International Production Location and 'Pro Forma' Financial Hedging of Exchange Rate Risk

For two hypothetical firms with different home currencies, this study compares alternative production locations if the firms compete in one firm’s home country. Using simple three-outcome scenarios, the study shows that a firm’s foreign exchange (FX) exposure depends on the currency location of both firms’ production. The study features a simple "pro forma" financial hedging analysis of FX exposure that provides a straightforward way to evaluate the production location alternatives. If the FX rate process has no projected trend and the countries’ operating costs are equivalent at the current spot FX rate, the hedging analysis shows that the firms’ combined value is maximized if they produce in different currency areas