Zeus Public Limited Company: International Financial Management - Essay Example

International Financial Management Executive Summary The aim of this report is to evaluate the main features of the country and financial risk in the global business environment. Country risk applies to the foreign investment, and the financial risk is the variation of the home currency asset value. Three types of country risk which have an effect on Zeus Plc have been discussed. Expected Utility Theory and the Modigliani-Miller theory is also taken into consideration which explains that the financial decisions of a company do not have an effect on its value. The report has also focused on the International Fisher Effect and the importance of project financing. Zeus Plc can apply for the direct loan from the host government in order to finance its project. The host country i.e. Malaysia must arrange for the venture capital in order to reduce the financial risk associated with Zeus Plc. Table of content 1.0 Introduction 3 1.1 Country Risk 3 1.2 Types of Venture 4 2.0 Literature review 4 2.1 Effect of Country Risk on Zeus Shareholders 4 2.1.1 Political Risk 4 2.1.2 Legal Risk 5 2.1.3 Exchange Rate Risk 5 2.2 International Fisher Effect, Purchasing Power & Interest Rate Parity 5 2.3 Financial Risk 5 2.4 Utility Theory 6 2.5 Traditional Theory 6 2.6 Effect of Financing 6 3.0 Conclusions and Recommendations 6 Reference List 8 Appendix 11 1.0 Introduction 1.1 Country Risk Country risk was described by Levi (1990) as the type of risk that, because of a consequence of war, social or political events, or revolution; a firm might not be rewarded or paid for their exports. It applies to credit granted within trade and also to the foreign investment (Kosmidou, Doumpos and Zopounidis, 2010). However, it is also a part of financial risk. Scholars describe financial risk as a common term that is used for multiple risks that are close associated with and involves financial transaction (Frenkel et al, 2004; Siddaiah, 2010). In this regards, notion of debt and equity also becomes prevalent. The relation between debt and equity reflects the debt used for financing a company and equity of shareholders. In terms of the country risk ranking, UK is at 19th place as compared to 11th position in 2008. The score declines which means that in general the country risk of UK is 10 points less than the standard score designed for the AAA sovereigns (See Appendix 1 (Euromoney, 2012). As of now, its country risk rating is A2 (Globaledge, 2014). 1.2 Types of Venture Three types of ventures have been discussed i.e. joint venture, franchising, and subsidiary. Joint venture is the type of strategic alliance of two different companies where both of them decide to act jointly, normally forming a two different legal entity, for a similar purpose (Uta, 2001; Van and Wachowicz, 2008). Lima (2008) stated a subsidiary means a unit which is actually controlled by a different entity (Epstein and Jermakowicz, 2010). 2.0 Literature review 2.1 Effect of Country Risk on Zeus Shareholders Zeus Plc is assumed to be a large global mining company in the United Kingdom, which is deeming to extract minerals from the deposits which it owns at Tapir River in Malaysia. Country risk is generally higher with the longer term and direct investments. There are various types of country risk associated with Zeus Plc in undertaking the project. These risks are: political risk, exchange rate risk, legal risk. The mining zone is generally rated as “high risk” for the reason of probable future costs of cleanup, though some companies which have a good environmental records symbolizes lower risks as compared to others (Schrecker, 1993). 2.1.1 Political Risk The utmost source of the political risk which may have an impact on Zeus Plc is the legal and regulatory reforms, which also includes the obligation of royalties and additional taxes. Taxation risk can be described as risk that directly impacts the in terms of the capital gain and dividend income on each share and thereby making the stocks of the company less attractive. Political risk is just not restricted to government actions but the company may also experience an increase in the worker strikes which will affect the operation of Zeus Plc. These aspects make the mining sector mainly vulnerable to the threat of nationalization, increased governmental involvement, contract negotiation, vulnerable towards changes in the political philosophy, environmental concerns, and challenges by the local communities (Laird et al, 2014; Darling 2011). Zeus Plc can take various measures to lessen the political risk such as financing from main international investors to raise impact of the political argument from any unfortunate governmental actions; political risk cover; and engagement with the local people through policies of corporate social responsibility and human resources. 