Foreign Investment Strategy

LonMark International has affiliates in many European countries, the UK, Japan, and the Americas.  Even though most transactions occur on the local level, a multinational association such as LonMark International has to worry about currency exchange rates when managing its foreign transactions.  Membership dues and other revenues may be collected in one currency, assets denominated in another, and profits measured in a third.

Lucky for LonMark, there are only a few transactions that need to take place on the foreign exchange market because most of the revenues stay with the local affiliate to pay for operations, sales, and marketing.  However, LonMark might be able to take better advantage of their international status by increasing their financial investments in foreign markets. By changing accounting practices to treat foreign and domestic revenues and expenditures differently, LonMark can alter their tax situation and cash flows. In order to make these decisions, LonMark must develop a consistent strategy, employ an individual or team to monitor the exchange markets, and be cautious of changing foreign regulations and laws that might affect how they do business in foreign countries.

Strategy

As a non-profit association, LonMark does not have an obligation to make money for its share holders and does not need to expose itself to unnecessary foreign exchange risk.  The majority of both revenues and expenditures from international affiliate operations is received and spent in the local currency.  Therefore, LonMark does not have to concern itself with hedging foreign currencies.

For this exercise however, we can assume that on occasion, LonMark International’s home office in the US needs to help fund an event in an European or other country to help and a new or growing affiliate. For foreign exchange risk to be a factor, LonMark must commit to a payment in the future for this event, otherwise they would simply pay the spot exchange rate for that day.

If Lonmark knows that must make a payment for a marketing event in the future they can neutralize its foreign exchange risk a few different ways:

• The first way would be to enter a money market hedge.  This method is best if LonMark has the capital today to pay for services in the future.  LonMark can change their money into the foreign currency on today’s spot market and then buy a money market security that will mature when the payable is needed.
• The second method to neutralize risk for a future expenditure in a foreign currency would be to purchase a forward exchange contract.  In this case LonMark would commit to paying a predetermined exchange rate for the money needed.  In this case, even if the exchange rate fluctuates, LonMark is locked in at the agreed upon exchange rate and can account for this amount without exposing itself to risk.
• Finally, LonMark can hedge its foreign currency transactions by purchasing or selling options.  Many exchanges around the world trade these options, most notably in Chicago, New York and London.  LonMark could place a long hedge to cover any exchange fluctuations in the short term.  This strategy improves its cash flow over the money market hedging method.

Since LonMark is not speculating on foreign exchange investments, their primary objectives are to minimize risk and variability in cash flows.  Entering a forward contract or using futures options would be the best methods for hedging foreign exchange risk, but these methods may require more involvement from management since they have a small staff.

Management

LonMark has a very small staff and the majority of their work is marketing LonMark technology to companies and governments.  Passive hedging of foreign currency exchanges will allow LonMark to continue to concentrate on what matters most to them, marketing.  Passive hedging involves using forward contracts to best avoid exchange risk.

If LonMark is to increase transactions between its headquarters in the US and affiliates it could possibly consider limited active futures options trading, but since its primary objective is not to make more money for share holders, passive hedging is adequate. Monitoring exchange rates should always be a concern of LonMark management however as it could be used as a marketing tool.  For example if the US dollar becomes weaker to the Euro, American suppliers of LonMark products will become cheaper for European nations.

Regulatory

Before making an investment in a foreign country, LonMark should carefully consult with an expert on the prospective countries regulations on foreign investment. Laws and regulations are just as important as the exchange rate because they can specify capital gains that can be extracted from the country.  Since LonMark is a non-profit association, there may be accounting regulations it must follow with foreign investments.

Recommendation

When making foreign investments, LonMark should take the least risky strategy.  Using forward exchange contracts will help LonMark best account for its deliverables and receivables.  Management should use passive trading and simply try to minimize the risk to the fullest.  While this is a boring strategy, LonMark’s mission is to promote interoperability technology and not generate investment revenues.