Hi there I need help answering ASSIGNMENT 1 ONLY by Friday afternoon. I have attached the study pack to help answer the question. Thanks!

FIN4802 ASSIGNMENTS ASSIGNMENT 01 Due date: 13 May 2016 Unique number: 839176 Answer the following questions and submit your assignment through myUnisa (https://myunisa.ac.za) Question 1 [25] 1.1 Grace Moogzt is a foreign exchange dealer with Standard Bank. She notices the following quotes. Spot exchange rate One year forward exchange rate One year USD interest rate One year Rand interest rate R12.5123/US$ R12.3214/US$ 8.5% p.a. 11.5% p.a. a. Is the interest rate parity holding? You may ignore transaction costs. [5] b. Show that an arbitrage opportunity exists. [3] c. Calculate the arbitrage profit that can be made assuming that Grace Moogzt is authorised to work with US$2 000 000 or the Rand equivalent. Show all the steps that need to be taken to make arbitrage profit. [9] 1.2 A call option allows the holder to buy US$200 000 at an exercise exchange rate of 1.6000 (AUD/USD). If the premium paid is 5 Australian cents for each USD, calculate the net payoff at the following spot exchange rates: (i) 1.7240 [2] (ii) 1.8150 [2] (iii) 1.5365 [2] (iv) At what exchange rate will the holder break even? [2] Question 2 [25] 2.1 The time from acceptance to maturity on a US$1 000 000 banker's acceptance (BA) is 120 days. The importer's bank's acceptance commission is 1.75% and the market rate for 120day BAs is 5.75%. Assume that there are 360 days in a year. You are required to determine the following: (a) The proceeds the exporter will receive if he holds the BA until maturity. [2] (b) The acceptance commission paid to the importer's bank. [2] (c) The proceeds the exporter receives if he discounts the B/A. [3] (d) The all-in-rate (interest rate) the bank receives and the bond equivalent yield the importer's bank will earn from discounting the BA with the exporter. [5] (e) If the exporter's opportunity cost of capital is 10%, should he discount the BA or hold it to maturity? [6] Open Rubric 2.2 A put option allows the holder to sell NOK400 000 at an exercise exchange rate of 0.2540 (AUD/NOK). If the premium paid is 0.7 Australian cents for each NOK, calculate the net payoff at the following spot exchange rates: (i) (ii) (iii) (iv) 0.2410 0.2786 0.1856. At what exchange rate will the holder break even? [2] [2] [2] [1] TOTAL [50] ASSIGNMENT 02 Due date: 23 SEPTEMBER 2016 Unique number: 710573 Answer the following questions on the answer book and submit your assignment through myUnisa (https://myunisa.ac.za) Question 1 [20 Marks] A U.S. multinational company is considering whether to borrow British Pounds for one year. It finds that the quoted interest rate for the British Pounds is 10 percent and the quoted rate for the U.S. dollar is 16 percent. It then develops a probability distribution for the British Pound's possible percentage change in value over the life of the loan as follows: Possible rate of change in the British Pound over the life of the loan -5% -2% -1% +1% +3% +5% +7% +10% Probability of occurrence 10% 15% 5% 20% 15% 10% 15% 10% (a) Calculate the effective financing rate for every possible rate of change in the British Pound if it does occur. [10] (b) Determine the expected financing rate of the British Pounds [5] (c) Should the U.S. multinational company borrow U.S. dollars or British Pounds? Substantiate your answer. [5] -2- Question 2 [17 Marks] ABC LTD, a U.K. multinational enterprise is contemplating making a foreign capital expenditure in South Africa. The initial cost of the project is ZAR50 million. The annual cash flows over the five year economic life of the project are estimated to be ZAR13 million, ZAR18 million, ZAR25 million, ZAR10 million, and ZAR9 million. The parent firm's cost of capital in pounds is 7.5 percent. Long-run inflation is forecasted to be 4 percent per annum in the U.K. and 12 percent in South Africa. The current spot foreign exchange rate is ZAR/ = 15.56. Determine the NPV for the project in by: (a) Calculating the NPV in ZAR using the ZAR equivalent cost of capital according to the Fisher Effect and then converting to at the current spot rate. [5] (b) Converting all cash flows from ZAR to at Purchasing Power Parity forecasted exchange rates and then calculating the NPV at the pound cost of capital. [7] (c) What is the NPV in pounds if the actual pattern of ZAR/ exchange rates is: S(0) = 15.56, S(1) = 14.56, S(2) = 16.72, S(3) = 15.78, S(4) = 16.54, and S(5) = 16.32? Justify the difference in the actual and the forecasted NPV [5] Question 3 [13 Marks] ABC Ltd would like to assess the country risk of South Africa. ABC Ltd has identified various political and financial risk factors, as shown below. Political Risk Factor Blockage of fund transfers Bureaucracy Financial Risk Factor Interest rate Inflation Exchange rate Competition Growth Assigned Rating 6 2 Assigned Rating 4 5 4 3 7 Assigned Weight 55% 45% Assigned Weight 20% 15% 10% 30% 25% ABC Ltd has assigned an overall rating of 75 percent to political risk factors and of 25 percent to financial risk factors. The investment policy for ABC Ltd mentions that the company can only invest in a country if the country risk is below 4.5. Should ABC Ltd consider South Africa for investment? [13] TOTAL [50 Marks] TOPIC 1: THE INTERNATIONAL FINANCE ENVIRONMENT 1.1 AIM OF THE TOPIC This topic focuses on the context within which the financial managers of MNCs make their decisions. The discussions focus on key terminology, instruments and institutions that are central to such decision making. 