Custom «International Business» Essay Paper Sample
To begin with, it is notable that the field of international finance is dynamic and in constant evolution. Multinational enterprises is that they possess operating subsidiaries, branches or affiliates located in foreign countries, and many of them are owned by a combination of domestic and foreign shareholders. Such a dispersed structure is vulnerable to disruptions instigated by changing economic conditions, competition, terrorism, natural disasters and global political developments. As a result, the ability of an enterprise to adjust or otherwise to the changing situations will determine its success or failure. According to Dumistrecu (2005), there are four main types of transactions that from which exposures arise. They include: purchasing or selling on credit goods or services when prices are stated in foreign currencies and borrowing or lending funds when repayment is to be made in foreign currency. In addition, being party to an unperformed foreign exchange forward contract and acquiring assets or incurring liabilities denominated in foreign currencies may result in exposure.
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Foreign exchange rate risks arise from unexpected changes in foreign exchange rates, the measure of which can be quantified with the statistical measure of variance or standard deviation. To be precise, foreign exchange rate risk is arises from international parity conditions notably the International Fisher Effect and Purchasing Power Parity affect enterprises in the long run. This means that the value of an enterprise in national currency is sensitive with respect to unprecedented changes in the foreign exchange rate. According to Buckley (2004, p.640) treasury is concerned with borrowing, investing liquid resources and managing foreign exchange and interest rate exposures, with a view to ensuring that funds are raised cheaply; adequate returns are realized on invested liquid funds and companies meet their liabilities as they are being cushioned from interest rate exposures. Apparently, exposures act to diminish the value of the company.
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Transaction exposure, is kind of exposure relates to how changes in the rate of exchange affect the value in home currency terms expected cash flows in foreign currency terms that concern transactions that are already entered into. In reference to Buckley (2004, p.169), since the forward rate is in the long run an unbiased predictor of the future sport rate based on the bulk of empirical work on the expectations theory of the four way equivalence model, future spot results can be approximated. Covering forward in a situation may be of little worth to a firm that has a large number of transactions in foreign currency, if in the long term approximation of the future spot rate results in being on the higher side as often as tha low side. Though covering forward may equal the results achieved from running the debt to maturity and taking the spot rate, it reduce the threat of short-term financial problems.
The conventional method used to mitigate exposure is hedging. Bartram, Dufey and Frenkel (2005, p.396) indicate that this relates to the management of investment portfolios, with focus on fixed-income securities and by extension commercial receivables will primarily concentrate on minimizing potential losses resulting from changed exchange rates. It is advisable that risk averse managers in firms with few or vast transactions in foreign currency should practice selective covering. As far as lending and borrowing denominated in foreign currencies are concerned, the international Fisher effect stipulates that the penalty for borrowing in a hard currency will be exactly solved by the benefit of a low interest rate. Although the International fisher effect underpins that foreign exchange exposure on borrowing does not matter, other studies suggest medium term to long term benefits. Practically the international Fisher effect is empirically a long-run phenomenon and often disequilibrium that may result in vast losses for international borrowers occur when correction is attempted, thus the treasurer should measure these risks for management to be effected.
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Economic Exposure is concerned with the changes that may occur in foreign exchange rates when the present value of operating cash flows of an enterprise changes when expressed in the parent currency. In reference to Buckley (2000, p.171), based on the purchasing power parity theory, changes in exchange rates are associated with different relative rates of inflation. The foundation of the argument that economic exposure does not matter is in the purchasing power parity theory. This theory holds that devaluation of home currency favors local exporting firms since imports become relatively expensive. On the other hand, a high-country inflation rate has adverse effects on exporting companies. Thus devaluation creates advantages that correct disadvantages resulting from high relative inflation rates. However, in practice, the benefits of devaluation do not always exactly offset the earlier penalties of inflation, since all the costs of a firm do not inflate at the same rate as the general inflation prevailing in the country.
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Exposure will affect a firm when the individual costs are not in tandem with the general inflation. In such cases, multinationals opt to relocate to countries that have a relatively lower inflation rates or source inputs from other locations. Though not an exact cover for economic exposure, the simple act of financing firm operations in part or wholly in foreign currency a considerable impact in the current value of operations. Forward markets and currency options have also been used to check economic exposure. Monitoring and managing economic exposure by venturing into forward or option markets to cushion the present value of anticipated future cash flows for fixed times of operation in overseas is critical.
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The implications to the firm include the adoption of internal methods of risk management.According to Bhalla (2005, p. 534), internal exposure management aims at reducing or preventing an exposed position from arising, while the external management techniques are used to insure losses that may result from ineffectiveness of internal techniques. Bartram, Dufey and Frenkel (2005, p.408) indicate that the internal methods include leading or lagging, the matching or netting of cash flows in foreign currency or the use of transfer pricing. Netting means that affiliated companies trade with each other receive or pay, at regular intervals only the net amount of the intergroup debt. Asymmetric foreign exchange rate exposures present the customer with an option to choose the best currency price. Adjusting pricing in various ways as a reaction to currency appreciation and depreciations are some of the real financial options available. Alternatively, availability of parallel stable currencies can be an option for the firm involved.
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Translation exposure occurs in the consolidation of a firm's foreign currency items into group's financial statements denominated in the currency of the parent firm. It is argued that different translation methods have different impacts upon a company's reported earning's par share. Value at risk is a single number estimate of how much a company can lose due to volatility of the instrument it holds or an unhedged currency payable or receivable. Measures should be taken to control this exposure especially when the company is near to its gearing constraints, lest the borrowing covenant be breached.
One of the ways of mitigating exposure risks is to centralize exposure management. Besides such a policy ensuring that the whole company follows a consistent policy, it facilitates the matching of exposures among subsidiaries. This approach will ensure that the best exchange rates in the market are realized and a limited team of expertise will be required thus cost reduction is realized. Additionally, though with a few disadvantages such as high up-front costs, centralize exposure management helps integration with cash management and the pooling of skills and systems investment. The treasury should always ensure that profit is realized first, through improved exchange rates on deals.
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Secondly, taking owing to the fact that not all areas can be covered, selective hedging should be done based on appropriate forecasting. Finally, profits can be realized from constantly speculating on currencies to ensure that exchange options are only taken when rates are favorable. Hedging measures should also be upheld by firms to ensure that losses do not arise out of circumstances that can be directly controlled. In conclusion, the ongoing globalization process has led to the growth of many firms to international status. Exposure to risks of loss of capital and profits as a result of constantly changing exchange rates is reality in global business. Looking forward, firms must therefore, formulate policies to ensure that they either profit from, or are cushioned from such effects.