GLOBAL FINANCE 1
Week 2 TD 1
A weak dollar would test the patience of investors seeking for foreign investments. If the dollar is expected to strengthen, US investors will increase their investments in foreign securities. In this manner, the investors hope to sell their securities when the dollar strengthens in exchange for higher returns. Therefore, investors would acquire foreign securities if the dollar is expected to strengthen.
A stronger dollar could enlarge the balance of trade deficit by boosting expenditure. Local consumers will be encouraged to purchase more imports since the volume of goods acquired would be higher than when the dollar was weaker. The imports would supersede the exports and thereby enlarge the balance of trade deficit. A weaker dollar would encourage savings as people anticipate for the currency to strengthen. Less consumption of imports would elevate the level of exports. Therefore, a weaker dollar would inadvertently reduce the balance of trade deficit.
Governments can give their local firms a competitive advantage in the international arena by reducing the tariffs levied on exports. This would make it easier for local businesses to conduct international trade. It would also make locally-produced goods cheaper in foreign markets. The government can also negotiate for higher quotas for local products in international markets. Governments can also join free trade zones that would provide local firms with the platform to showcase their products.
Week 2 TD 2
The Chinesebalance of trade deficit would not be eliminated no matter how muchthe Yen is revalued upward. The Chinese Yen has been undervalued fordecades. Recent estimates have shown that the Chinese Yen has beenundervalued by as much as 28.5% about the US dollar. This impliesthat Chinese exports to the US are usually subsidized by 28.5%. Thisalso acts as the tax on all exports made to China by the US. Manyfactors would have to coincide for the elimination of the Chinesebalance of trade. Chinese trade partners would have to increase theirlevel of savings so as to complement upward revaluation of thecurrency.
For example, theUS has a poor saving culture accompanied by stagnant salaries. Thenumber of exports would remain close to the current levels becausesavings would remain small. Therefore, the imports would stillsupersede the exports. Upward revaluation of the Chinese Yen wouldalso be met with retaliatory measures aimed at negating the impact.For example, Chinese authorities would limit imports by imposingtariffs on foreign goods and services. This measure would have theoverall effect of maintaining the balance of trade deficit.Manipulation of currency makes it impossible for an upwardrevaluation of currency to have any meaningful impact.
Week 3 TD 1
1. A fixedexchange rate refers to one where the government manually sets theexchange rates. Fixed exchange rate systems are implemented to ensurestability in capital movements and foreign trade. The government hasto maintain large reserves so as to fix the exchange rates. Freelyfloating exchange rate systems refer to where market forces of demandand supply set the rates free from government intervention. A managedexchange rate system refers to where both market forces and thegovernment contribute to the overall exchange rate. A fixed exchangerate system is usually quite stable while a freely floating systemkeeps fluctuating.
2. Governments ofAsian countries limit their currencies from floating freely due tovarious reasons. First, it permits greater freedom from management byinternational bodies such as IMF. Under the floating system, theCentral Bank has little mandate to intervene in the market. Marketefficiency is also enhanced by floating exchange rate systems sincecapital flows restrictions do not exist. Floating exchange ratesystems shield a country from the macroeconomic instabilities inother countries. This explains why Asian countries have beenreluctant to change their freely floating currencies. On the otherhand, freely floating exchange rate systems create room for highvolatility. It also worsens existing difficulties such as highinflation and currency depreciation.
3. The directintervention of Asian banks to raise interest rates failed to preventweakening of currencies since they employ freely floating exchangerate systems. Such a system worsens existing problems since itperpetuates pre-existing conditions. This explains why the currenciescontinued to weaken nonetheless.
Week 3 TD 2
The monthly announcement of the trade deficit sometimes has such an impact on foreign exchange trading. This is because the balance of trade shows the difference between the value of imports and exports. Foreign exchange traders base their reaction on the relative strength of the dollar. If the dollar seems weak, a huge deficit will motivate them to sell less of the currency. A weak deficit would move them to retain the currency. On the other hand, a smaller deficit backed by a strong dollar would move them to sell more currency. A larger deficit would motivate them to retain the currency.
In some periods, foreign exchange traders would not respond to an enormous deficit in the balance of trade since the strength of the dollar remains unchanged. In such a situation, selling more or less of the currency would have no benefits to foreign exchange traders. The relative strength of the dollar prior and post the deficit announcement is the greatest factor governing the reactions of foreign currency traders. An extremely fluctuating dollar would cause plenty of uncertainty in financial markets. Foreign exchange traders would be hesitant to sell or buy any currency when the strength of the dollar can neither be ascertained nor predicted with an unerring level of accuracy.
Week 4 TD 1
1. If the currentaccount shows a deficit, this will necessitate the relevantauthorities to finance such a deficit. The most common approach wouldinvolve selling capital assets held abroad. The capital account wouldreduce since an asset has been sold. However, the current accountwould receive cash inflow as earnings from investment. Consequently,the overall balance of payments will be reduced.
