International Finance - Factors Affecting the Balance of International Trade - Assignment Example

I) a) What is the product you want to sell? For the next project of our small MNC XYZ Corp. we have decided to focus our business on the sale, distribution and manufacturing of footwear for the domestic Indonesian market. We will use economies of scale to expand our manufacturing capabilities to export our product line to the rest of the world from our Asian manufacturing partners. b) How will you sell the product in that country? Although we currently do not have any manufacturing partners in Indonesia we will initially use the manufacturing capabilities of our other Asian manufacturing partners to supply the initial demand for our products in the Indonesian domestic market. We will use strategically located distribution partners to help quickly penetrate the market during our initial product launch phase. As a MNC XYZ Corp. is looking to expand our manufacturing capabilities inside Indonesia to serve local and regional demand, if the local market, infrastructure, economic and labor conditions prove favorable for an expansion in the near future (Pertama). c) Is there some evidence that consumers in that country would buy this type of product? For Indonesia, the footwear industry represents one of the countrys most important sources of labor and revenues for the entire country. By employing millions of laborers, directly and indirectly, the footwear industry serves as a catalyst for robust growth of the local economy, despite intense global competition in the manufacturing market. The domestic footwear market, is an important economic asset for all Indonesian footwear manufacturers and distributors from low-cost footwear manufacturing for general public consumption, to high-end luxury manufacturers to serve the growing upper and middle classes in the country. The countrys robust economic growth has given rise to a rapidly expanding middle-class therefore increasing the demand for all goods. The increased participation rate of Indonesian for in all port activities of around 25% has especially contributed to the increased demand for quality sports footwear and accessories (Gbgindonasia) . d) Will any expenses you incur from producing the product be in dollars or some other currency? Being a small developing country, Indonesia depends heavily on foreign raw and processed materials imports to support their growing manufacturing industry. In the case of the footwear industry, limited supplies of crucial raw materials,especially leather, requires heavy investments in foreign imports to supply the necessary raw and processed materials for their production The importation of live animal products is heavily regulated in Indonesia. Additionally, despite the country being one of the worlds largest producers of raw rubber, much of their annual production of rubber is exported abroad just for processing due to limited rubber processing infrastructure. The constant need of foreign currency to support their manufacturing industries exposes the Indonesian manufacturing industry to significant currency exchange rate risks and economic fluctuations which can negatively impact the long-term success of the firm, and their bottom line. II) a) Identify the factors that can affect the balance of trade between the U.S. and the country that you targeted for your business. Explain how each of these factors may affect the demand of your product (8). High inflation levels- A high level of inflation in Indonesia will cause prices for imported goods and materials to increase, relative to the U.S. Dollar. Therefore, the price of imported goods will increase causing decreased consumer demand for all imported goods and services. National average income variations- As real income increases levels of consumer spending will increase due to increased availability of consumer disposable income and vice versa. Changes in government regulations or policies - A change in government economic policy or import regulations can have a negative impact in the balance of trade between the U.S. and Indonesia. Governmental subsidies for domestic exporters - It is a type of protectionist policy in which some governments offer economic subsidies for domestic firms in order to increase consumer demand for their products due to lower production costs compared with their global competitors. This type of preferential treatment for local businesses can have a negative impact on the domestic sales and export levels of MNC. Restriction on Imports Another type of protectionist policy which affects importers are the level of restrictions and tariffs on imported goods and materials. This type of economic policy goes against the open market and creates unfair advantages for local companies in terms of artificially reduced costs and lower consumer prices for domestic products. b) Which of these factors are likely to be most important in affecting the demand for your products? Of all these factors the most likely culprits that could negatively affect the performance of MNC in Indonesia are governmental restriction on certain imports and any future changes in economic policy and trade brought about by changes in central government policy. III) a) Explain how you will use the spot market for your business? Unless the firm enters into some form of forward contract to protect ourselves4 against currency