Discuss about the International Financial Management for Democratisation.
Given Exchange Rate: EURUSD = 1.1 it means 1 Euro = 1 US Dollars
Increase of 2% value of dollar is equal to 1$ * 102% = $1.02
New Exchange rate: (Euro 1.1/US Dollar 1)* US Dollar 1.02 = 1.122/1 it means EURUSD = 1.1220 (Deegan, 2013)
B:
|
EURUSD |
1.1043 |
|
GBPUSD |
1.2970 |
Exchange Rate given:
It means EUR/USD = 1.1043/1 and GBP/USD = 1.2970/1 (Berger and Harjes, 2009)
Cross Exchange Rates= GBP/USD divided by EUR/USD which means 1.2970/1 divided by 1.1043/1 it can also be expressed as GBP/USD multiplied by USD/EUR (Jakab, Lukyantsau and Wang, 2015)
So, on the basis of above calculation GBPEUR = 1.1745
|
EURUSD |
1.1043 |
|
GBPUSD |
1.2970 |
|
USDEUR |
0.9056 |
|
GBPEUR |
1.1745 |
Triangular arbitrage occurs when there is discrepancy between three currencies (Foreign Currencies) and currency exchange rates do not match up with each other. Arbitrage can be referred to an opportunity that arises in the financial market when similar asset can be purchased and sold at the same time in different prices due to exchange rate difference (Borio, 2014). Triangular arbitrage is also known as three points arbitrage or cross currency arbitrage that can provide profit to the arbitrator when he uses three or more currencies to make profits. There is great role of cross currency calculation while arbitrator uses triangular arbitrage in order to make more profits. The process performing the triangular arbitrage is given as under:
On the basis of above information it can be said that there is direct relation of cross currency exchange rate and triangular arbitrage because without direct application of cross exchange rates in the triangular arbitrage process. So it can be said that cross exchange rate calculation is required for doing the triangular arbitrage as there are three currencies involved in triangular arbitrage and calculation to needed to find what benefit change from base currency to third currency will provide to arbitrator (Madura, 2007).
Purchasing power parity refers to the macro economic theory that shows that exchanges rates between different currencies are at equilibrium when the purchasing power of these currencies is same at each of two selected countries. In easy language it can be said that exchange rate between any of the two selected countries must be equal to ratio of two countries price structure that contains fixed level of basket of goods and services. To more simplify this theory, it can be understand as when the price level in the domestic country is increasing (it means that country experiences inflation) than in order to return to the purchasing power parity exchange rate of that country must be depreciated in accordance to certain change exchange rate during the period (Taylor, 2013).
Formula used in purchasing power parity= S1 / S0 = (1 + Iy) ÷ (1 + Ix)
Where:
Application of above formula to calculate the inflation rate:
Home Currency is US Dollar and home country is USA
Foreign Currency is EURO and foreign country is Europe
= S1 / S0 = (1 + Iy) ÷ (1 + Ix)
Given data:
|
Date |
Currency |
Rate |
|
Jan-17 |
EURUSD |
1.1000 |
|
Dec-17 |
EURUSD |
1.1440 |
Applying in formula we get
= 1.144/1.100 = (1 + Iy) ÷ (1 + Ix)
Here y represent foreign country (Europe) and x represent home country (USA)
So it can be said that home country (USA) has higher inflation rate and it is 4% greater than the domestic inflation rate (Ignatiuk, 2009).
B:
= S1 / S0 = (1 + Iy) ÷ (1 + Ix)
= S1 / 1.100 = (1+Y) ÷ (1 + 1.03Y)
So closing exchange rate will be EURUSD = 1.03 which means $1.03 can be received for 1 euro. Real Change in value of dollar will be 6.6%.
The exchange rate is having an important role for the business companies involves in trading of their products and services at a global level. The currency fluctuations are the outcome of the floating exchange rate system as business conducts their operations in foreign currencies other than domestic currency in varying countries. The price of a currency is dependent on the forces of demand and supply in the currency markets and thus change in these factors causes fluctuations in the currency rates (Gills and Thompson, 2006).
The changes in the exchange rate have a direct impact on the price of goods and services traded on an international level. For example, depreciation in the value of a foreign currency will cause the exports to become cheaper and will make imports more expensive and vice-versa thus there is a large implication of changes in the currency rate on the growth and development of global business organizations. The exchange rate changes also have a direct impact on the rate of inflation and thus impacting the economic growth and development of a country.
Business organization tend to mitigate the impact of changes in the real currency rate by the use of hedging so that it does not cause a large impact o the operating profits. The changes in currency rate directly impact the operating profit by increasing the operational cost and the prices of the products and services manufactured (Fouejieu and Roger, 2013).
