For your job as the business reporter for a local newspaper, you are asked to put together a series of articles on multinational finance and the international currency markets for your readers. Much recent local press coverage has been given to losses in the foreign exchange markets by JGAR, a local firm that is the subsidiary of Daedlufetarg, a large German manufacturing firm.
Your editor would like you to address several specific questions dealing with multinational finance. Prepare a response to the following memorandum from your editor:
To: Business Reporter
From: Perry White, Editor, Daily Planet
Re: Upcoming Series on Multinational Finance
In your upcoming series on multinational finance, I would like to make sure you cover several specific points. Before you begin this assignment, I want to make sure we are all reading from the same script because accuracy has always been the cornerstone of the Daily Planet. I’d like a response to the following questions before we proceed:
a. What new problems and factors are encountered in international, as opposed to domestic, financial management?
When getting into international finance some problems and factors are added to the ones experienced within domestic finance. These problems come from exchange rate, cross border barriers and financing opportunities in the global market but they do not get rid of the typical Business and Financial Risks. Business Risks can be identified as the ones that come out with competition from other companies, reduction in sales or any other factor that may affect the activities of the MNC, and Financial Risk is related with the firm’s financial structure.
The international trade and investment of a MNC requires the handling of foreign currencies which is sometimes translated as an Exchange Rate risk due to the volatility of the exchange rate. Added to this exchange risk, Multinational Companies deals with Political Risks due to the changing political systems of different nations among their legal resolutions, taxation procedures of movements in policies.
b. What does the term arbitrage profit mean?
Arbitrage profit means riskless profit, this is possible thanks to arbitrageurs who are individuals involved in the process of buying and selling in more than one country to achieve this riskless profit.
c. What can a firm do to reduce exchange risk?
In order for a firm to reduce its exchange risk some firms use forward-market and money-market hedges, nonetheless when these tools are not available MNC apply leading and lagging strategies which are practiced to defer income and thereby delay paying taxes and to create unhedged positions in order to speculate; cash managers may delay paying out currencies they expect to appreciate and accelerate paying out currencies they expect to depreciate.
d. What are the differences among a forward contract, a futures contract, and options?
▪ Forward contracts are agreements between two parties where the buyer agrees to purchase an asset (the foreign currency) and the seller agrees to sell the asset at a specific date at a price agreed upon now. ▪ Futures contracts are similar but are standardized and traded on an organized exchange. ▪ Options offer the buyer the right, but not the obligation, to buy or sell an underlying asset (the foreign currency) at a fixed price up to or on a specific date.
Use the following data in your responses to the remaining questions:
Selling Quotes for Foreign Currencies in New York
|COUNTRY-CURRENCY |CONTRACT |S/FOREIGN | |Canada-dollar |Spot |.8450 | | |30-day |.8415 | | |90-day |.8390 | |Japan-yen |Spot |.004700 | | |30-day |.004750 | | |90-day |.004820 | |Switzerland-franc |Spot |.5150 | | |30-day |.5182 | | |90-day |.5328 |
e. An American business needs to pay (a) 15,000 Canadian dollars, (b) 1.5 million yen, and (c) 55,000 Swiss francs to businesses abroad. What are the dollar payments to the respective countries?
We will use spot rates for calculations since time of payment is not specified.
Canadian-dollar 15,000 = $12,675 USD = 15000 x0.845
Japan-yen 1,500,000 = $7,050 USD = 1500000 x0.0047
Swiss francs 55,000 = $28,325 USD = 55000 x0.515
f. An American business pays $20,000, $5,000, and $15,000 to suppliers in, respectively, Japan, Switzerland, and Canada. How much, in local currencies, do the suppliers receive?
Japan = $20,000/0.0047 = $4,255,319 Yen
Switzerland= $5,000/0.515 = $9,709 Swiss francs
Canada= $15,000 /0.845 = $17,751 Canadian dollars
g. Compute the indirect quote for the spot and forward Canadian dollar contract.
The indirect quote indicates the number of units of a foreign currency that can be bought for one unit of the home currency.
Indirect quote = foreign currency / home currency
|Contract |S/ foreign | |Spot |.8450 | |30 days |.8415 | |90 days |.8390 |
|Indirect quote |[pic] |$ | |Spot |[pic] = |1.1834 | |Forward | | | |30 days |[pic] = |1.1883 | |90 days |[pic]= |1.1918 |
h. You own $10,000. The dollar rate in Tokyo is 216.6752. The yen rate in New York is given in the preceding table. Are arbitrage profits possible? Set up an arbitrage scheme with your capital. What is the gain (loss) in dollars?
▪ $10,000 dollars
▪ Dollar rate in Tokyo is $216.6752 yen per dollar
▪ Yen rate in New York according to table: 1 yen /0.004700 dollar ▪
Actual Yen rate in Tokyo: 1 yen/ 0.004615 dollar
Arbitrage profits will be possible because the indirect rates are out of line (they are different). This is possible assuming no transaction cost.
$10,000 dollars X 216.6752 = 2,166,752
|Amount of money in yens = $2,166,752 | | |Table rate |Actual Rate | |0.004700 |0.004615 | |Amount dollars= $10,183.7344 |Amount dollars= $10,000 | |Difference= $183.7344 |Difference= $0.00 |
(2,166,752 yen ) X (0.004700) = $10,183.7344 dollars
(2,166,752 yen) X (0.004615) = $10,000.00 dollars
Profit gain= $10,183.7344 dollars – $10,000.00 dollars= 183.7344 Profit gain= $ 183.7344 dollars
i. Compute the Canadian dollar/yen spot rate from the data in the preceding table.
Canadian Dollar/ U.S. Dollar Rate: 1 / .8450 = 1.1834
Yen/ U.S. Dollar Rate: 1 / .004700= 179.78
As we can see 1.1834 Canadian Dollar is equal to 1 American Dollar; meanwhile 212.76 Yen is the same that 1 American Dollar, it means that for each 212.76 Yen you have 1 American Dollar.