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We need to figure out our foreign exchange procedures because we do not have any right now.

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In June 2019, Patti Kornak, BusBoard Prototype Systems Ltd. (BusBoard) 's general manager, had been having some challenging days at work. Ongoing changes in currency values made it difficult for her to decide when to buy and sell US dollars (USD) (see Exhibit 1). She wanted to evaluate BusBoard’s methods for managing USD currency exchange and to consider how to make the company more profitable based on currency movements. She recognized the need to address this quickly. During a management meeting, she stated,

 

We need to figure out our foreign exchange procedures because we do not have any right now. Our exposure to the USD is large, and timing our trades poorly can hurt the company. It is not helping that revenues have been low for the past few months, and our choices with currency could have a major impact on BusBoard’s ability to continue operations. One option is for me to continue to trade currency based on instinct, and I could try to learn how to do this more efficiently. Another option is for us to look at some financial contracts. With less than US$5 million in sales per year, I do not know if our size will be a limitation. I’m willing to look at both options, but whatever we do, we need to get started before the exchange rate moves against us again.

 

Based in Calgary, Alberta, BusBoard made most of its sales in USD, with the remainder in Canadian dollars (CAD). Patti had little training with currency strategies, so converting USD while preserving the value of the company was an area of uncertainty for her.

BusBoard had recently placed an order totalling approximately US$25,000 for parts and supplies from one of its Taiwanese suppliers at a USD/CAD exchange rate of 0.748.1 BusBoard generally paid 50 per cent upfront, so making only a partial payment at the time introduced the risk that the second half of the payment could become more expensive in the future. Regardless of what she decided to do about the company’s ongoing exposure, Patti needed to move quickly. Between depressed revenues and currency conversion concerns, BusBoard’s long-term viability looked uncertain.

BUSBOARD PROTOTYPE SYSTEMS INC.

 

BusBoard designed and manufactured printed circuit boards targeted at the electronics hobbyist market (see Exhibit 2). The founding partners worked in the company and included Patti as general manager, Scot Kornak as president and engineering lead, and a third partner who managed accounting. BusBoard manufactured products that were useful and built to high quality standards. Scot’s goals were ambitious—he wanted the company to release a new product every month. It was challenging to design something new with such regularity, but Scot reminded the engineers that “We have many good ideas that could be added to our sales list. All it will take is some engineering work or supplier sourcing.” One recent product innovation was the Junior Genius Blinky Lights Kit—an educational electronic circuit kit. BusBoard increased its exposure through distributor agreements with well-established, reliable partners such as Amazon.com Inc., Arrow Electronics, Jameco Electronics (Jameco), Mouser Electronics, and dozens of smaller companies. Since its inception, BusBoard had developed many unique printed circuit board products and modified, enhanced, combined, and redesigned these to fit many different needs and markets. The company also designed and resold complementary hobbyist parts and products, including enclosures, hookup wires, plastic parts, microcontroller boards, and peripherals.

 

The Kornaks also owned Kornak Technologies Inc. (KTI), an engineering design and manufacturing company. KTI’s exposure to the USD was similar to BusBoard’s in terms of sales percentage, although not as large in volume. Patti did not want BusBoard’s exchange rate decisions to cause problems for KTI’s profitability.

 

THE ELECTRONICS HOBBYIST MARKET IN THE UNITED STATES

 

BusBoard’s primary market included electronics hobbyists in the United States, with a small percentage of its customers located in Canada. In 2014, shipments of electronics components within the United States grew at a rate of 4.9 per cent,2 which was faster than the overall economy was growing.3 A survey conducted by Jameco showed that orders for electronic components from do-it-yourselfers and hobbyists were steadily increasing.4 Greg Harris, Jameco’s vice-president of marketing, said “the electronics hobby is booming. Our study found an underlying passion for electronics that builds the kinds of skills that make the American economy strong.”5 Of the 1,700 hobbyists surveyed, 68 per cent believed that their hobby was a key part of building the American economy.6

 

POLITICS AND THE USD/CAD EXCHANGE RATE

 

Political interactions between the United States and Canada had an important effect on the value of the currencies.7 Since his inauguration in 2017, US President Donald Trump had emphasized a campaign promise he had made to Americans, saying that his administration would take an “America-first” view, prioritize American jobs, build up the American economy, and protect American industry from foreign competition.8 For BusBoard, the potential effect of these policy priorities was not certain.9 If the United States were to levy increased tariffs on Canadian imports, the value of the USD would likely change. There was also debate in the United States regarding import tariffs on goods originating in China.10 It was possible that the US government would levy tariffs on more than US$30 billion worth of Chinese imports, an action that would reduce China’s long-standing advantage as a low-cost producer.11 Expectations of this tariff increase had already caused manufacturers in Taiwan to look more attractive than they had under previous tariff regimes. For a North American customer, it was relatively uncomplicated to switch from a Chinese manufacturer to a Taiwanese manufacturer, thereby maintaining low-cost production and avoiding the possibility that new tariffs might increase the cost of goods.