1.2 CONTENTS OF THE TOPIC Study Unit 1: Overview of multinational financial management Study Unit 2: International flow of funds and balance of payments Study Unit 3: International financial markets Study Unit 4: Exchange rate determination Study Unit 5: Currency derivatives STUDY UNIT 1 OVERVIEW OF MULTINATIONAL FINANCIAL MANAGEMENT LEARNING OUTCOMES On completion of this study unit, you should be able to understand what is special about international finance understand why MNCs are important players in international economic competition identify the main goal of the MNC and conflicts with that goal describe key theories that justify international business understand the common methods used to conduct international business identify some limitations associated with international business describe the impact of international opportunities on an MNC's value 1.1 OVERVIEW OF THE UNIT In general, MNCs seek out, undertake and integrate production, marketing and R & D, and financing opportunities on a global basis. Because of their international operations, MNCs 4 face unique risks as well as opportunities. Three major dimensions distinguish international finance from purely domestic finance, namely, foreign exchange and political risks, market imperfections and expanded opportunity sets. The decisions made by financial managers of MNCs should reflect these additional risks and opportunities and be consistent with the goal of the firm. This study unit describes the goal of the financial manager of MNCs, namely to maximize shareholder wealth. However, you should be aware of various problems and constraints that are encountered in achieving this goal. There are three major theories that explain the motive of firms expanding their business internationally. Bear in mind that these theories are not mutually exclusive but complement one another in developing a rationale for the evolution of the MNC. Chapter 1 of the prescribed textbook gives an overview of multinational financial management. In order to achieve the learning outcomes of this study unit, you are required to read through the following seven sub-headings of the chapter: x x x x x x x 1.2 Goals of the MNC Theories of international business International business methods International opportunities Exposure to international risk Overview of an MNC's cash flows Valuation model for an MNC SOUTH AFRICAN FINANCIAL ENVIRONMENT The immediate financial environment of the South African MNC consists of local financial institutions, the local money market, the capital market, and the foreign exchange market, and futures and options markets. Based on their exposure to different types of risks, the financial institutions of South Africa can be divided into a few broad functional categories: central banking, banking, insurance and investment. The central bank, the "government's banker", is the sole issuer of (primary) money. The banks as the custodians of the general public's money create liabilities (cheques) that are generally accepted as a means of payment. For a fee or premium insurance companies protect their clients against various risks. Investment firms deal in the short-term and long-term securities markets, either for their own account or as agents of investors. Since the rand became a free-floating currency, the foreign exchange market of South Africa has made substantial progress in eliminating exchange controls. South African banks play an active role in the foreign exchange market where they provide service to individual clients and multinational enterprises. The South African Futures Exchange (SAFEX) offers rand/dollar futures contracts and currency options and aims to continually enhance the facilities offered for trading derivatives to the local and the international clients. 5 1.3 ACTIVITIES Self-test Do the self-test questions for chapter 1. Answers to the self-test questions are provided at the end of the prescribed textbook. Case study 1: Decision to Expand Internationally The continuing case in the textbook allows you to apply the concepts you have just learned to solve problems faced by a firm, Blades PLC. This is a convenient way for you to "grow" with a firm by applying various concepts that you learn in different chapters, to the same firm. Study the case "Blades, PLC: Decision to Expand Internationally" and answer the questions following the case study. Suggested answers are provided below: 1. The advantages Blades could gain from importing from Thailand include potentially lowering Blades' cost of goods sold. If the inputs (rubber and plastic) are cheaper when imported from a foreign country such as Thailand, this would increase Blades' net income. Since numerous competitors of Blades are already importing components from Thailand, importing would increase Blades' competitiveness in the UK, especially since its prices are among the highest in the roller blade industry. Furthermore, since Blades is considering longer range plans in Thailand, importing from and exporting to Thailand may present it with an opportunity to establish initial relationships with some Thai suppliers. As far as exporting is concerned, Blades could be one of the first firms to sell roller blades in Thailand. Considering that Blades is contemplating to eventually shift its sales to Thailand, this could be a major competitive advantage. 2. There are several potential disadvantages Blades should consider. First of all, Blades would be exposed to currency fluctuations in the Thai baht. For example, the dollar cost of imported inputs may become more expensive over time if the baht appreciates even if Thai suppliers do not adjust their prices. However, Blades' sales in Thailand would also increase in dollar terms if the baht appreciates, even if Blades does not increase its prices. Blades, Inc. would also be exposed to the economic conditions in Thailand. For example, if there is a recession, Blades would suffer from decreased sales to Thailand. In the long run, Blades should be aware of any regulatory and environmental constraints the Thai government may impose on it (such as pollution controls). Furthermore, the company should be aware of the political risk involved in operating in Thailand. For example, the likelihood of expropriation by the Thai government should be assessed. 