Question

An article in the Toronto Star discussed the Canadian teams that play in the National Hockey League, the National Basketball Association, Major League Baseball, and Major League Soccer. The article noted, "Under their collective agreements players get paid in U.S. dollars. The majority of [team] revenue, however, is in Canadian currency." Are Canadian professional sports teams better off when the Canadian dollar increases in value relative to the U.S. dollar or when it decreases in value? Briefly explain.

Short answer

Canadian teams are generally better off when the Canadian dollar increases in value relative to the US dollar. An increase in the Canadian dollar value makes paying their expenses (player salaries in US dollars) less costly, as they need fewer Canadian dollars to obtain the necessary US dollars. Consequently, a decrease in the Canadian dollar value would have the opposite effect, making the player salaries more costly in terms of Canadian dollars.

Step-by-step solution

- Understand the Problem

The first step to answering this exercise is to understand what's being asked. The teams are earning their revenue in Canadian dollars but their costs (in this case, player salaries) are in US dollars. This setup leads to the question: are the Canadian teams better off when the Canadian dollar increases or decreases in value relative to the US dollar?

- Analyze the Effects of an Increasing Canadian Dollar Value

If the Canadian dollar increases in value relative to the US dollar, it means that with each Canadian dollar, you would get more US dollars. In this situation, the teams would be better off when paying their players (their expenses), since they would be able to obtain the necessary US dollars with fewer Canadian dollars. However, this wouldn't affect the team's earnings, as the revenue would still be in Canadian dollars.

- Analyze the Effects of a Decreasing Canadian Dollar Value

On the other hand, if the Canadian dollar decreases in value relative to the US dollar, each Canadian dollar would yield fewer US dollars. This would make the player salaries (expenses) more costly for the Canadian teams, as they would need more Canadian dollars to obtain the necessary US dollars to pay the players. Again, the earnings would remain unaffected as they remain in Canadian dollars.

Key concepts

Foreign Exchange Rates

Understanding foreign exchange rates is essential for businesses that deal in multiple currencies. At its core, an exchange rate is the value of one currency in relation to another. For example, if a Canadian professional sports team has to pay player salaries in U.S. dollars but earns revenue in Canadian dollars, they are subject to exchange rate fluctuations.

When the Canadian dollar strengthens against the U.S. dollar, the cost of paying salaries in U.S. dollars decreases because each Canadian dollar can purchase more U.S. dollars. Conversely, if the Canadian dollar weakens, the team would find the cost of salaries rising, necessitating more Canadian dollars for the same amount of U.S. dollars.

Impact on Costs

Small changes in exchange rates can have a significant impact on a business's costs, especially when large transactions are involved, like player salaries in professional sports teams. This relationship emphasizes why understanding and monitoring foreign exchange rates is crucial for financial planning and budgeting in international business operations.

Business Revenue

Business revenue is the income earned by a company from its sales of goods or services. For international businesses, or those earning in one currency and spending in another, like Canadian professional sports teams, revenue is affected by currency values.

If these teams earn their revenues in Canadian dollars and the Canadian dollar value rises, their revenue when converted to U.S. dollars, increases without changing the volume of goods or services (tickets, merchandise, etc.) sold. This means they can more easily cover expenses like player salaries that are in U.S. dollars. However, if the Canadian dollar value falls, their revenue when converted to cover U.S. dollar expenses, like player salaries, would decrease, potentially affecting their ability to pay without adjusting business operations.

Revenue in Multiple Currencies

For businesses that operate in multiple countries, earning revenue in different currencies can be a risk but also an opportunity to take advantage of favorable exchange rates, highlighting the importance of strategic financial planning.

Expense Management

Expense management in business involves tracking, analyzing, and controlling the money spent to ensure that operations run smoothly and profits can be maximized. A key component of expense management for businesses operating in an international context, such as Canadian sports teams, is accounting for currency exchange.

When the Canadian dollar weakens compared to the U.S. dollar, the teams' expenses for player salaries will effectively increase. To manage these expenses effectively, teams may employ strategies like forward contracts to lock in exchange rates or maintain accounts in multiple currencies to mitigate risks.

Strategic Expense Planning

Effective expense management includes forecasting and hedging against currency fluctuations to protect the business's bottom line. By understanding and anticipating the impact of foreign exchange rates, businesses can create a more resilient financial strategy that accommodates the dynamic nature of international markets.