International Financial Management of International Investments Plc - Essay Example

Running head: international financial management 12th August Introduction International financial management entails management of finance in a global business atmosphere. Most importantly, it implies making money by doing trade that involves foreign currency. While some companies have adopted various strategies to increase their capital in the domestic market, others have invested their capital abroad for various reasons. These include first, efficient production of products in the foreign market as compared to domestic market. Secondly, companies are able to easily obtain raw materials that they use in their production facilities. Thirdly, firms aim at broadening their market. Fourthly, companies aim at increasing their returns. In terms of career, International financial management is focused to the students who aim at being involved in investment across the border where they will be involved in making financing decision while working managers, investors or consultants. Four key areas that are covered by International financial management include currencies, multinational financial decision making, institution and finance and cross border valuation. This paper seeks to discuss various issues that came about during the half yearly meeting of International Investments plc from various stakeholders. Section 1 Being the world’s primary reserve, the dollar is a key aspect that helps US government to keep interest at low level. On their part, foreign countries buy the US treasury debt for two main reasons. First, it is an investment that the countries can use to improve their monetary policies. Secondly, dollar-denominated assets as compared to other currencies are the best way to hold foreign exchange reserves (Brealey and Myers, 1991). As indicated by Catherine Mann, long-term global economic health demands that United States and the trading partners to collect internal imbalances as well as external balances. In order to ensure that the future position of the dollar remains strong there is need for co-dependency between US and the trading partners (Grimwade, 2000). In the case of depreciation of a dollar, there will be an economic problem that will involve global re-balancing. Global re-balancing refers to complementary narrowing of two imbalances across the globe. These include expansive dependence of other countries on the net exports of the US as well as the increasing US current account deficit. One of the key roles of global co-dependency is that it prevents the dollar from depreciation while at the same time keeping the current configuration of the world imbalances at the best position (John, 1999). However, as imbalances increases in most countries globally, it has become increasingly difficult to address the global co-dependency without facing a crisis in the currencies systems, financial assets, global exchange of goods as well as local and global growth. Based on its importance in establishing strong global economy, the dollar has been effectively being prohibited by policy makers from getting into broad-based depreciation (Catherine, 2004). One of the important aspects that are common to both the rest of the world and US is that while their paths towards maintaining strong dollar are not sustainable, if they come together, they become sustainable for a long period of time. Mr Wart should not be worried about the future value of the dollar since through global co-dependency between US and other parts of the world has become strong as the concept of globalization takes the centre stage. Despite the short term period, there have been empirical suggestions that the dollar will highly depreciate leading to poor performance of financial market; this is not likely to occur as the result of the microeconomic policies as well as global co-dependency adopted by the US and the rest of other countries. One of the major roles of the dollar in the development of economy across many countries is global re-balancing. Just like the UK, the US exports has indicated an increasing trend in the exports as well as imports. The country balance of payment, which implies an accounting of the countries global transactions for a specified period of time, has significantly improved. As indicated by the capital account, financial account as well as current account of both the US and UK, there has been an increase in the credits for both the countries (Triffin, 1961). Based on the increase in the business transactions between the US and UK, the demand for dollar has increased thus making it stronger. Another point to note is the increase in the number of transactions and high level of investment that the US has embarked on especially in the developing countries. It is worth noting that majority of the third world countries have turned to importing products from US (Laursen, 2009). In this way, the current demand for dollars worldwide is high an aspect that will still occur in future as countries under the leadership of US engages on global co-dependency Section 2 In their efforts to increase the profits and expand market share, local and international businesses have embarked on trading on the financial market. Thus, it is imperative for such firms to make reliable decisions through the assistance of market and economic analysts. It is imperative to note that the behaviour of stock market cannot be easily predicted by investment firms or traders. This is based on the fact that various factors could result to falling or rising on the market prices (Stern, 1973). In their efforts to explain future prices of the stock, various chartist theories have come up with wide ranges of suggestions. Similarly, the theory of random walks has been applied by other schools of thought. Despite the diversified view by the theories, they share the same assumption that indicates that the past behaviour of security prices have resourceful information pertaining the future behaviour (Tausch, 2008). During their trading in the money market, the percentage movement in the currency is what matters and not the value of one unit of a currency. One of the major aspects that make the number of businesses investing in financial market to increase is the large number of markets that are involved in the financial sector. The major one is the capital market. Capital market consists of stock market that entails buying and selling of shares and common stock. It also covers bond market which provides finance by issuing bonds. Future markets, on their part involve central financial exchange where investors can sell and buy standardized future contracts (Sweeney, 2002). The contracts that are involved in the future market indicate the financial instrument that a party will sell or buy. In addition, it indicates the quantity, delivery month, minimum tick value, and the currency to be used in the trading process (Schweickert, 1995). Money market covers short term instrument that are used to finance business activities. Some of the notable instruments include treasury bills, bills of exchange, commercial papers, and certificates of deposit among others. Other markets include commodity markets, derivatives markets, foreign exchange markets and insurance markets. During their business activities, businesses apply three notable market pricing techniques. First, it is the law of one price. This law implies the same product should not have two prices. Thus, when a company buys bonds or stock they expect to get same price for the products. The second law is that of arbitrage. This law depicts that once an individuals or a business decides to trade without risks, certain outcome are expected and there is no profit made. It is essential to note that just like in other products; traders must be ready to face the risks that are involved in the financial market. Additionally, arbitrage indicates that investors should