The interest rates of any country are affected by number of factors. Among them inflation rate is much impacted. Interest rate is directly proportional to the change in inflation rate. So it can be said that if inflation rate rises it will also increase the interest rate of that particular country and if there is decrease in the inflation rate than interest rate will also decreases. Rates of interest in any country are very much impacted by the inflation and deflation. Inflation occurs when there is decrease in purchasing power of money and people need to spend more to buy the same of value of good that they are buying before the inflation has occurred. In inflation condition people having the investment demands the higher rate of interest as it was asked prior to inflation and this factor increases the rate of interest rate further as compared to expected rise in interest rates. In case when there has been compared of two countries on the change of rate of interest due to change in inflation rate than country with higher inflation rate will face higher increase in interest rate as compared to country with lower rate of inflation. This is the reason why domestic country (USA) has faced higher interest rate as compared to Euro area. The exchange rate change clearly shows that USA has faced the higher rate of inflation as compared to Euro area (Ignatiuk, 2009).
The interest rate of government bonds are not affected by the increase in inflation rate it is because return on the government bonds are secured by the government itself and they bear any difference due to inflation are bear by the government. This is the reason why in practice there are changes in interest rate of bonds due to inflation but does not change in real world as it is secured by the government (Wang, 2009).
The country risk is regarded as the significant risks associated with investing in a foreign country. The major types of country risk include political uncertainty, fluctuations in exchange rate, economic conditions and sovereign risk. This type of risk varies from one country to another as the nature of uncertainties is different in various countries. The analysis of the risk associated with a country is particularly conducted for examining the potential growth and development of a business on carrying out its operations in the respective country. Thus, the countries having excessive risk is often avoided for investment purpose by multinational companies (Bouchet, Clark and Groslambert, 2003).
The conduction of business operations on an international level often induces various types of risks that are not present in the domestic transactions. The risks are regarded a country risk and one of the major risk that a global business has to face is of foreign exchange risk. The risk occurs due to exposure of a corporation to fluctuations in the exchange rate as it conducts its transactions in foreign currencies. The changes in the foreign exchange rate can have a large impact on the value of assets and liabilities that are denominated in foreign currencies of a business corporation. The exchange rate volatility can be regarded as the tendency of foreign countries to appreciate or depreciate in the value and thereby impacting the profits realized from carrying out business transactions in foreign currencies (Fouejieu and Roger, 2013).
The business investors need to examine primarily the exchange rate volatility as a major contributor of country risks impacting the opportunities of business growth and success in a new country. There is a large impact on the operating profit of multinational companies due to fluctuations in the foreign exchange rates. The business managers need to take into account the operating exposure to exchange rate volatility at the time of implementing the decisions of expanding their products and services at an international level. The operating exposure to floating exchange rates is becoming a matter of serious concern as the countries worldwide are adopting the use of divergent monetary policies. These changes are largely impacting the operating profits of multinational companies and as such increases the country risk for them. Also, the companies does not conduct their operations globally are also largely impacted with the changes in the exchange rates. This is because these companies often face competition from the foreign firms in the domestic market (Wagner, 2012).
The exchange rate volatility can be regarded as a most pertinent reason for country risks but there is also a large difference between them. The exchange rate volatility represents only a specific type of risk present within a country that can impact the profitability position of a business due to changes in the currency rates. However, country risk includes other type of risk as well in addition to exchange rate volatility such as political and economic uncertainty impacting the operations of a business company. These types of uncertainties can also result in causing instability within the operating environment of a country and can result in causing market volatility. The presence of instability within the operating environment of a country due to conditions such as political unrest, slower economic growth or sovereign risk can largely impact the investment decisions of business managers. As such, the economies having the presence of such risk are struggling to attract investors even if there is lower risk of fluctuations in the foreign currency rate (Kosmidou, Doumpom and Zopounidis, 2010).
However, exchange rate volatility can be regarded as a major type of market risk that a business corporation needs to analyze properly before investing in a country in comparison to other type of risks. This is because it directly impacts the operating profit of a business entity and is also largely uncontrollable. The business companies often adopt the use of sensitivity analysis for predicting the changes in the foreign currencies and hedging contracts to manage it but the risk have a large impact on the business operations. On the other hand, other type of county risk can be controlled by making realize to the government of host country that the business company would promote the economic growth and development of the country (Wagner, 2012). This could promote the change in the government bodies and foreign policy providing the political and economic support to the growth of the business. Also, the countries are involving id developing a joint association such as European Union to promote free trade of goods and services among the member countries. This would also help in reducing the political and economic instability within the countries. Thus, it can be said that there country risk analysis have a broad range of risk and the businesses need to adopt specific procedures for mitigating all of them as it would also help in reducing the exchange rate volatility (Kosmidou, Doumpom and Zopounidis, 2010).
Globalization process can be stated to be repaid integration of economy worldwide promoting the interlinking between the various countries. It has facilitated improving the trade flows between the different countries and promoting their economic growth and development. Multi-national companies (MNCs) are the business enterprises carrying out their production sin more than one country in order to gain location specific advantages. These specific advantages can be economic labor, high availability of raw materials and supportive government policies and regulations. Thus, the production and selling of products and services by the MNC’s at wide level causes the economic linkage of various countries and thus supporting the globalization process. The operation of multinational economies in different countries requires significant investment known as foreign direct investment that will act as a major contributor of capital inflows into the domestic economy. The global capital flows in turn promotes the interconnections between the world economy and support the process of globalization (Gills and Thompson, 2006).
