Risk Analysis of Japanese Trading Company Ltd and Gumpbell Soup Company Inc - Case Study Example

Finance and Accounting no topic Identify and discuss the risks of either or both parties When a company decides to participate in international business activities, it also takes additional risks along with the additional Opportunities. According to the case study it can be seen that Japanese Trading Company Ltd and Gumpbell Soup Company Inc. have decided to expand by undertaking international business strategies. The Japanese Trading Company Ltd. (JTC) is well renowned company based in Tokyo, Japan. The company is a distributor of various ranges of goods and products all over the Asia. Since past many years, it has expanded its market for distribution and sale of food products but still it does not have its own production and manufacturing system due to inadequate supply system of raw materials and unavailability of specialized capacity to produce any specific customized food products. Thus it needs get food products from various overseas suppliers to continue its distribution business. Majority of food products that the company distributes are manufactured by companies which are located in USA. Now the company has developed a new market for spicy chicken noodle soup product which is desirable among Asian customers. Thus to avail this products the company is searching manufactures for this particular product who will be able to add special flavor and aroma to attract the Asian customers. Among many other manufacturers, it has shortlisted two companies, Slick Willie and Gumpbell Soup Company. But the finalization depends on the price quotes and the quality of the product provided by the companies. Gumpbell Soup Company Inc. is a New York based old line food manufacturing company which was founded in 1896. It went public in 1999 and has offered majority of its stock to the public. It has a high reputation among its customers as a renowned international food company that manufactures and sells wide ranges of food products across the USA and rest of the world. The company has a very comprehensive operation which includes research and development department for development of new and unique products, production plant and department to control the quality of food products all over the USA. It also has strong domestic and international distribution network to boost its sales. Although it has strong reputation among its customers but still it faces a strong competition from its major competitor Slick Willie’s Foods on the ground of pricing strategy. The price of Gumpbell it’s higher than its competitor Slick Willie as it has more experienced labor and highly qualified division to maintain quality of its food products. The company is interested in expanding its distribution network and customer base in various Asian countries such as South Korea and Japan and thus it has considered the new business deal with JTC as a good business opportunity if they mutually agree with each other in every aspect of the contract. Gumpbell is looking for a short term contract rather a longer term deal. The company wants to hedge itself against any economic exchange rate exposure in international market and thus wants to keep a space to increase its pricing policy with JTC in future if there is an increase in its cost of production. Now we need to consider the risks involved in this international business transaction from the view point of both the parties. Currency Exchange Rate Risk There are various risks involved in the international business transaction between JTC and Gumpbell. One of the most important risk is currency exchange rate risk which is a financial risk faced by the companies which are involved in international trade by the unexpected changes in the currency exchange rate between two countries. The currency exchange rate between two countries can fluctuate over a period of time which can lead to unanticipated gain or loss. It includes mainly three types of exposure or risk such as economic exposure, translation exposure and transaction exposure. Transaction Exposure Transaction exposure occurs when the values of the cash flows of a company can be changed unexpectedly due to a contract where the value of the cash flow can be denominated in foreign currency. According to the case study it can be seen that both the companies can face transaction exposure risk as the actual denominated currency which will be used in the transaction has not been finalized yet. Gumpbell has valued its cost of production and profit margin on USD currency. The current cost of production of the chicken noodle soup product is approx $6.50 per case and each case contains 24 cans of 15 ounce weight each. The cost of production includes cost of raw materials, labeling, canning, labor, energy and cost of packaging materials. It doesn’t include the cost of transportation. Gumpbell wants to keep $2.00 gross profit margin per case over the current cost of production and thus the cost of each case will be $8.50 for JTC. Now we need to understand the values are based on US dollars and the actual denominated current is not decided. The current exchange rate is 1 USD = 118.25 Japanese Yen. Now if we assume that if the currency denomination is decided on USD then if dollar value gets appreciated then to buy 1 dollar more yen will be needed. As JTC is importing food products from Gumpbell at a cost of $8.50 per case thus it will need to pay more yen to get one case of spicy chicken noodle soup which will be an unexpected loss for JTC