2. An increase inthe value of the dollar would reduce the current account deficit.This is because traders will favor exporting American products tointernational markets. Furthermore, foreign exchange traders willsell more dollars so as to capitalize on the high value of thecurrency. American investors will also seek to acquire more capitalassets abroad. Such assets would be preserved until the governmentneeded to finance future increases in current account deficits.Therefore, an increase in the value of the dollar would reduce thebalance on the current account.
3. An increase inthe current account deficit implies that imports supersede the valueof exports. This could be caused by a reduction in savings due toheightened customer demand. Higher salaries and an increased numberof taxable individuals would create an abundance of the capitalavailable in financial markets. A greater influx of goods andservices into the country would lower the value of the dollar.Therefore, if the current account deficit increases, the dollardecreases in value.
Week 4 TD 2
When economicconditions are expected to strengthen, the local currencyappreciates. This is because the level of exports increase. Localtraders find more courage to access international markets. Anincrease in exports is accompanied by increased activity on the partof foreign exchange traders. Selling more currency would cause thevalue of the currency to appreciate. Additionally, foreign investorswould hurry to sell their assets in a country whose economicconditions are expected to strengthen. The level of savings wouldalso drop as local investors look for foreign opportunities.Consequently, the local currency appreciates whenever economicconditions are expected to strengthen.
Increasednational income would increase imports since consumers would maintaina less proportion of their income in savings. This could weaken localcurrency due to the influx of foreign products into the local market.Increased economic growth could also strengthen domestic demand byincreasing employment opportunities. Local traders and investorswould be empowered to seek international markets for their productsand services. An increase in the amount of FDI would inevitablycreate upward pressure on the value of the currency. Greater economicgrowth would lead to the acquisition of more capital assets inforeign countries. Buying capital assets in other countries isrecorded as an outflow in the capital account. Conducting suchtransactions has the overall effect of increasing the value of localcurrency.
Week 5 TD 1
1. Variousfactors expose a firm’s degree of transaction exposure in aparticular currency. The first factor concerns the variability of thecurrency. A low level of currency variability is desirable since itreduces transaction exposure. The second factor involves thecorrelations between currencies. A small degree of currencycorrelation is ideal for currencies that produce net inflows.However, a high standard of currency correlation is ideal forconflicting pairs of currencies.
2. Appreciationof the home currency would reduce inflows since competition increasesand demand falls. On the other hand, depreciation of the homecurrency increases inflows since it reduces competition and increasesdemand for goods.
3. This occurs inthe event where the domestic firm competes with established foreigncompanies that operate within the same market. In such a case,consumers will seek to buy foreign products when the local currencystrengthens due to exchange rate fluctuations.
Week 5 TD 2
ABC Corporationcan reduce its economic exposure through several means. Firstly, itcan renegotiate its contract with the French government such that itreceives most, if not all, of its payments in US dollars rather thanFrench Frank. Alternatively, ABC Corp. can convert 90% of itsexpenses into French Frank so as to reduce their exposure to exchangerate fluctuations. Furthermore, since ABC is a multi-nationalcorporation, it can either expand or move its operations to France.From that point forward, ABC Corp. can use its French subsidiary as afront for the business. The French government can also be directed todeal directly with the French office rather than remitting paymentsto the US-based office.
ABC Corp. runsthe risk of running out of operation unless it either reduces oreliminates its economic exposure to exchange rate fluctuations. Thisis because the US dollar is more valuable than the French Frank.Paying 90% of its expenses in US dollars would strip the profits ofthe company since the French government remits payments solely inFrench Frank. Moreover, ABC Corp. is liable to pay 35% corporatetaxes since it is based in the US. In this regard, opening a newoffice in France may be a good option to consider.
Week 6 TD 1
1. Countries withstrict restrictions on international trade are usually independent ofexternal economies due to insulation. They remain shielded to themacroeconomic troubles experienced in other economies. Thelimitations on FDI would also protect these economies from externalinfluences. Fluctuations of exchange rates would typically not affectthese independent economies. Multinational corporations would desireto enter such countries so as to maximize their profits with neitherexternal influence nor scrutiny. However, relaxing such restrictionswould make these economies less independent since they would beexposed to international factors.
2. The decisionto produce and sell stereos in Taiwan would only be sensible if theproceeds from Taiwan would supersede those in the US. However, if thelow costs failed to translate to higher revenues, it would be best toremain within the US where high returns offset the high costs.
3. The statementmeans that the MNC would remain on the lookout for opportunities toexpand its operations in additional countries. MNCs always seek tobroaden the market for their products and maximize on economies ofscale.
Week 6 TD 2
1. Political riskcan be incorporated into the capital budgeting process throughvarious methods. The first step involves putting a premium on therisk such that the expected returns are higher than those without anypolitical risk. It is also prudent to establish a payback period whenthe foreign investment would be paid back after incorporating thepolitical risk. Obtaining a certainty equivalent for the investmentwould help to outline guaranteed returns from the project. Asensitivity analysis would contribute to portraying the measure ofthe responsiveness of the expected returns to various factors such astax, investments, the cost of sales, and sales. In this manner,political risk can be factored into the capital budgeting process.