6 Another important issue involved in Blades' long-run plans is how the foreign subsidiary would be monitored. Geographical distance may make monitoring very difficult. This is an especially important point since Thai managers may conform to goals other than the maximization of shareholder wealth. 3. There are at least three theories of international business: the theory of comparative advantage, the imperfect markets theory, and the product cycle theory. In the short run, Blades would like to import from Thailand because inputs such as rubber and plastic are cheaper in Thailand. Also, it would like to export to Thailand to take advantage of the fact that few roller blades are currently sold in Thailand. Both of these factors suggest that the imperfect markets theory applies to Blades in the short run. In the long run, the goal is to possibly establish a subsidiary in Thailand and to be one of the first roller blade manufacturers in Thailand. The superiority of its production process suggests that the theory of comparative advantage would apply to Blades in the long run. However, the product cycle theory also applies to Blades, since its UK sales are declining and Blades feels that it must eventually establish a subsidiary in Thailand in order to preserve its competitive advantage over Thai competitors. 4. Since Ben Holt is very unfamiliar with international business, and since Blades has never operated outside the United Kingdom, establishment of a subsidiary in Thailand is probably not the best way for Blades to gain a foothold in Thailand in the long run. Blades should initially consider a joint venture with Thai firms that manufacture roller blades. The advantage would be access to Thai distribution channels, familiarity of the Thai firm with customs and ethics in Thailand, and an established market. Of course, since Blades' production process is unique, a joint venture would provide the Thai subsidiary with knowledge of the production purposes, which it may duplicate after the joint venture terminates. Go through the case study and attempt the questions based on it to reinforce your understanding of the concepts. 1.4 REFLECTION Before you continue to the next study unit, reflect on the following questions: a. b. c. d. e. 1.5 Where do you think you will be able to use the skills you learned in this study unit in your professional life? What did you find difficult? Why do you think you found it difficult? Do you understand it now or do you need more help? What are you going to do about it? What did you find interesting in this study unit? Why? How long did you take to work through chapter 1 for this study unit? Are you still on schedule or do you need to adjust your study program? How do you feel now? CONCLUSION The end of Chapter 1 gives a summary of concepts you have learnt. Confirm that all learning 7 outcomes have been achieved. In the next study unit you are going to learn about how international business is facilitated by markets that allow for the flow of funds between countries. Recommended further reading Foley, C. Fritz, and Kalina Manova. International trade, multinational activity, and corporate finance. No. w20634. National Bureau of Economic Research, 2014. Fourie, LJ, Falkena, HB & Kok, WJ. 1999. The student guide to the South African financial system. 2nd edition. Midrand: International Thomson Publishing. Iapadre, P. Lelio. "Measuring international specialization." International Advances in Economic Research 7.2 (2001): 173-183. Meliciani, Valentina. Technology, trade and growth in OECD countries: does specialisation matter?. Routledge, 2012. Lessard, DR. 1991. Global competition and corporate finance in the 1990s. Journal of Applied Corporate Finance, Winter: 59-72. Roux, A. 1998. Everyone's guide to the South African economy. 5th edition. Zebra Press. Trehan, B. 1995. Trade and growth: some recent evidence, in The international finance reader, edited by RW Kolb. 3rd Edition. Cambridge, Mass: Blackwell:335-338. 8 STUDY UNIT 10 MEASURING EXPOSURE TO EXCHANGE RATE FLUCTUATIONS LEARNING OUTCOMES On completion of this study unit, you should be able to discuss the relevance of an MNC's exposure to exchange rate risk describe how transaction exposure can be measured identify what factors affect a firm's degree of transaction exposure in a particular currency explain how a firm can utilize regression analysis to measure its economic exposure identify what factors affect a firm's degree of economic exposure in a particular currency describe how translation exposure can be measured identify what factors affect a firm's degree of translation exposure in a particular currency assess the impact of exchange rate exposure on an MNC's value 10.1 OVERVIEW OF THE UNIT Recognition of the existence of the exchange rate risk and the measurement of the degree to which the firm is exposed constitutes the first step in formulating policy for managing exchange risk exposure. If the firm is highly exposed, then it can consider techniques to reduce its exposure. This unit identifies three forms of exposure: transaction exposure, economic exposure and translation exposure. Measurement of each type of exposure is discussed in turn. Chapter 10 of the prescribed text is your required reading. In order to achieve the learning outcomes of this study unit, you are required to read through the following five subheadings of the chapter: x Is exchange rate risk relevant? x Types of exposure x Transaction exposure x Economic exposure x Translation exposure 10.2 ACTIVITIES 42 Self-test Do the self-test questions for chapter 10. Answers to the self-test questions are provided at the end of the prescribed textbook. Case Study: Assessment of Exchange Rate Exposure Study the case "Blades, PLC: Assessment of Exchange Rate Exposure" and answer the questions that follow it. Suggested answers are provided below: 1. Blades is subject to transaction and economic exposure, but is not subject to translation exposure. Transaction exposure is the degree to which the value of future cash transactions can be affected by exchange rate fluctuations. Economic exposure is the degree to which a firm's present value of future cash flows can be influenced by exchange rate fluctuations. Translation exposure is the exposure of an MNC's consolidated financial statements to exchange rate fluctuations. 