and gain for Gumpbell as it will get more yen. Now if the denomination currency is decided as Yen and the value of yen gets appreciated then JTC will have to pay less yen to buy 1 dollar. Thus it will be an unexpected gain for JTC and on the other side as Gumpbell is exporting its products it will face an unexpected loss from the currency fluctuations. Translation Exposure Translation exposure can be defined as the extent to which a firm’s financial reporting can be affected by the movements of exchange rates between two countries. It involves revaluation of foreign assets which are kept in foreign currency as the exchange rate of foreign currency may fluctuate over time. It will create an exchange gain or loss. Thus according to the case study if the denominated currency is decided as USD then from the view point of Gumpbell it can be said that its value of inventory will appreciate with the appreciation of dollar value and JTC needs to pay more yen to get the products and this situation will reverse if the dollar value depreciates against the Japanese yen. Now if the denomination currency is decided as Japanese yen then from the view point of JTC it can be said that it will have pay less for the product if the value of Japanese yen appreciates against US dollar. Thus it will create an exchange gain for JTC and as an exporter it will create an exchange loss for Gumpbell. The situation will reverse if the value of denominated currency yen depreciates against USD. Thus value of inventory will increase or decrease based on the fluctuation of currency exchange rates. Economic Exposure Economic exposure is also known as operating risk or exposure which is risk of changing market value of a company due to unanticipated fluctuations in exchange rates. If the currency exchange rate appreciates or decreases then the cost of production and the sale price of the end product can also be affected due to the change and it may act on the profits. According to the case study it can be seen that the denominated currency has not been decided yet. Thus if we assume that the denominated currency is decided as US dollars then from the view point of JTC it can be said that if dollar value appreciates then JTC needs to pay more price to buy 1 dollar of product. Thus with the appreciation of USD the profit of JTC will be affected. Now if the dollar value depreciates and USD is the denominated currency then JTC needs to pay fewer prices to buy 1 dollar of product which lead to increase the profit of JTC. But if the denominated currency is decided as Japanese yen then from the view point of Gumpbell it can be said that if the value of Japanese yen depreciates then as an exporter value of the company will increase as it will gain more yen and the profit of the company will also increase. But if the value of Japanese yen appreciates then as an exporter the market value of Gumpbell will decrease and the profit will also reduce as it will get less yen than previous condition. Thus economic exposure may affect the market value of the company and profitability with the appreciation and depreciation of the currency exchange rate. Proposal as a solution for the identified risks According to the identifies risks stated in the previous section for both the companies it can be said that to avoid the risks both the companies need to take some measure before involving in the international trade. Firstly from the view point of Gumpbell, if it has option to choose t5he denomination currency then it would be profitable for the company to choose USD as the billing and pricing currency. On the other side, Japanese yen will be the profitable currency for JTC as the billing and pricing currency. Considering national currency is profitable for any company as in this way the company can eliminate the exchange risk. But this may create conflict between the companies as both the company will want to keep the denomination currency in the national currency. Thus they need to add a buffer margin to any invoice that are quoted in foreign currency or they need to create a specific contract by which the seller and buyer can share the risk of fluctuations in foreign currency exchange rates during the time of validity and creation of the invoice and the payment date of the invoice. Apart from these, the companies can utilize various financial instruments like forward contract, future contract and options derivatives to hedge the foreign currency exchange rate risk. These instruments are helpful in reducing the currency exchange rate risk for both the parties. Thus both Gumpbell and JTC need to avail this proposal as solution to the identified risks of the business. Justification for the specific proposal Forward contract A redid contract between two gatherings to purchase or offer a benefit at a tagged cost on a future date. A forward contract can be utilized for supporting or hypothesis, in spite of the fact that its non-institutionalized nature makes it especially adept for supporting. Dissimilar to standard futures gets, a forward contract can be modified to any ware, sum and conveyance date. A forward contract settlement can happen on a money or conveyance premise. Forward contracts dont exchange on a unified trade and are in this way viewed as over-the-counter (OTC) instruments. While their OTC nature makes it less demanding to alter terms, the absence of a concentrated clearinghouse likewise offers climb to a higher level of default danger. As an issue, forward contracts are not as effortlessly accessible to the retail financial