Question Four: Broncos CO. Read the following scenario and answer the questions that follow. Broncos Co. is a U.S. firm with a Chinese subsidiary that produces cell phones in China and sells them in Japan. This subsidiary pays its wages and its rent in Chinese Yuan, which is stable against the dollar. The cell phones sold to Japan are denominated in Japanese yen. Assume that Broncos Co. expects that the Chinese Yuan will continue to stay stable against the dollar. The subsidiarys main goal is to generate profits for itself and reinvest the profits. It does not plan to remit any funds to the U.S. parent.

Questions: 1. Assume that the Japanese yen strengthens against the U.S. dollar over time. How would this be expected to affect the profits earned by the Chinese subsidiary?

2. If Broncos Co. had established its subsidiary in Tokyo, Japan instead of China, would its subsidiarys profits be more exposed or less exposed to exchange rate risk? Why?

3. Why do you think that Broncos Co. established the subsidiary in China instead of Japan? Assume no major country risk barriers.

4. If the Chinese subsidiary needs to borrow money to finance its expansion and wants to reduce its exchange rate risk, should it borrow U.S. dollars, Chinese Yuan, or Japanese yen? Justify your answer.