2. Consolidated Net Cash Flow Assessment of Blades, Inc. Currency US dollar Inflow: (200,000 pairs $80 per pair) Japanese yen Outflow: (1,700 pairs 7,440 yen per pair) Thai baht Inflow: (180,000 pairs 4,594 baht per pair) Outflow: (72,000 pairs 2,871 baht per pair) Total Inflow Net Inflow or Outflow Total Outflow Expected Exchange Rate Net Inflow or Outflow as Measured in U.S. Dollars 16,000,000 16,000,000 (inflow) 0.67 10,720,000 (inflow) 12,648,000 12,648,000 (outflow) 0.0055 69,564 (outflow) 826,920,000 206,712,000 620,208,000 (inflow) 0.016 9,923,328 (inflow) Estimating the Range of Net Inflows or Outflows for Blades, Inc. Range of Possible 43 Range of Possible Net Inflows or Outflows in U.S. Dollars (Based on British pound Japanese yen Thai baht Net Inflow or Exchange Rates at Range of Possible Net Outflow 16,000,000.00 (inflow) End of Period 0.68 to 0.65 Exchange Rate* 10,400,000 to 10,880,000 (inflow) 12,648,000.00 (outflow) 0.0053 to 0.0058 67,034 to 73,358 (outflow) 620,208,000.00 (inflow) 0.013 to 0.019 8,062,704 to 117,839,520 (inflow) *Ranges are calculated by multiplying the net inflow or outflow and the exchange rates in the range. 3. If Blades does not enter into the agreement with the US firm but continues its current importing and exporting practices in Asia, the increased correlations between the Japanese yen and the Thai baht will reduce Blades' level of transaction exposure. This is because Blades generates net inflows denominated in Thai baht but net outflows denominated in Japanese yen. For example, if the Thai baht depreciates, resulting in reduced pound revenue, the Japanese yen will also depreciate, resulting in reduced pound costs. 4. Importing components from Japan would probably not be a good way to reduce Blades' transaction exposure in the long run. Although the correlation between the Thai baht and the Japanese yen is currently quite high, it has been low and unstable in the past. Once the current economic problems that caused the currently high correlation subside, the correlation between the two currencies will probably return to its normal level. Since Blades only reduces its net transaction exposure by importing from Japan because of the high correlation between the two currencies, Blades' net transaction exposure may actually increase once the correlation between the baht and the yen returns to normal levels. 5. If Blades enters into the agreement with Jogs its overall level of transaction exposure would increase because the resulting transactions would increase Blades' net cash inflows denominated in foreign currencies. However, the increase in transaction exposure is probably not too high, since the correlations between the two Asian currencies and the British pound are relatively low. For example, a depreciation in the dollar would likely be accompanied by an appreciation in the Thai baht and the Japanese yen. The depreciation of the dollar would result in reduced pound revenue from Blades' US exports. However, this reduction would be offset by increased pound revenue from Thailand, even though Blades' pound costs incurred due to Japanese imports would also increase. 6. Blades' UK sales were likely negatively affected by the depreciation of the baht since several Thai manufacturers located in Thailand have begun targeting the UK roller blade market. This is because Blades' UK customers can obtain foreign roller blades more cheaply with a strengthened pound. Blades' exports to Thailand were affected negatively by the depreciation, as the baht it received were converted into fewer pounds. Blades' imports from Thailand were 44 probably affected positively by a depreciation of the baht, as fewer pounds were needed to obtain the baht to pay for the imports. Since the correlation between the baht and the yen has been high, the yen probably also depreciated, leading to reduced pound costs for Blades to pay for the Japanese imports. 10.3 REFLECTION Before you continue to the next study unit, reflect on the following questions: a. Can you confirm you have achieved the learning outcomes of this study unit? b. What did you find difficult? Why do you think you found it difficult? Do you understand it now or do you need more help? What are you going to do about it? c. Will you be able to use the skills you learned in this study unit in your professional life? d. Go to online student resources (http://www.cengage.co.uk/madura_fox/students/stu_title.htm) and test yourself on your understanding of the study unit. 10.4 CONCLUSION The end of Chapter 10 gives a summary of concepts you have learnt. The next study unit is on managing transaction exposure. 