specialist as futures contracts. A forward is an understanding between two counterparties - a purchaser and vender. The purchaser consents to purchase a fundamental resource from the other party (the dealer). The conveyance of the benefit happens at a later time, yet the cost is resolved at the time of procurement. Key peculiarities of forward contracts are: Exceedingly tweaked - Counterparties can focus and characterize the terms and peculiarities to fit their particular needs, including when conveyance will happen and the precise character of the basic resource. All gatherings are presented to counterparty default hazard - This is the hazard that the other party may not make the obliged conveyance or installment. Exchanges happen in vast, private and to a great extent unregulated markets comprising of banks, venture banks, government and companies. Fundamental resources can be stocks, securities, outside monetary forms, products or some mix thereof. The fundamental resource could even be investment rates. They have a tendency to be held to development and have almost no business liquidity. Any dedication between two gatherings to exchange an advantage later on is a forward contract. Future Contract It is contract for the most part made on the exchanging floor of a futures trade, to purchase or offer a specific merchandise or budgetary instrument at a foreordained cost later on. Futures contracts detail the quality and amount of the basic resource; they are institutionalized to encourage exchanging on a futures trade. A few futures contracts may call for physical conveyance of the benefit, while others are settled in real money. Future contracts are additionally assertions between two gatherings in which the purchaser consents to purchase a basic resource from the other party (the vender). The conveyance of the benefit happens at a later time; however the cost is resolved at the time of procurement. Terms and conditions are institutionalized. Exchanging happens on a formal trade wherein the trade gives a spot to take part in these exchanges and sets an instrument for the gatherings to exchange these contracts. There is no default hazard in light of the fact that the trade goes about as an issue, ensuring conveyance and installment by utilization of a clearing house. The clearing house ensures itself from default by obliging its counterparties to settle increases and misfortunes or imprint to market their positions regularly. Futures are exceedingly institutionalized, have profound liquidity in their business sectors and exchange on a trade. A financial specialist can counterbalance his or her future position by taking part in an inverse exchange before the expressed development of the contract. Options An option is regular manifestation of a subordinate. Its a contract, or a procurement of a contract, that provides for one gathering (the option holder) the right, yet not the commitment to perform a pointed out exchange with an alternate gathering (the option backer or option essayist) as indicated by defined terms. Options can be implanted into numerous sorts of contracts. For instance, an organization may issue a bond with an option that will permit the organization to purchase the bonds in ten years at a set cost. Standalone options exchange on trades or OTC. They are connected to a mixed bag of fundamental resources. Most trade exchanged options have stocks as their fundamental resource however OTC-exchanged options have an enormous mixture of basic resources (securities, coinage, things, swaps, or wicker bin of advantages). There are two fundamental sorts of options: calls and puts: Call options give the holder the right (however not the commitment) to buy a hidden resource at an indicated value (the strike cost), for a certain time of time. In the event that the stock neglects to meet the strike cost before the termination date, the option lapses and gets to be useless. Financial specialists purchase calls when they think the offer cost of the fundamental security will climb or offer a call on the off chance that they think it will fall. Offering an option is additionally alluded to as ""composing"" an option. Put options give the holder the right to offer a hidden resource at a tagged value (the strike cost). The merchant (or essayist) of the put option is committed to purchase the stock at the strike cost. Put options can be practiced whenever before the option terminates. Speculators purchase puts on the off chance that they think the offer cost of the basic stock will fall, or offer one in the event that they think it will climb. Put purchasers - the individuals who hold a "long" - put are either theoretical purchasers searching for power or "protection" purchasers who need to ensure their long positions in a stock for the time of time secured by the option. Put dealers hold a "short" anticipating that the business sector will move upward (or at any rate stay stable) a most dire outcome imaginable for a put vender is a descending business turn. The most extreme benefit is constrained to the put premium got and is attained when the cost of underlies is at or over the options strike cost at termination. The greatest misfortune is boundless for a revealed put essayist. To acquire these rights, the purchaser must pay an option premium (cost). This is the measure of money the purchaser pays the dealer to acquire the right that the option is allowing them. The premium is paid when the contract is launched. Works Cited Hou, A. Risk Management. 2013.Web. November 21, 2014. Read More