In addition to promoting the trade flows, the buying and selling of products and services by multinational corporations also promotes the process of globalization. The outsourcing of production processes to lesser developed countries for realizing operational cost benefits also increases the interconnectedness between the different countries. Therefore, it can be said that multinational corporations are causing the flow of more goods and services, investments and technologies and leading to developed of an advanced and integrated economies around the world. This is largely due to greater availability of products from any part of the world into a respective country. For example, business corporations such as Ford and Hyundai by carrying out their production functions in less developed countries such as India is causing greater availability of cars within these countries. The greater movement of labor and raw materials across the world due to operations of MNCs is responsible for development of better links across the various countries (Benedek, Feyter and Marrella, 2007).
The increased communication between different countries due to operations of a multinational corporation is leading to the development of an integrated economy. The increased trade flows, rapid access to technology, media, education, healthcare, products and other resources are promoting the economic growth of the countries at a global level. The process of globalization supported by the operations of MNCs is causing the reduction in global poverty and is also helpful in reducing the political and economic instability with uniform distribution of resources. It also provides more employment opportunities to the people worldwide and leading to facilitating the economic growth of the countries. However, there are also some negative effects associated with the globalization that also need to be taken into consideration. It has been regarded that globalization is a major contributor of increasing the environmental pollution due to increased number of business activities that produces larger amount of waste and release of harmful substances into the atmosphere. The environmental degradation caused due to business activities of multinational companies is the most serious issues that need to be tackled for realizing the large benefits of the globalization process (Brooks, 2011).
In addition to this, it can also cause exploration of domestic economies by negatively impacting the growth rate of domestic business entities. Also, the multinational corporations have also lead to an increase of social injustice within the countries due to their unhealthy working conditions that can often cause health issues among the workforce diversity employed within these companies. These types of issues have been highlighted in various types of companies such as Toyota, Samsungs and other larger manufacturing companies. In this context, it is essential by the government of various countries to implement strict rules and regulations for monitoring the business activities of multinational companies. This is essential to keep a track of their business operations on the environmental and community so that the sustainability risk can be reduced to a larger extent. The multinational companies should be mandated to comply with all the rule sad regulations in the country of its operations to ensure that the negative effect of its functions can be reduced to a large extent. This is essential so that the host economy realizes larger benefits from the process of globalization in comparison to its negative impacts (Blanco, and Razzaque, 2011).
Globalization can be attributed to be associated with both types of outcomes that can be good or bad. The force of globalization promoted by multinational companies is good in the sense that it is leading to the development of an integrated economy facilitating better exchange of resources between them. Thus, people living in a developing economy can utilize the products and services of a developed economy and thus can improve their living conditions. The greater employment opportunities tend to increase the purchasing power of consumers and leading to the business growth and development. However, there are also some negative effects of the process as discussed that need to be overcome by the MNCs to ensure that it only have a positive effect on the world economies (Gills and Thompson, 2006).
References
Benedek, W., Feyter, K. and Marrella, K. 2007. European Inter-University Centre for Human Rights and Democratisation. Cambridge University Press.
Berger, H and Harjes, H. 2009. Does Global Liquidity Matter for Monetary Policy in the Euro Area?. International Monetary Fund.
Blanco, E. and Razzaque, J. 2011. Globalisation and Natural Resources Law: Challenges, Key Issues and Perspectives. Edward Elgar Publishing.
Borio, C., 2014. The financial cycle and macroeconomics: What have we learnt? Journal of Banking & Finance, 45, pp.182-198.
Bouchet, M., Clark, E. and Groslambert, B. 2003. Country Risk Assessment: A Guide to Global Investment Strategy. John Wiley & Sons.
Brooks, S. 2011. Producing Security: Multinational Corporations, Globalization, and the Changing Calculus of Conflict. Princeton University Press.
Deegan, C., 2013. Financial accounting theory. McGraw-Hill Education Australia.
Fouejieu, A. and Roger, S. 2013. Inflation Targeting and Country Risk: An Empirical Investigation. International Monetary Fund.
Gills, B. and Thompson, W. 2006. Globalization and Global History. Psychology Press.
Ignatiuk, A. 2009. The Principle, Practise and Problems of Purchasing Power Parity Theory. GRIN Verlag.
Jakab, Z., Lukyantsau, P. and Wang, S. 2015. A Global Projection Model for Euro Area Large Economies. International Monetary Fund.
Kosmidou, K., Doumpos, M. and Zopounidis, C. 2010. Country Risk Evaluation: Methods and Applications. Springer.
Madura, J. 2007. International Financial Management. Cengage Learning.
Taylor, M. 2013. Purchasing Power Parity and Real Exchange Rates. Routledge.
Wagner, D. 2012. Managing Country Risk: A Practitioner’s Guide to Effective Cross-Border Risk Analysis. CRC Press.
Wang, P. 2009. The Economics of Foreign Exchange and Global Finance. Springer Science & Business Media.
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