45 STUDY UNIT 11 MANAGING TRANSACTION EXPOSURE LEARNING OUTCOMES On completion of this study unit, you should be able to identify the net transaction exposure of a firm justify hedging of transaction exposure identify the commonly used techniques for hedging transaction exposure explain how each technique can be used to hedge payables and receivables compare the cash flows that would be expected from each hedging technique compare the advantages and disadvantages of the various hedging techniques explain the limitations of hedging transaction exposure suggest other methods of managing risk when hedging is not available explain how transaction exposure management affects an MNC's value 11.1 OVERVIEW OF THE UNIT Transaction exposure is the degree to which the value of future cash transactions can be affected by exchange rate fluctuations. It measures changes in the value of outstanding financial obligations prior to a change in exchange rates but not due to be settled until after the exchange rates change. It should be noted that there is no consensus on whether the firm should hedge. Those who do not support hedging would argue that exchange risk management at corporate level does not add value to the firm since investors can do this by themselves. In addition, it is argued that what matters in the firm valuation in only systematic risk, while corporate risk management is about total risk. Supporters of corporate hedging point out that hedging can be beneficial to the firm when one takes into consideration market imperfections such as information asymmetry, differential transactions costs, default costs and progressive corporate taxes. Chapter 11 of the prescribed text is your required reading. In order to achieve the 46 learning outcomes of this study unit, you are required to read through the following five subheadings of the chapter: x Transaction exposure x Techniques to eliminate transaction exposure x Limitation of hedging x Hedging long-term transaction exposure x Alternative hedging techniques Appendices 11A and 11B are optional reading and are not mandatory. 11.2 ACTIVITIES Self-test Do the self-test questions for chapter 11. Answers to the self-test questions are provided at the end of the prescribed textbook. Case Study: Management of Transaction Exposure Study the case "Blades, Inc.: Management of Transaction Exposure" and answer the questions that follow it. Suggested answers are provided below: 1. Based on the analysis, it appears that Blades should hedge its baht exposure. The money market hedge appears to be the most appropriate for Blades because it results in the highest dollar value for the net baht inflows. There is only a 20 percent chance that remaining unhedged will result in a higher dollar amount to be received in 90 days. Calculation of Net Baht Paid or Received in 90 Days: Baht-denominated inflow: Pairs sold Revenue per pair = Number of baht received in 90 days Baht-denominated outflow: Pairs manufactured Estimated cost per pair = Number of baht needed in 90 days 45,000 4,594 206,730,000 18,000 3,000 54,000,000 Net inflow (outflow) in baht anticipated in 90 days 47 152,730,000 Forward Hedge: Sell baht 90 days forward: Baht-denominated revenue - Forward rate of baht = Pounds to be received in 90 days 152,730,000 0.0143 2,184,039 Money Market Hedge: Borrow baht, convert to $, invest $, use receivables to pay off loan in 90 days: Amount in baht borrowed (152,730,000/1.04) Pounds received from converting baht (146,855,769.20 0.0153) Pounds accumulated after 90 days (2,246,893 1.021) 146,855,769.20 2,246,893 2,294,077 Remain Unhedged: Possible Spot Rate for the Thai Baht in 90 Days 0.0133 0.0142 0.0145 0.0147 0.0153 0.0157 Total s received from converting 152,730,000 baht 2,031,309 2,168,766 2,214,585 2,245,131 2,336,769 2,297,861 2. Well, it depends on Blades' level of risk aversion. Remaining unhedged seems attractive but there is a 20% chance that the outcome will be worse than the forward hedge. To protect against that, a put option might be the best alternative, protecting against the worst 20% downside risk and yet allowing participation in gains through any appreciation in the value of the dollar. Calculation of Dollars Received in 90 Days: Pound-denominated inflow: Pairs sold Revenue per pair = Number of dollars received in 90 days 50,000 80 4,000,000 Forward Hedge: Sell pounds 90 days forward: Pound-denominated revenue Forward rate of dollar = Pounds to be received in 90 days 4,000,000 0.67 2,680,000 Money Market Hedge: Borrow pounds, convert to $, invest $, use receivables to pay off loan in 90 days: Amount in pounds borrowed (4,000,000/1.02) 3,921,569 48 Pounds received from converting pounds (3,921,568.63 0.66) Pounds accumulated after 90 days (2,588,236 1.021) 2,588,236 2,642,589 Put Option Hedge: Purchase put option: Possible Spot Rate in 90 Days () 0.69 0.68 0.675 0.671 0.666 0.658 Premium per Unit Paid for Option () 0.01 0.01 0.01 0.01 0.01 0.01 Exercise Option? N N Y Y Y Y Total pounds Received per Unit (after accounting for the premium) 0.68 0.67 0.67 0.67 0.67 0.67 Total pounds Received from Converting 4,000,000 Dollars 2,720,000 2,680,000 2,680,000 2,680,000 2,680,000 2,680,000 Probability 5% 20% 30% 25% 15% 5% Remain Unhedged: Possible Spot Rate in 90 Days ($) 0.69 0.68 0.675 0.671 0.666 0.658 Total Dollars Received from Converting Pounds 2,760,000 2,720,000 2,700,000 2,684,000 2,664,000 2,632,000 Probability 5% 20% 30% 25% 15% 5% 3. In general, it is easier for Blades to hedge its inflows denominated in foreign currencies. This is because Blades' outflows are subject to two uncertain variables, the amount of the payables denominated in the foreign currency due to fluctuations in market prices and the future exchange rate. Since Blades has export agreements with its major customers, its pound inflows are uncertain only because of exchange rate changes. 4. In this case, none of the hedges would require Blades to over-hedge. Usually, the put option hedge would require Blades to over-hedge, since Ben Holt wishes to hedge the entire exposure and there are 31,250 pounds in a put option. In this case, however, Blades will receive 4,000,000 pounds in 90 days and will need to purchase 128 put options in order to exactly cover this exposure. Given Blades' exporting arrangements, it is not subject to over-hedging using the money market hedge. Both the British and Thai retailers have entered into arrangements with Blades under which prices are fixed. Consequently, it is unlikely that the actual amount received in the future will differ from the expected amount. 