also lower costs in foreign operations,
thus reduced the negative impacts on profit margins.
moderates negative impact
1980s - High Transaction Exposure
U.S. dollar strengthens
Foreign payables to Caterpillar become more expensive
Loss of foreign sales
= reduced revenues

Limited means of managing Transaction Exposure
= Massive reductions in future cash flows
Mid-2000s, Reduced Transaction Risk
U.S. dollar weakens + Boom in Infrastructure demand + reduced Caterpillar prices to foreign consumers
Increased receivables and revenues for Caterpillar
Reduced costs for Caterpillar (cheaper production overseas)
Improved productivity + expansion in foreign manufacturing facilities
Forward Exchange
= High profit margins
Derivatives Hedging
"When two parties agree to exchange currency and execute the deal at some specific date in the future" (Hill 2011, pp. 316)
2008, Reduced Transaction Exposure
U.S. dollar strengthens
Backhoe
Excavator
Forward Contracts & Options
Revenues decline
Costs decline (foreign production assets)
Limited negative impacts on Profit Margins
B) Downside of its approach
Globalisation
Forward Exchange
Likelihood of strategy not being as affective as in 2008.

More competition within the global market that have adopted globalisation.
Based on future expectations of the foreign exchange market.

Wrong move and a firm may not be able to rectify decision.
Currency's value is determined by market forces, government intervention as well as demand and supply of currency.
THANK-YOU
- Balance of foreign assets versus liabities
What can impact Translation Exposure ?
- Widespread diversification of foreign assets and liabilites
Translation Exposure at Caterpillar
- Consolidated financial statements translated and measured in U.S. dollars
- Increased exposure since 1980s
- BUT massive cost benefits in 2008
- Use of current rate methods - frequent evaluation of the firm’s translation exposure position
Reference List


1. Caterpillar, 2013. Caterpillar - Key Facilities. [Online]
Available at: http://www.caterpillar.com/en/company/corp-overview/global-footprint/eame/uk/key-facilities.html
[Accessed 20 September 2014].
2. Caterpillar, 2013 Corporate Overview: Global Footprint, viewed 8 September 2014, <http://www.caterpillar.com/en/company/corp-overview/global-footprint.html >

3. Goldberg , L. S. & Crockett, K., 1998. The Dollar and U.S. Manufacturing. Current Issues in Economics and Finance, 4(12), pp. 1-6.
4. Hagelin , N. & Pramborg, B., 2004. Hedging Foreign Exchange Exposure: Risk Reduction from Transaction and Translation Exposure. Journal of International Financial Management and Accounting, 15(1), pp. 1-20.
5. Hagelin, N., 2003. Why firms hedge with currency derivatives: an examination of transaction and translation exposure. Applied Financial Economics, 13(1), pp. 55-69.
6. Hill, C W. L 2011, Global Business Today, 7th edn , McGraw-Hill Irwin, New York

7. International Council of Sustainable Development, 2010. Caterpillar vs. Komatsu: Four Decades of Global Competition. [Online]
Available at: http://theinternationalcouncil.blogspot.com.au/2005/08/caterpillar-vs-komatsu-four-decades-of.html
[Accessed 20 September 2014].
8. Kelleher, JB 2008, ‘U.S. Exporters can win from the strong dollar’, International Herald Tribune, pp. 15.

9. Levenick, S 2014, Caterpillar Testimony, testimony draft, Caterpillar Inc., U.S. House of Representatives Transportation and Infrastructure Committee, viewed 28 August 2014, <http://transportation.house.gov/uploadedfiles/2014-01-14-levenick.pdf>

10. Neilson, GL, Martin, KL & Powers, E 2008, The secrets to successful strategy execution, viewed 28 August 2004, <http://hbr.org/2008/06/the-secrets-to-successful-strategy-execution/ar/3 >

11. Obstfeld, M 2009, ‘National Bureau of Economic Research’, Time of troubles: the Yen and Japan's economy, 1985-2008, no. w14816, viewed 28 August 2014, <http://eml.berkeley.edu/~obstfeld/paper_march09.pdf >

12. Palermo, E., 2014. How to Succeed in Business the Caterpillar Way. [Online]
Available at: http://www.businessnewsdaily.com/5795-how-to-succeed-in-business-the-caterpillar-way.html
[Accessed 12 September 2014].
13. Rao, U, Scheller-Wolf, A. & Tayur, S 2000, ‘Development of a rapid-response supply chain at Caterpillar’, Operations Research, pp. 189-204.

14. Schroeder, R., 2014. McCain tone on Caterpillar’s corporate taxes softer than his view on Apple’s. [Online]
Available at: http://blogs.marketwatch.com/capitolreport/2014/04/01/mccain-tone-on-caterpillars-corporate-taxes-softer-than-his-view-on-apples/
[Accessed 20 September 2014].
15. Wilkinson, J., 2013. Translation Exposure - The Strategic CFO. [Online]
Available at: http://strategiccfo.com/wikicfo/translation-exposure/
[Accessed 20 September 2014].

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