In forward Contract, an exchange rate is quoted today for settlement at a future date.
E (S1) = Exercise Price * No. of units
Taken information from above figures, expected amount of CAD received after one year using forward contract hedge = 10,00,000 * 0.45 = CAD 4,50,000
Purchasing power parity focuses on ‘inflation-exchange rate’ relationship.
E (S1) = Current Spot rate * expected difference in inflation rates
E (S1) = So *(1 + Id)
(1 + If)
E (S1) = Expected Spot Rate at end of expiration period i.e. 1year
So = Current Spot Rate i.e. 0.40 PEN/CAD
Id = Inflation rate in domestic currency i.e. 3%
If = Inflation rate in foreign currency i.e. 2%
Thus, expected amount of CAD received after one year using PPP:
E (S1) = 0.40 * (1 + 3%) = 0.4039 PEN/CAD
(1 + 2%)
E (S1) = 0.4039 * 10,00,000 = CAD 4,03,900
In put option, gives buyer the right, but not the obligation, to sell a specified no. of units of commodity or currency to seller of option at a fixed price on or up to a specified date.
Premium is also paid by the buyer at the inception of the contract.
Therefore, Premium Amount received = CAD 0.07 per sole * 10, 00,000 soles = CAD 7,00,00
If Expected spot price is greater than exercise price, then buyer do not exercise put option but where Expected spot price is less than exercise price, then buyer exercise put option. In both cases, Buyer has to pay premium amount.
Transaction exposure is also called as Transaction risk.
Example: Suppose that a company based in US signs a contract with a company based in Belgium to purchase a product. The contract states that payment should be made on supplier’s country currency i.e. Payment should be made in Euros (€). US Co. agrees to pay to Belgium co. $1.5/€ for every product purchased. After the completion of agreement, sale might not take place immediately then there is a possibility of change in ratios of dollars to Euros (which could be favorable change or adverse change or no change) before the final sale is happened. Thus, this risk of change is the transaction exposure.
In other words, greater the time between agreement and settlement of contract, greater is the risk of Transaction Exposure.
Measures to reduce Transaction Exposure in MNC: Multi-national Corporation should enter a contract in forward exchange rate, which lowers the risk of transaction exposure.
Example: Suppose a small European Company only sell the products in their local market and do not export their exports, then also company would be adversely affected because of high value of Euros it make imports from other countries cheaper which increases competition in European markets.
In other words, Economic exposure deals with unanticipated fluctuations in foreign exchange rates which can have a significant impact on company’s market value.
Measures to reduce Economic Exposure in MNC: Economic exposure can be reduced either through operational strategies such as diversification of finance sources, product markets, production facilities etc or through currency risk strategies such as currency swaps etc. (Source: DFPT)
|
Foreign Direct Investment (FDI) |
Portfolio Investment (PI) |
|
FDI refers to making investments in acquisition and control of physical assets in another country. |
PI refers to making investments in financial securities such as equities, debt instruments including investments in mutual funds etc. |
|
FDI carries the seeds that can lead to consistent economic growth. |
High Volatility of PI’s cannot ensure stable economic growth. |
|
FDI projects are managed with great efficiency. |
PI projects are less efficiently managed. |
|
Both Ownership and management rights obtained by FDI investors. |
Only Ownership rights are gained by PI investors. |
|
In FDI, Investors do not sell their stake easily. |
In PI, investors can easily sell their stake in financial assets. |
|
FDI results in transfer of funds. |
PI results in capital inflows. |
|
In FDI, investors can invest in both financial as well as in non-financial assets. |
In PI, investors only invest in financial assets. |
|
FDI investors have substantial interest in the firm. |
PI investors only have short-term interest in the firm. |
|
At end of 2015, FDI has only 24% of total foreign investment in Australia. (Source: ABS Data). |
At end of 2015, PI has only 54% of total foreign investment in Australia. (Source: ABS Data) |
2004 (Figures in Billion$)
|
Countries |
2004 |
% of total |
|
United States of America |
368.4 |
32% |
|
UK |
281.6 |
24% |
|
Japan |
43.8 |
4% |
|
Netherlands |
26.0 |
2% |
|
Hong Kong (SAR of China) |
23.4 |
2% |
|
New Zealand |
22.4 |
2% |
|
Switzerland |
20.5 |
2% |
|
Belgium and Luxembourg |
20.4 |
2% |
(Source: Australian Bureau of Statistics, Catalogue 5352.0)
FOREIGN INVESTMENT IN AUSTRALIA, LEVELS, 31 December 2004
2014 (Figures in Billion $)
|
Countries |
2014 |
% of total |
|
United States of America |
758.2 |
27% |
|
UK |
484.2 |
17% |
|
Belgium |
226.1 |
8% |
|
Japan |
174.7 |
6% |
|
Singapore |
80.2 |
3% |
|
Hong Kong (SAR of China) |
77.3 |
3% |
(Source: Australian Bureau of Statistics, Catalogue 5352.0)
Australia is the rich resource country having a high skilled workforce (ranked 6th in the world, Source: ABS). Australia also promotes competition and it is known for the innovation by bringing new technologies and services to the Australian Market.