5. Blades could import sufficient materials to completely offset the baht-denominated inflows this period. Since Blades will generate baht-denominated revenue of 45,000 4,594 = THB206,730,000 this quarter, it could import materials sufficient to manufacture 206,730,000/3,000 = 68,910 pairs of Speedos in the current quarter. It could then instruct its Thai customer to make payment directly to the Thai supplier. 49 The tradeoff of accelerating the purchases from Thailand in order to reduce Blades' transaction exposure this quarter is that the transaction exposure in subsequent quarters will be correspondingly higher. Furthermore, Blades' inventory position will be very high this quarter, and it may incur additional expenses in order to accommodate the higher inventory. 6. Yes, Blades could modify its payment practices in order to reduce its transaction exposure in Thailand. Currently, Blades pays the Thai suppliers sixty days earlier than its competitors. If the Thai baht depreciates over these sixty days, lagging payment would result in a lower pound cost for Blades. The tradeoff resulting from lagging payments to the Thai suppliers is that Blades cannot use the baht-denominated costs to offset the baht-denominated revenue. This is because baht will be received and needed at different times. Consequently, Blades may have to hedge its exposure more often. 7. Blades has fixed-price exporting arrangements with both the Thai and UK customers for the next two years. Furthermore, the timing of the resulting foreign currency inflows is known. Since long-term hedging techniques are particularly appropriate for firms that can accurately estimate their foreign currency payables or receivables that will occur in the future, Blades could benefit from long-term hedging techniques. For example, it could enter into long-term forward contracts for Thai baht and/or dollars, swap currencies with another firm in the future, or agree to a parallel loan. 11.3 REFLECTION Before you continue to the next study unit, reflect on the following questions: a. Can you confirm you have achieved the learning outcomes of this study unit? b. What did you find difficult? Why do you think you found it difficult? Do you understand it now or do you need more help? What are you going to do about it? c. Will you be able to use the skills you learned in this study unit in your professional life? d. Go to online student resources (http://www.cengage.co.uk/madura_fox/students/stu_title.htm) and test yourself on your understanding of the study unit. 11.4 CONCLUSION The end of Chapter 11 gives a summary of concepts you have learnt. The next study unit is on the management of economic and translation exposure. 50 STUDY UNIT 12 MANAGING ECONOMIC EXPOSURE AND TRANSLATION EXPOSURE LEARNING OUTCOMES On completion of this study unit, you should be able to explain how an MNC can hedge its economic exposure explain the importance of managing economic exposure explain how economic exposure can be reduced through restructuring explain how an MNC can hedge its translation exposure explain the limitations of hedging translation exposure discuss how managing economic exposure impacts on an MNC's value 12.1 OVERVIEW OF THE UNIT Even after hedging all transaction exposure, the operating cash flows of MNCs may still be sensitive to fluctuations in exchange rates. In addition, the consolidated financial statements of the parent MNCs are subject to translation exposure because of various conventions in translating foreign currency assets and liabilities. Chapter 12 of the prescribed text is your required reading. In order to achieve the learning outcomes of this study unit, you are required to read through the following four subheadings of the chapter: x Economic exposure x A case study in hedging economic exposure x Hedging exposure to fixed assets x Managing translation exposure 12.2 ACTIVITIES Self-test Do the self-test questions for chapter 12. 51 Answers to the self-test questions are provided at the end of the prescribed textbook. Case Study: Assessment of Economic Exposure Study the case "Blades, PLC: Assessment of Economic Exposure" and answer the questions that follow it. Suggested answers are provided below: 1. If the Thai customer renews its commitment for another three years, the price Blades receives in baht would continue to be fixed. Conversely, Blades' cost of goods sold incurred in Thailand would be subject to the high level of inflation in Thailand. In addition, the high inflation may cause the baht to depreciate, which would reduce the dollars received from baht-denominated sales to Thailand. 2. Before renewing its commitment to purchase a fixed number of products at a fixed price from Blades, the Thai importer would have to assess the advantages and disadvantages of such an arrangement. If the Thai level of inflation continues to be high, the retailer has the advantage of incurring costs denominated in baht that are not subject to the high level of inflation. However, if consumers in Thailand continue to reduce their spending on leisure products, the Thai firm may not be able to sell all of the products it has purchased from Blades. If the Thai economy returns to a high growth level, the Thai customer will probably renew its commitment. This is because it can be reasonably certain that it will sell all of the products it has committed itself to purchase from Blades. Furthermore, the costs it incurs are still not subject to the high level of inflation prevailing in Thailand. 3. Blades, Inc. does not appear to be subject to a high level of economic exposure based on the analysis. Nevertheless, a depreciation of the Thai baht by 10 percent to an average level of $.0198 over the year would decrease its earnings before taxes by approximately 5 percent. Thus, Blades, Inc. is subject to some economic exposure. 