2.1.2 Legal Risk Legal risk of Zeus Plc is particularly associated with security or safety of title as well as with the requirement/lack of legal base for mining privileges of an overseas investor and invalidation or termination of exploration. Key issues which are related towards the legal risk are: whether the rights of extracting minerals have been correctly approved by state or not; or whether there are potential disputes linked with the project. A negative reaction towards these may result in the validity of title or challenging the label or title of mining project (Onthegroundgroup, 2013). 2.1.3 Exchange Rate Risk Exchange rate risk may also have an impact on the project undertaken by Zeus Plc. It comprises of a range of indirect price manipulating forces which drive the demand of mineral such as cobalt and chrome; and also the market factors that will have an impact on the volume and cost of the mineral supply. On demand side all these forces involves the power of the international economy, changes in the patterns of metal use in community, substitution threat for end users, and government interference on the demand of mineral (Barr and Raimbault, 2012). On supply side problems of the input costs, potential government restriction, and the market structure are among the exchange rate risk (Trench, Packey and Sykes, 2014). 2.2 International Fisher Effect, Purchasing Power & Interest Rate Parity The International Fisher Effect is a premise which is regarded as a mixture of Fisher Effect and Purchasing Power Parity. The theory of International Fisher Effect argues that the rates of real interest across the countries will be the same because of the probability of arbitrage prospects between the financial or monetary markets which normally takes place in the structure of capital flows. The rate of real interest equality signifies that the state with higher rate of interest should have higher rate of inflation which will make the actual value of country’s currency diminish over time (Ersan, 2008; Hatemi, 2009). The Purchasing Power Parity declares that the differentials of inflation rate between the two countries would give an equivalent but opposite outcome in the rate of spot exchange. The theory of Interest Rate Parity declares that in free marketplace the difference in percentage between the spot and forward rates will usually equal the dissimilarity between the rates of interest of two countries (Vaghefi, Paulson and Tomlinson, 1991). 2.3 Financial Risk Financial risk which may be related with the company is the variation of the home currency asset value, liability, and the operating income which is attributable towards unforeseen changes in the global or foreign markets. The most familiar is the foreign exchange risk, which is regarded as an optimistic function of the exposure of foreign exchange and the discrepancy of unexpected changes in the exchange rates (Rugman, 2009; Keown, 2004). In this regards, notion of debt and equity also becomes prevalent. The relation between debt and equity reflects the debt used for financing a company and equity of shareholder. In case of mining project, the financial risk related with the concern of currency are different as hard currency would most probably be produced from the mine export operations (Hoffman, 2007). 2.4 Utility Theory Expected Utility Theory is broadly considered as a rational move towards making of decisions which involves risk. However, the approach gives no precise role to evaluations of the risk and return. Neumann and Morgenstern (1947) argue that if the decision maker acknowledges a certain group of assumptions relating to “rational selection” then he should evaluate alternatives by the use of probable utility calculation (Bell, 1995; Barbera, Hammond and Seidl, 2004). 2.5 Traditional Theory The Modigliani-Miller theory provides situations under which the financial decisions of a company do not have an effect on its value. The first proposal discovers that under definite conditions, the debt-to-equity ratio of a company does not have an effect on its market cost or value. Second proposal discovers that the leverage ratio of a company has no consequence on the weighted average cost of capital. The third proposal ascertains that the company’s market value is not dependent on its dividend procedure. The fourth proposal ascertains that the equity owners are unresponsive about the financial policy of the firm (Villamil, 2012; Daske and Gebhardt, 2006). 2.6 Effect of Financing Multilateral Investment Guarantee Agency plays an important role towards providing guarantees against the risk in order to guard the cross-border venture in the developing countries. It protects the investors from the threat of transfer restriction, breach of contract, and expropriation. Moreover, it also promotes FDI investments by providing cover to the investors against the political risk (Miga, 2011). Project financing helps to reduce the country risk as well as financial risk associated with the projects. There are two types of financing facilities: direct loan is provided for the small projects, and loan guarantees are given for the larger projects. The characteristics which are used by the multinational companies to measure the financial risk of the company are the gross domestic product of the country, exchange rate, interest rate, and the inflation rate (Madura, 2014). Thus, by reducing the risks associated with the assignment, the project financing adds value to an assignment or the project undertaken (Bekaert and Hodrick, 2009). 