2. Foreign DirectInvestment (FDI) has various advantages and disadvantages compared toa licensing agreement with a foreign partner. FDI provides unlimitedaccess to markets and resources. It also reduces production costs byminimizing the disparity between costs and revenues. On the otherhand, FDI can be quite risky especially in volatile countries.Additionally, it may become expensive to invest in foreign countriesas compared to exportation. Political changes may also lead toexpropriation whereby the government controls all resources.
Week 7 TD 1
1. If banks didnot provide trade-related services, foreign trade would be crippled.Electronic transfer of funds would never be feasible when tradersexisted in different parts of the world. Moreover, it would not bepossible to convert currencies since banks offer foreign exchangeservices. Banks also provide guarantees for the purchase of goods.International trade would be riskier without the involvement of banksto issue credit facilities.
2. For anexporter, a bank guarantees the payment of the note at maturity. Thisinstills confidence in the exporter to sell his products on credit.Ultimately, it leads the exporter to increase his volume of sales.For an importer, a banker`s acceptance provides access to the lowestrates available in the money market. On the other hand, banks earnstamping fees that make up for its loss of interest income. In theseways, the banker’s acceptance can be beneficial to an importer,exporter, and the bank.
3. The exportercan receive payment either by waiting for the maturity of the checkor discounting the draft with the bank at a specified rate. Althoughit may take longer for the check to gain maturity, the value of thepayment will be higher.
Week 7 TD 2
Countertraderefers to an alternative form of international trade whereby goodsand services are exchanged instead of using conventional paymentusing currency. Countertrade can take several forms depending on needand convenience. Direct offset occurs where a seller of a good agreesto buy materials employed in the production of that good. Thisarrangement makes imported goods cheaper and hence benefits theforeign country importing the good. Indirect offset occurs where animporter commits to making a viable investment in the country beforeimporting the product. Switch trading is another form of countertradeinvolving three countries. Two of these countries usually have a hugetrade imbalance while the third country has a business relationshipwith both. In this arrangement, the third country buys what the firstcountry requires from the second nation and then trades it to thefirst country in exchange for something the third country needs.
For a country,countertrade helps to rectify imbalances in trade and shield theoutput of domestic firms. It also contributes to finding alternativeexport markets. For a firm, countertrade helps to streamline entryinto complicated markets and increase sales. Countertrade also helpsa company to dispose surplus products and gain competitive advantage.The negotiations for countertrade are usually time-consuming,complicated, and prone to logistical issues. The value and quality oftraded goods are also difficult to pinpoint.
Week 8 TD 1
Target Inc. facesa quandary considering whether to expand into Thailand or remain inthe US. A high demand in Thailand corresponds with decreasing profitmargins in the US. On the other hand, the Thai currency has beenforecasted to depreciate greatly over the next three years. Severalfactors contribute towards the decision whether to expand or not.First, the company should acquire estimates of the expected extent ofdecline in the currency. It is also crucial to factor the effects ofsuch depreciation on the expected profit margins in Thailand. TargetInc. should also evaluate consumer behavior in Thailand concerninghow spending habits interrelate to the value of the local currency.
Moreover, thecompany should obtain reliable estimates of expected profit marginsin the US within the next three years. Such estimates can be obtainedfrom an extrapolation of current trends in the decline of profitmargins. The estimates obtained from both Thailand and the US marketsshould be used as the basis for making final decisions. If theexpected depreciation of the currency would have negligible effect onthe demand and profit margins in Thailand, then expanding into Thaimarkets would be proper. On the other hand, if the expected profitmargins in the US would still be higher to the rates in Thailand,then expansion plans would be shelved until the baht faces betterprospects.
Week 8 TD 2
a.) The estimatedNPV of the divestiture would be smaller due to the forecasts of theEuro’s value being revised downward. Since the Euro forecastconcerns future periods, it is expected that future cash flows wouldbe adversely affected. The NPV a week earlier had been computed witha higher level of expected future cash flows. However, a reduction inthe future value of the Euro would inevitably dent future cash flows.Consequently, a smaller NPV would force Fetco Co. to respond to theoffer by agreeing to sell the subsidiary. In this instance, thedivestiture would no longer be feasible. Further delays in sellingthe subsidiary could cause the buying company to either lower orwithdraw its offer.
b.) If thelong-term interest rate in the US suddenly declines, the NPV of thedivestiture would be smaller than it was last week. The time value ofmoney guarantees that amounts will appreciate after passage of time.A dollar today would be worth much more in the future. An increase ininterest rates implies that the values of cash flows rise beyond acertain threshold. Present values based on lower interest rates wouldincrease proportionately depending on the increase in interest rates.Therefore, the NPV of the divestiture would be smaller when long-terminterest rates decline.