Case Analysis Example: OSG Corporation

OSG Corporation is a world-renowned Japanese manufacturer of cutting tools that are used by industries across the globe. Despite standing out in its business operations, the president, Teruhide Osawa, felt that the 24 April 2006 rampant appreciation of the Japanese Yen (JPY) against the United States Dollar (USD) was likely to have an impact on the firm's business. Although the appreciation did not depict imminent threats in a short term, it was imperative for the company to proceed with caution. At the same time, OSG had global chances of growth and expansion which were likely to yield more returns. However, the president forecast the need for ameliorating the company's internal operations before venturing into the growth prospects presented.

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OSG Company Problem

On 24 April 2006, the JPY was drastically appreciated against the USD. This situation presented variations in the exchange market across the world. The G7 meeting, held three days earlier, caused the dollar depreciation and demanded an increment in the elasticity of currency in what was viewed as a move that contributed to the appreciation of other Asian currencies comprising of the JPY (Misawa, 2006). As a result of the rampant waiver in the exchange between the USD and the JPY, the OSG president entreated the general manager of the Support Finance Group to conduct a detailed analysis of how the company would react to the global exchange market and evaluate the means of handling the situation (Misawa, 2006). The primary concern of the president was to have an accurate perspective of how the company was hedging foreign currency exposures after the incidence of the JPY appreciation. Bearing in mind that OSG had entered into import and export contracts, the fluctuation in the JPY/ USD exchange was likely to affect business transactions of the company.

OSG Quantitative Analysis

After decades of operation in Japan, OSG diversified and invested in foreign nations including the USA, Brazil, and other countries on the European and Asian continents. The accelerated growth of the automobile industry presented vast opportunities for OSG (Misawa, 2006). In 1997, the company opened headquarters in Europe due to the expansion of business on the continent. The latter was attributed to Japan's automotive industry growth both locally and in Europe. Sales representatives in Europe greatly helped in establishing the company in the continent amid constrained resources and stiff competition. OSG later established subsidiaries in Europe to boost the work being done by the sales representatives. The company was able to enter into contracts with the dominant and upcoming motor vehicle manufacturers in Asia, America, and Europe thereby increasing its sales volumes. In 2006, the company drafted a plan to enable it to increase its tap supply in the USA automotive industry (Misawa, 2006).

In 2005, many economies around the globe grew especially in the Asia despite the increasing prices of crude oil. In Japan, the economy was recovering from a 15-year recession which had adversely impacted the development of many industries in the country. Capital investments made by individuals, the increase in exports, and domestic consumption boosted the recovery from recession (Misawa, 2006). As for OSG, the company reported an augmentation in sales of all their products and regions of operations. In the 2005 fiscal year, the company registered an 18.4% annual increase in net sales that translate into ¥78,132 million. The net sales represented a sum of all the company's divisions. In America, the sales totaled to ¥12, 587 million, which marked a 25.5% increase from the previous fiscal year. The increase was attributed to the introduction of the North American aerospace industry that became a prominent client of OSG. In Asia, with the exclusion of Japan, the net sales increased by ¥13, 045 million which was a 38.9% rise from the previous fiscal year. In Europe, the company registered a sales increase of 18.5%, which represented ¥4, 634 million (Misawa, 2006). The remaining proportion of net sales came from the company's operations in Japan.

OSG Corporation Solutions

The subsequent increase in the OSG's sales brought an increment in the company's foreign exchange exposure. Before being registered in the balance sheet, all debits and credits were converted to JPY (Misawa, 2006). To avoid a foreign exchange policy that would result in detrimental impacts, OSG had to apply several hedging mechanisms. One tactic involved OSG making invoices to foreign buyers in JPY thereby transferring the transaction risk to them. However, the practice presented a new challenge because it has been tough for companies in the importing countries to pay OSG in yens since it is not widely accepted (Misawa, 2006). The latter would make the company less competitive since most importing companies preferred transacting in USD.

Alternatively, OSG could apply other hedging mechanisms that would diminish the risk of foreign exchange exposure. The use of money market hedging system was an applicable method. The method entails equating some assets of the company with the liabilities in the denominated currency. The method involves acquiring a short-term loan in a currency similar to the company’s receivables and which it wishes to hedge (Misawa, 2006). The quality of the account receivable of the company must however, be more valuable than the interest charged on the loan. Another alternative that OSG would consider is ruling out hedging as a means to curb foreign exposure. By so doing, the company takes a transaction risk with the hope that the exchange rate does not cause huge losses to them (Misawa, 2006).

OSG Company Recommendations

The drastic appreciation of the dollar within a three-day period was likely to stir some impacts even though not in the short-run. As seen earlier, OSG was doing well in its business to the extent that there were growth prospects available at the time of the appreciation. However, the company had to mitigate the likelihood of foreign exposure. As indicated in a report presented to the board, the company was not hedging as would have been required since it relied on forwarding contracts (Misawa, 2006). OSG could further avoid international exposure through buying out an option. The latter means that a company trading in the USA was permitted to buy or sell a specified amount of dollars before the elapse of the agreement period.

Despite hedging methods being viewed as a means to reduce currency volatility, it does not increase a company's cash flows. The last observation is explained by the fact that there are costs involved during hedging that lower the overall cash flow of the enterprise. Also, application of one method of hedging by the company may result in unfavorable conditions in the long run. Integration of different hedging methods would be beneficial to the company since it provides flexibility.

Reference

Misawa, M. (2006). OSG Corporation: Hedging Transaction Exposure. The University of Hong Kong press.