exchange risks which could negatively impact the company,the firm will use the currency spot rate in order to settle debts with our foreign suppliers and partners (Weller). b) What bank do you plan to use to exchange the foreign currency received for dollars? The Forex spot market is probably the most common way that MNC perform their currency exchange banking transactions. Online Forex market traders such as FXPro provides the tools and online spot rate exchange markets, 24-7 for their customers. According to investing.com, bid/ask spread for the U.S. Dollar against the Indonesian Rupiah was 12,675.0 / 12,705.0 IDR to 1 USD for 12/15/2014 (Investing). c) Will you possibly need a forward market? Explain. In the case that the firms financial forecasts predict a high likelihood that the Indonesian currency will weaken against the dollar in the near future,XYZ can enter into a forward contract in order to hedge against a stronger predicted dollar value at the time the transaction and the currency exchange will take place to settle the payment (Investopedia). d) Accessing recent exchange rates. According to www.oanda.com the spot exchange value of the U.S. dollar against the Indonesian Rupiah has been following an upwards trend in value. THe value of the dollar has increased from 12,136 IDR on November 16,2014 to 12,383 on December 15,2014,a 2.04% increase in value in one month. If we look at the currency exchange rate movement for the last 90 days,we can appreciate a more normal trend in currency value especially in the previous two months. The exchange rate varied from around 12,000 to just over 12,157 from Sept. 22 to to Nov. 24 2014, due to normal variations in currency exchange value attributed to varying demand and regular market conditions. For the last year,the rupiah started out with a similar value than its current value. A weakening dollar caused the Rupiah to appreciate against the dollar reaching a value of 11,297 at March 31,2014.Changing market condition caused the dollar to start an upward trend in value which still continues to this day. IV) What key factors will likely affect the value of the foreign currency of concern over time? Some of the key determinants which can influence a currencys exchange rate are (Van Bergen): Differentials in inflation and interest rates- In general,historically countries with a lower inflation rate than average will exhibit rising currency values. A countrys central bank can manipulate interest rates to make it more attractive for foreign investors looking for a higher return. As a result of demand and supply,higher interest rates will result in increased foreign capital investment,raising the currency value as a result. Current account deficits- A country with current account deficit,will suffer a trade balance where ts exports do not cover the amount of imports the country is currently consuming,creating a deficit. A deficit in the current account requires the country to borrow capital in order to cover the difference. Excess demand for the foreign currency,compared with their own causes the value of their own currency to decrease. Levels of Public Debt- In countries with large debt loads and considerable public deficits, tend to discourage foreign investments. This is due to the fact that a high debt load encourages economic inflation,which in turn makes any debt and its interest payments less valuable to investors,due to currency devaluation. V) a) How can your business be affected if the Fed attempts to straighten the dollar in the foreign exchange market. A Fed intervention to increase the value of the dollar in the currency market can negatively affect the sale of imported goods to Indonesia due to decreased consumer power because of domestic currency devaluation. b) If the Fed decides to weaken the dollar,how will your business be affected? A decreased value of the dollar in the currency market will tend to increase demand for imported goods. Although overall demand for imported products will increase,deceased U.S. Dollar value will cause the revenues per sale to decrease proportionally to the change in relative currency value. c) How can indirect central bank intervention affect your business even if there is no impact on exchange rates? A countrys central bank is in charge of economic policy and setting interest rates. A lower interest rate will discourage foreign investment in the host country,therefore making it less attractive to foreign investment capital and lowering the currency value as a result decreased currency demand due to lower foreign capital investments . VI) Monitoring Exchange Rate Trends a) Does it appear there is a trend during the last five weeks?What is the mean percentage change over these weeks? As seen on oanda.com, the Rupiah has been steadily decreasing in value for the last five weeks when compared to the U.S. Dollar. from November 3 to December 15,2014,the rupiah has changed from 12,132 to 12,383,a 2.1% decrease in overall value for the Rupiah. b) If you believed that the currency value would continue on the same trend,would it appreciate or depreciate in the near future? If the Rupiah continues on the same short term trend,it will continue to depreciate compared to the dollar,therefore decreasing the value of their exports and increasing the relative value of their imported goods. VII) a) Describe your exposure to exchange rate risk Since a lot of raw