3.0 Conclusions and Recommendations The report has examined the various types of risk which are associated with Zeus Plc while undertaking the project. It is strongly recommended that the company should take important steps towards managing its political, legal, and exchange rate risks; as well as the exchange rate risk. It can adopt the concept of project financing which will provide cover to the company against the country as well as financial risk. The country risk can be managed by using proper assessment of the risk and one of the common ways to deal is international invest agreements. In addition, purchase of risk insurance can also be a viable option. Reference List Barbera, S., Hammond, P. and Seidl, C., 2004. Handbook of Utility Theory. Heidelberg: Springer Science & Business Media. Barr, A. and Raimbault, C.A., 2012. Emerging Risks: A Strategic Management Guide. England: Gower Publishinh Ltd. Bekaert, G. and Hodrick, R. J., 2009. International financial management. New Delhi: Pearson Prentice Hall. Bell, D.E., 1995. Risk, Return, and Utility. INFORMS Journal, 41(1), p.23. Darling, P., 2011. SME Mining Engineering Handbook. United States: Society for Mining, Metallury, and Exploration, Inc. Daske, H. and Gebhardt, G., 2006. International financial reporting standards and experts’ perceptions of disclosure quality. Abacus, 42(3), pp.461-498. Epstein, B. J. and Jermakowicz, E. K., 2010. WILEY Interpretation and Application of International Financial Reporting Standards 2010. United States of America: John Wiley & Sons. Ersan, E., 2008. International Fisher Effect: A Reexamination within the Co-integration and Dsur Framework. [pdf] Available at: < http://etd.lib.metu.edu.tr/upload/12610157/index.pdf> [Accessed 22 Nov 2014]. Euromoney, 2012. Country Risk: Moody’s behind the curve on UK sovereign risk. [online] Available at: < http://www.euromoney.com/Article/2979562/Country-risk-Moodys-behind-the-curve-on-UK-sovereign-risk.html> [Accessed 22 Nov 2014]. Frenkel, M., Karmann, A., Scholtens, B. and Scholtens, L.J.R., 2004. Sovereign Risk and Financial Crisis. Berlin: Springer Science & Business Media. Globaledge, 2014. United Kingdom: Risk Assessment. [online] Available at: [Accessed 22 Nov 2014]. Hatemi, A., 2009. The International Fisher Effect: Theory and Application. Investment Management and Financial Innovation, 6(1), p.117. Hoffman, S.C., 2007. The Law and Business of International Project Finance: A resource for Governments, Sponsers, Lawyers, and Project Participants. England: Cambridge University Press. Keown, A.J., Martin, J.D., Petty, J.W. and Scott, D.F., 2004. Foundations of Finance: The Logic and Practice of Financial Management. Asia: Pearson Education Asia Ltd. Kosmidou, K., Doumpos, M. and Zopounidis, C., 2010. Country Risk Evaluation. Berlin: Springer Science & Business Media. Laird, I.A., Sabahi, B., Sourgens, F.G. and Weiler, T.J., 2014. Investment Treaty Arbitration and International Law. United States of America: Juris Publishing, Inc. Lima, J.M.C., 2008. Patterns of Internationalization for Developing Country Enterprises. [pdf] Available at: [Accessed 22 Nov 2014]. Madura, J., 2014. International Financial Management. United States of America: Cengage Learning. Miga, 2011. Multilateral Investment Guarantee Agency: World Bank Group. [online] Available at: < http://www.miga.org/> [Accessed 22 Nov 2014]. Onthegroundgroup, 2013. When the Tide Turns: Legal Risk Management Planning for Mining Project in Latin America. [pdf] Available at: [Accessed 22 Nov 2014]. Rugman, A.M., 2009. The Oxford Handbook of International Business. New York: Oxford university Press. Schrecker, T., 1993. Sustainable Development, Getting There from Here. Ontario: National Round Table Publication. Siddaiah, T., 2010. International Financial Management. New Delhi: Pearson Education India. Trench, A., Packey, D.J. and Sykes, J., 2014. Non-Technical Risks and Their Impact on the Mining Industry, in Mineral Resources and Ore Reserve Estimation. United States of America: The Australian Institute of Mining and Metallury. Uta., 2001. Entry Methods. [pdf] Available at: [Accessed 22 Nov 2014]. Vaghefi, M.R., Paulson, S.K. and Tomlinson, W.H., 1991. International Business: Theory and Practice. New York: Taylor and Francis. Van H. J. C. and Wachowicz, J. M., 2008. Fundamentals of financial management. New Delhi: Pearson Education. Villamil, A.P., 2012. The Modigliani-Miller Theorm. [pdf] Available at: [Accessed 22 Nov 2014]. Appendix UK Country Risk Score (Source: ECR, 2012) Read More