take the advantage of the differences in prices within the market in order to capitalize on the imbalances thus making profits (Sparks, 2007). The third law is the efficient market pricing. This entails the efficient market hypothesis that covers the random walk and market efficiency. One of the notable concepts that cause market prices for shares, bonds and other financial products is valuation model. According to this model, good news results into increase in the market prices while bad news leads to decrease in prices. Another aspect that is important in the money market is pattern. One of the key aspects of pattern to the investors is that it enables them to predict the future. In case the traders are not able to predict the movement in prices, then it implies that there is no pattern thus making the movement to be random (Homaifar, 2004). The use of probability in the financial market is extensive. For example, a range of possible prices increases over the time at a regular rate if two conditions are met. First, if the movement is random and secondly, if the per period variation is constant. Range of possible prices is chosen if the investors are 95% confident that the prices will fall within the range. Section 3 As indicated by Mr Moldy, large number of firms has now viewed revenue from abroad as the major source of income that they use to expand their operations. Through the use of internet as well as the establishment of production facilities abroad, the companies aim at increasing total output in foreign countries. By embarking on foreign domestic investment, firms aim at attaining a bargaining power. Some of the notable sources of bargaining power for MNCs include technology, product differentiation, increasing capital, expanding the worldwide scale, increasing exports and product diversity among others. A multinational corporation may engage in foreign products markets, foreign subsidiary or in the international financial markets (Robertson and Bain, 1966). According to the Rugman Bargaining model, the goals of Multinational Corporation include increasing sales, attaining more resources, increasing profits and creating a positive image on the eyes of the public and government. However, the financial problems that the companies face are providing limitation on their activities. One of the major problems that such companies face is fluctuations in currency exchange rates. This entails a problem that occurs whenever a financial transaction is undertaken through the use of a currency that is not similar to the base currency in the home country. Another cause of foreign exchange risk is the use of a different currency by a foreign subsidiary rather than the one adopted by the consolidated firm in the home country. One of the problem that arises as the result of foreign exchange risk is transaction exposure. This is a risk that arises when payables and receivables are subjected to changes that were unanticipated due the use of foreign currencies. Economic exposure on its part occurs when the market value of a company is influenced by the exchange rate fluctuations that were unexpected. Adjustment in the exchange rates can have negative implication on the firm market share in terms of competition, cash flows and company’s value. Notable implication of economic exposure is affecting the present value of future cash flows. Another problem that arises due to foreign exchange risk is translation exposure (Moffett et al. 2009). Translation exposure entails the level to which the financial reporting of a firm is affected by the changes in the exchange rate. Based on the fact that all companies are under obligation to prepare consolidated financial statements, multinational firms must translate foreign liabilities and assets from foreign to domestic currency. Translation exposure has negative impact on reported earnings thus affecting its stock price. Contingent exposure entails the problem that the exporting companies face while bidding for projects in foreign countries. The same problem may occur if a firm enters into a contract with foreign countries. Contingent exposure occurs due to changes that occur in the currencies while a company is engaging in foreign business transactions. The problem of foreign exchange risk can be evaluated or measured by checking at the three global parity conditions which includes interest rate parity, purchasing power parity as well as international fisher effect (Bhagwati, 2004). Another way of measuring this financial problem is through checking the standard deviation as well as the variance of variables for example the rates of change or the percentage returns. The higher the standard deviation, the higher the currency risks. However, despite its usage in evaluating the financial exchange risk, the standard deviation has been criticized by many economists based on its inaccuracy as a risk indicator. In this regard, semivariance and average absolute deviation have been more reliable in measuring the financial risk (Chew and Quek, 2003). As the result of the foreign exchange risks, firms that are engaging on foreign projects must come with methods of eliminating the risks. Through the use of hedging strategies, companies are able to reduce the risks. For example, transaction exposure can be reduced through the use of foreign exchange derivatives, options, currency invoicing, exposure netting, and future contracts among others. On its part, translation exposure can be addressed by undertaking a balance sheet hedge or through the use of foreign exchange derivatives. Other notable problem that firms that relies on exporting face is taxation as well as trade barriers. In their effort to increase government revenues, most countries have emulated strong taxation system that should be followed by local and foreign investors (Gitman, 1976). In most cases, foreign firm’s faces higher taxation an aspect that reduces their profits thus hindering their expansion strategies. Similarly, some governments have put in place trade barriers that aim at protecting local companies from unfair competition from foreign firms (Berezin, 2005). In this way, the foreign firms face limited operations thus facing financial problems in other countries. In order to address the issue of over taxation and trade barriers, firms that heavily rely on exportation have taken initiatives to negotiate with foreign government. Additionally, through the organizations such as the World Trade Organization, countries across the globe are able to make trade agreements that eliminate the barriers and other risk affecting the foreign direct investments. Conclusion As noted by Catherine Mann, the value of the dollar will remain stable due to the positive relationship that exists between US and other countries. By removing the internal and external imbalances, the dollar will continue to be used by the global community as a way of storing reserves as well as investments. Based on the above discussion, Mr Wart should not be worried about the value of the dollar since through the leadership of US and other developed countries, global co-dependency is still being advocated for (Prest et al, 1998). As businesses face financial challenges, they have come up with ways to deal with the problems. This evident from the way many firms have turned into investing in financial markets. Based on the changing interest rates and value of currencies, it is imperative for firms that aim at investing in financial markets to hire experienced and skilled economic analysts. In this way, they will be in a better position to make a more reliable expectation on the financial markets trends and interest rates. The major financial problem that firms which engage in foreign domestic investment includes currency risk that results to transaction exposure, economic exposure, translation exposure, and contingent exposure. 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