0.015 0.01425 0.0135 0.654 0.6213 0.5886 52 THB=0.015 $=0.654 Sales (1) UK (520,000 units 72/pair) (2) Thai (180,000 units THB4,594 Exchange Rate) (3) US (200,000 units $80 Exchange Rate) (4) Total Cost of goods sold: (5) U.S. ([900,000 - 80,000] units 70) (6) Thai (80,000 units THB3,000 Exchange Rate) (7) Total (8) Gross profit Operating Expenses: (9) UK: Fixed (10) UK: Variable (11% of UK sales)*** (11) Total (12) Earnings before taxes 4. THB=0.01425 $=0.6213 THB=0.0135 $=0.5886 37,440,000 12,403,800 37,440,000 11,783,610 37,440,000 11,163,420 10,464,000 60,307,800 59,164,410 58,021,020 37,539,600 3,600,000 37,539,600 3,420,000 37,539,600 3,240,000 41,139,600 19,168,200 40,959,600 18,204,810 40,779,600 17,241,420 2,000,000 4,118,400 6,118,400 13,049,800 2,000,000 4,118,400 6,118,400 12,085,600 2,000,000 4,118,400 6,118,400 11,123,020 9,940,800 9,417,600 If the dollar and the Thai baht are perfectly correlated, Blades' level of economic exposure increases. This is because Blades generates inflows in both dollars and baht. Under this scenario, a depreciation of the dollar and the baht by 10 percent would reduce Blades' earnings before taxes by approximately 14.75 percent. Sales (1) UK (520,000 units 72/pair) (2) Thai (180,000 units THB4,594 Exchange Rate) (3) British (200,000 units 80 pounds Exchange Rate) (4) Total Cost of goods sold: (5) U.S. ([900,000 - 80,000] units $70) (6) Thai (80,000 units THB3,000 Exchange Rate) (7) Total (8) Gross profit Operating Expenses: (9) U.S.: Fixed (10) U.S.: Variable (11% of U.S. sales) (11) Total (12) Earnings before taxes THB=0.015 THB=0.0135 $=0.654 $=0.5886 37,440,000 12,403,800 37,440,000 11,163,420 10,464,000 60,307,800 58,021,020 37,539,600 3,600,000 37,539,600 3,240,000 41,139,600 19,168,200 40,779,600 17,241,420 2,000,000 4,118,400 6,118,400 13,049,800 2,000,000 4,118,400 6,118,400 11,123,020 53 Joint 10% depreciation 9,417,600 14.76% decline in profits 5. There are several actions Blades could take. The analysis above illustrates that economic exposure can be reduced by conducting its international business in countries whose currencies are not highly correlated. Thus, Blades could be exporting to or importing from other countries besides Thailand and the United States. Another action Blades could take is to borrow in baht, which would reduce the number of baht that would have to be converted to pounds, as the baht receivables could be used to repay to baht-denominated loans. The borrowed funds could then be converted to dollars to pay for UK supplies. However, the high level of interest rates may not make this a feasible alternative. To further reduce its economic exposure, Blades could also buy more supplies from Thailand instead of the UK in order to create more cash outflows in baht. This would further reduce the level of economic exposure, as more baht revenues could be used to buy Thai supplies. However, the success of this approach depends on the impact of the high level of inflation in Thailand on market prices for the imported components. 12.3 REFLECTION Before you continue to the next study unit, reflect on the following questions: a. Can you confirm you have achieved the learning outcomes of this study unit? b. What did you find difficult? Why do you think you found it difficult? Do you understand it now or do you need more help? What are you going to do about it? c. Will you be able to use the skills you learned in this study unit in your professional life? d. Go to online student resources (http://www.cengage.co.uk/madura_fox/students/stu_title.htm) and test yourself on your understanding of the study unit. 12.4 CONCLUSION The end of Chapter 12 gives a summary of concepts you have learnt. The next Topic is on long-term asset and liability management. 54 STUDY UNIT 13 MULTINATIONAL CAPITAL BUDGETING LEARNING OUTCOMES On completion of this study unit, you should be able to explain major differences between domestic capital budgeting and international capital budgeting compare the capital budgeting analysis of an MNC's subsidiary with that of its parent assess the profitability of foreign investments by identifying incremental cash flows demonstrate how to implement multinational capital budgeting explain how the risk of international projects can be incorporated into the analysis explain the impact of multinational capital budgeting on an MNC's value 13.1 OVERVIEW OF THE UNIT MNCs evaluate long-term investment projects by using multinational capital budgeting, which is much more complex than domestic capital budgeting. The following are some reasons for this added complexity: Differences between parent and project cash flows Differences between foreign and domestic business risk Differences between foreign and domestic inflation rates Foreign tax regulations Exchange rate risk Political risk Project specific financing Even though the NPV rule is the most appropriate decision criterion, numerous adjustments have to be made to incorporate the additional economic and political risks faced by the firm. 56 This chapter is not in the prescribed textbook. It has been retired to the internet site and the international element of the chapter has been intergrated with the chapter on Foreign Direct Investment. This chapter has been extensively revised and extended to include host country MNC relationships. The additional_reading_2 uploaded on myUNISA is your required reading for this study unit. In order to achieve the learning outcomes of this study unit, you are required to read through the following five sub-headings of the material: x x x x x 13.2 Subsidiary versus parent perspective Input for multinational capital bidgeting Multinational capital budgeting example Factors to consider in multinational capital budgeting Adjusting project assessment for risk ACTIVITIES Self-test Do the self-test questions for