materials have to be imported,XYZ Corp. is exposed to fluctuations in the spot currency rate. Therefore,the price for its raw materials purchases vary from day to day,sometimes many times during a business day. b) Is your business exposed to transaction,translation and/or economic exposure? XYZ Corp is exposed to transaction exposure since the Indonesian domestic sales are subject to thee normal fluctuations of the currency exchange markets for its distributor sales. The company is also exposed to translation and economic exposure since material differences in accounting methods can affect the financial results between its local distributors in Indonesia and the parent company and the industry is subject to macro economic changes of the industry as a whole (Chand). VIII) a) Given your exposure to exchange risk,explain how you could use forwards contracts to hedge. b) Explain how you could you options to hedge your exposure In case that the dollar is depreciating as compared to the Rupiah in the near future and the trend is expected to continue in the foreseeable future, XYZ can enter into a forward discount contract in order to protect themselves against future dollar devaluation or vice versa. Using currency options to hedge against currency fluctuations can also become a viable alternative especially if the firm is not sure as to whether the future value of a specific currency will increase or decrease. Currency options give the contract holder, the choice as to whether exercise the depending on the currency value when the contract options are due. VIV) Denominating receivables in U.S. Dollars. For XYZ Corp. if sales proceeds are received in U.S. dollars instead of Indonesian currency, the company will not be exposed to currency risks or transaction exposure, but all other business risks, such as economic, inflation, interest rate or changes in governmental policies and average national income will still affect overall sales revenues and division profit margin. Additionally exchange rate movements can indirectly increase manufacturing costs for our Asian manufacturing partners when incurring in purchases of raw materials and supplies from Indonesian suppliers. For example, the majority of our raw rubber inventory used in footwear manufacturing is purchased from Indonesia. Establishing a subsidiary in a foreign country. Establishing a local manufacturing subsidiary might prove viable if local demand and market conditions are more favorable, as compared to expanding operations in one of or current Asian manufacturing facilities. Certain economic and market conditions could prove favorable to establishing a local manufacturing branch. For example, if governmental regulations and policies are geared towards encouraging foreign capital investment it can prove advantageous to expand manufacturing operations. The government can provide a myriad of ways to attract foreign investors, for example: offering,lower taxes for MNC government subsidized leasing arrangements for manufacturing operations Increased incentives ans subsidies geared towards job creation or capital expenditure These initiatives, along with other alternatives can allow a MNC to expand operations to the host country, since the financial incentives can allow the project to be more cost effective than expanding existing manufacturing operations. Some of the disadvantages of expanding to a new host country are that the company exposes themselves to new risks associated with operations in a new market. If future local demand falls significantly below estimates, the whole expansion project could prove to be financially disastrous. Changes in local governmental policies, changes in local economic conditions and social unrest could destroy product demand undermine the future stability and viability of the expansion project proposal. XI) Ensuring the payment for the sale merchandise in a foreign market can be assured with a simple letter of credit from an international banking institution. In Conclusion: For Indonesia, the footwear industry represents one of the countrys most important sources of labor and revenues for the entire country. The countrys robust economic growth has given rise to a rapidly expanding middle-class, therefore increasing the demand for all goods. As a MNC XYZ Corp. is looking to expand our manufacturing capabilities inside Indonesia to serve local and regional demand, if the local market, infrastructure, economic and labor conditions prove favorable for an expansion in the near future. By selling their products in the foreign Indonesian market, XYZ Corp will be exposed to many factors which can affect the sales of their footwear line. By using currency hedging the company can protect themselves against exchange rates variations,which could negatively impact the companys financial results. Work Cited Page Chand, S. 2014. “7 Most Influential Factors Affecting Foreign Trade.” 14 December 2014. Investing.com. 2014. “US Dollar Indonesian Rupiah.” 15 December 2014. Investopedia.com. 2014. “Forward Premium.” 14 December 2014. Gbgindonasia.com. “Indonasia Footwear Industry- Challenging Opportunities.” 14 December 2014. Pertama, C. 2009. “Indonasia Footwear Step to the World.”14 December 2014. Van Bergen, J. 2014. “Six Factors that Influence Exchange Rates.” 14 December 2014. Weller, C. 1997. “Currency Speculation: How Great a Danger.” 14 December 2014. Read More