Factors:
Therefore, on the basis of above factors, it is suggesting that foreign investment remains a steadily influence on the Australian economy which is important for the benefits of the economy and hence, above countries invests large amount of FDI in Australia.
FDI proved to be flexible during financial crisis, FDI opens up export opportunities thereby increasing export performance also encourages macroeconomic environment and digital innovation.
In FDI, investing countries cannot easily have entered as well as exist from FDI and also do not sell their FDI investment easily. FDI’s share is higher in countries with weaker credit ratings.
Hence, from both positive and negative reasons, it is evidenced that FDI has appraised a beneficial impact on economy of the world.
Most investments cover 5 sectors these are: Software and IT services, business services, financial services, chemical sector, manufacturing sector etc. In future forecast, it is seen that majority of foreign investment approvals are for New Dwellings.
Thus, future expectations of 5 years over 2014 are that US, UK, Singapore and Japan will remain in the largest source of FDI in Australia. Other major investing countries includes Hong Kong and China. India is also entered the top 10 list of FDI index. This survey indicates Asian Region are most interested in investing Australian FDI.
Thus, Australian FDI is projected to around 46727.90 AUD million in 202 (Source: ARIMA Model).
Hence, foreign investment has contributed to Australia’s sustained economic growth, innovation and ongoing prosperity.
References
Ahmad, Y, S., Cova, P. and Harrison, R. (2004) Foreign Direct Investment versus Portfolio Investment: A global games approach. University of Wisconsin: Whitewater working paper.
Australian Bureau of Statistics. (2004)5352.0 – International Investment Position, Australia: Supplementary Country Statistics. [Online]. Available from: https://www.abs.gov.au/AUSSTATS/[email protected]/allprimarymainfeatures/568F68EE36081C32CA2571C4007CCDE6?opendocument [Accessed 24 March 2017]
Australian Bureau of Statistics. (2014) 5352.0 – International Investment Position, Australia: Supplementary Country Statistics. [Online]. Available from: https://www.abs.gov.au/AUSSTATS/[email protected]/allprimarymainfeatures/011CD15D6E630B76CA257FAF001A4235?opendocument [Accessed 24 March 2017]
Australian Trade and Investment commission. (2017). Guide to investing. [Online]. Available from: https://www.austrade.gov.au/International/Invest/Investor-Guide [Accessed 24 March2017]
Clements, K, W. and Lan, Y. (2006) A new approach to Forecasting exchange rates. The University of Western Australia: Australia.
Department of Foreign Affairs and Trade. (2017). Australia and foreign investment. [Online]. Available from: https://dfat.gov.au/trade/topics/investment/Pages/australia-and-foreign-investment.aspx [Accessed 24 March 2017]
Eun, C,S. and Resnick, B,G. (2015) International Financial Management. 7th ed., New York: The McGraw Hill Companies Inc.
James, J., Marsh, I, W. and Sarno, L. (2012) Handbook of exchange rates. New Jersey: Wiley.
Kearney, A, T. (2016) The 2016 Foreign Direct Investment (FDI) Confidence Index. [Online]. Available from: https://www.austrade.gov.au/news/economic-analysis/the-2016-foreign-direct-investment-fdi-confidence-index [Accessed 24 March 2017]
Madura, J. and Fox, R. (2011) International Financial Management. 3rd ed., Hampshire: South-Western Cengage Learning.
Nasdaq. (2017). Foreign exchange risk. [Online]. Available from: https://www.nasdaq.com/investing/glossary/f/foreign-exchange-risk [Accessed 24 March2017]
Shapiro, A, C. (2010) Multinational Financial Management. 10th ed., University of Southern California: Hoffman, G.
Swieringa, J. and Wokker, C. (2016) Foreign Investment and Residential Property Price Growth. Australia: The Australian Treasury.
The Australian Government. (2015). Foreign Investment Reforms Factsheet: Foreign Investment in Australia. [Online]. Available from: https://firb.gov.au/files/2015/09/FIRB_fact_sheet_Foreign_investment_overview.pdf [Accessed 24 March 2017]
Trading Economics. (2017). Balance of Trade. [Online]. Available from: https://www.tradingeconomics.com/country-list/balance-of-trade [Accessed 24 March2017]
Trading Economics. (2017). Foreign Direct Investment/Forecast/2016-2020. [Online]. Available from: https://www.tradingeconomics.com/forecast/foreign-direct-investment [Accessed 24 March2017]
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