Question

In its 2016 Annual Report, Amazon stated, "We have foreign exchange risk." a. Briefly explain why Amazon is exposed to foreign exchange risk. b. If Amazon did not have operations in foreign countries, would its profit be affected in any way by fluctuations in the exchange value of the U.S. dollar? Briefly explain.

Short answer

Amazon is exposed to foreign exchange risk because it operates globally and its revenues and costs depend on the exchange rates between local currencies and the U.S. dollar. If Amazon didn't have foreign operations, its profits would be largely unaffected by fluctuations in the U.S. dollar value, although the competitiveness of its prices for imported goods might be impacted.

Step-by-step solution

Amazon's Exposure to Foreign Exchange Risk

Amazon is exposed to foreign exchange risk because it operates globally, which means it makes sales and incurs expenses in countries around the world. Consequently, its revenues and costs in those countries depend on the exchange rates between their local currencies and the U.S. dollar. If the value of those local currencies decreases relative to the U.S. dollar, Amazon's revenue in U.S. dollars will decrease, which could negatively impact its profitability.

Impact on Profits Without Foreign Operations

If Amazon did not have operations in foreign countries, its profits would be insulated from fluctuations in the value of the U.S. dollar in relation to other currencies. Any change in the value of the U.S. dollar would just affect the purchasing power of its U.S. customers, and not directly affect Amazon's revenue and expenses. However, it might impact the competitiveness of Amazon's prices for imported goods. An increase in the U.S. dollar value makes imports cheaper, which could potentially drive down Amazon's prices and decrease its profit margins.

Key concepts

global operations

Amazon, like many other multinational corporations, engages in what are known as "global operations." This means Amazon conducts business in multiple countries, crossing borders and engaging with different economic systems around the world.
The ramp up of such operations allows the company to reach a wider audience, expand market share, and increase revenue streams. However, working across different countries introduces complexities, such as dealing with various currencies, adhering to diverse regulatory standards, and navigating through unique local business environments.
One crucial element of global operations is the need to manage currency exchanges. Since Amazon earns revenue and incurs expenses in various currencies, it opens the door to currency-related challenges. Therefore, knowing when and how to convert these currencies—optimally and possibly hedging against risk—becomes a vital task in global operations. These tasks are designed to protect the company's profitability against sudden shifts in currency values.

exchange rates

Exchange rates define how one currency converts to another. They fluctuate based on multiple factors, such as economic stability, governmental policies, inflation, and interest rate changes.
For a company like Amazon that operates internationally, exchange rates play a pivotal role. The revenues Amazon generates in one country need to be converted to U.S. dollars for financial reporting purposes, and this conversion is subject to current exchange rates.

• If the local currency strengthens against the U.S. dollar, it results in an increase in dollar terms for Amazon’s overseas revenues.
• Conversely, if the local currency weakens, then revenues decrease when translated to U.S. dollars.

This movement impacts Amazon's financial statements, where volatile exchange rates can cause unexpected gains or losses. Understanding and monitoring exchange rates allows companies to take strategic decisions, such as implementing hedging strategies, to mitigate potential risks.

currency fluctuations

Currency fluctuations refer to the unpredictable changes in the exchange value of one currency against another. Such fluctuations can be driven by a spectrum of factors, including economic indicators, political events, market sentiment, and global trade developments.
In the context of international businesses like Amazon, currency fluctuations can significantly affect financial outcomes. A decrease in the value of foreign currencies relative to the U.S. dollar, for instance, can reduce the dollar value of earnings generated abroad.
This unpredictability can impact several key areas:

• **Pricing Strategy**: Amazon may need to adjust prices in international markets to maintain profitability or competitiveness.
• **Cost Management**: Fluctuating currencies can alter the cost of imported goods and services, impacting profit margins.
• **Financial Forecasting**: Predicting future revenues and costs becomes challenging when exchange rates are unstable.

By carefully analyzing these fluctuations, companies can devise strategies to reduce adverse impacts, ensuring smoother financial performance in a global marketplace.