 

New tariffs could increase BusBoard’s cost of goods in USD, but the potential impact was uncertain because most of BusBoard’s purchases passed through Canada.12 Inventory was purchased, repackaged, and shipped out of Canada without changing the harmonized sales code that served as identification for US tariff imposition decisions.

 

The value of the USD was an important consideration for Canadian companies that did business in the United States, and market processes affected the exchange rate between the two currencies. Despite the constant change in relative values, it was easy for Patti to manage USD transactions from 2010 to 2013 because the exchange rate had remained close to par, making the company’s forecasts in CAD more reliable. In 2016, the USD/CAD exchange rate was 0.67, which meant that a US$100 expenditure translated to approximately CA$149.13 Between January and May of 2017, the USD/CAD exchange rate remained relatively close to 0.74 (see Exhibit 1).

 

Trade between the United States and Canada was significant. In 2018, the United States imported US$353.6 billion worth of merchandise from Canada and exported US$360.5 billion of merchandise to Canada.14 Export Development Canada stated that in 2016, the United States and Canada had the largest trading relationship in the world, with 75 per cent of Canada’s exports destined for the United States.15 A small company like BusBoard did not have the capacity to affect the value of the two currencies, yet it was imperative to the company’s survival to control for the volatility. In 1969, Canada’s prime minister, Pierre Elliot Trudeau, summarized the relationship between the two countries by saying, “Living next to you is in some ways like sleeping with an elephant. No matter how friendly and even-tempered is the beast, if I can call it that, one is affected by every twitch and grunt.”16 The much larger United States had a significant economic impact on Canada and, therefore, on BusBoard’s profitability.

 

The primary factors that influenced the exchange rate between the USD and the CAD included oil prices, monetary policy decisions made by the two countries’ central banks, and inflation. When the price of oil was high, Canadian companies’ revenues in USD increased, and large amounts of USD flowing into Canada tended to strengthen the CAD. When the Bank of Canada made a monetary policy decision such as raising interest rates, foreign investment in Canada tended to become more attractive, increasing demand for the CAD and its value relative to other currencies.17 Inflation rates also contributed to differences between the trading value of USD and CAD. Countries with low inflation rates were likely to attract foreign investment capital, whereas countries with high inflation rates were more likely to repel foreign investment capital.18

 

PURCHASES IN USD

 

BusBoard’s primary suppliers were located in South Korea and Taiwan, and some of these suppliers had factories in China. BusBoard settled all of its transactions with non-Canadian suppliers in USD. These transactions had totalled 85 per cent of BusBoard’s annual purchases in 2018. In a recent transaction between BusBoard and one of the company’s Taiwanese manufacturers, the total value of the purchase was US$24,776, and BusBoard agreed to pay 50 per cent upfront (see Exhibit 3). At contract initiation, the USD/CAD exchange rate was 0.748. If BusBoard were to pay immediately, the cost in CAD of the 50 per cent upfront payment would be CA$16,562. For these types of transactions, Patti was concerned about the potential exchange rate when the remaining 50 per cent came due, and she wondered what the effect would be if the CAD were to strengthen or weaken. If she delayed payment and the exchange rate were to move in BusBoard’s favour, BusBoard could save money. Her choices were to either keep that money in a US bank account until payment was required, or trade it immediately and pay a USD/CAD exchange rate of 0.748. BusBoard had always based currency transaction decisions regarding customers in the United States on intuition and had never actively hedged its exposure. In a transaction between BusBoard and one of the company’s Korean manufacturers, BusBoard was subject to similar risks: between paying 50 per cent upfront and paying the balance upon shipping, the USD/CAD exchange rate could fluctuate significantly, meaning that the cost of the goods in CAD could substantially increase or decrease (see Exhibit 4).

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