additional_reading_2. Answers to the self-test questions will be posted on myUNISA. Study the case "Multinational Capital Budgeting by the Sports Exports Company" and answer the questions that follow it. Case Study: Small Business Dilemma - Multinational Capital Budgeting by the Sports Exports Company Jim Logan, owner of the Sports Exports Company (Ireland), has been pleased with his success in the United Kingdom. He began his business by producing basketballs and exporting them to the United Kingdom. While American-style basketball is still not nearly as popular in the United Kingdom as it is in the United States, his firm controls the market in the United Kingdom. Jim is considering an application of the same business in the US. He would produce the basketballs in Ireland and export them to a distributor of sporting goods in the US, who would sell the basketballs to retail stores. The distributor likely would want to pay for the product each month in dollars. Jim would need to hire one full-time employee in Ireland to produce the basketballs. He would also need to lease one more warehouse. 1. Describe the capital budgeting steps that would be necessary to determine whether this proposed project is feasible, as related to this specific situation. 2. Explain why there is uncertainty surrounding the cash flows of this project. 57 Suggested answers are provided below: 1. Jim would need to estimate the amount of basketballs that would be sold to the distributor in the US each month. The revenue to be received would be equal to the number of basketballs sold times the price (in dollars) per football. This revenue would be converted into euros, at the prevailing exchange rate. The value of the dollar can change over time. The dollar's value must be forecasted for each month, so that the euro cash inflows can be estimated. The cash outflows are the expenses of hiring a full-time employee to perform the production and the leasing of one more warehouse. These cash outflows are in euros and therefore are not directly affected by a change in the value of the dollar. Once the euro cash inflows and outflows are estimated, they can be used to derive the net cash flows. Then the net cash flows can be discounted to determine the present value of net cash flows. This project does not have an initial outlay, other than initial lease payment on the warehouse and perhaps a bulk purchase of material to produce the basketballs. The present value of cash flows would be compared to any initial expenses that represent the initial outlay, so that the net present value of the project could be determined. 2. First, the number of basketballs to be sold is very uncertain. The firm is attempting to sell a product in a country where it has little experience. The quantity of basketballs demanded affects the dollar revenue and the cost of production. Also, the value of the dollar is uncertain. If the dollar's value is lower than anticipated in the future, the euro revenue to be received would likely be less than anticipated. 13.3 REFLECTION Before you continue to the next study unit, reflect on the following questions: a. Can you confirm you have achieved the learning outcomes of this study unit? b. What did you find difficult? Why do you think you found it difficult? Do you understand it now or do you need more help? What are you going to do about it? c. Will you be able to use the skills you learned in this study unit in your professional life? d. Go to online student resources (http://www.cengage.co.uk/madura_fox/students/stu_title.htm) and test yourself on your understanding of the study unit. 13.4 CONCLUSION The end of Additional_reading_2 gives a summary of concepts you have learnt. The next study unit is on multinational restructuring. 58 STUDY UNIT 14 MULTINATIONAL RESTRUCTURING LEARNING OUTCOMES On completion of this study unit, you should be able to: explain why MNCs consider international acquisitions as a form of multinational restructuring explain how MNCs conduct valuation of foreign target firms explain why the values of target firms can vary depending on the situation of the acquiring firm identify other types of restructuring besides international acquisitions explain the impact of multinational restructuring on an MNC's value 14.1 OVERVIEW OF THE UNIT Multinational restructuring generally refers to the restructuring of the composition of assets and liabilities of the MNC. In order to capitalize on imperfections in product and factor markets, it is essential for MNCs to constantly re-evaluate their existing business and plans for future business. The process involves determining the optimum composition of assets to employ and the locations where the assets are employed. Additional_reading_3 on myUNISA is your required reading for this study unit. In order to achieve the learning outcomes of this study unit, you are required to read through the following six sub-headings of Additional_reading_3: x Background on multinational restructuring x Factors that affect the expected cash flows of the foreign target x Example of the valuation process x Why valuations of a target may vary among MNCs x Other types of multinational restructuring x Restructuring decisions as real options 14.2 ACTIVITIES Self-test Do the self-test questions for Additional_reading_3. 59 Answers to the self-test questions will be provided on myUNISA. Case Study: Small Business Dilemma: Multinational restructuring by the Sports Exports Company Study the case " Small Business Dilemma: Multinational restructuring by the Sports Exports Company" and answer the questions that follow it. The sports Exports Company (Ireland) has been successful in producing basketballs in Ireland and exporting them to the United Kingdom. Recently, Jim Logan (owner of the Sports Export Company) has considered restructuring his company by expanding throughout Europe. He plans to export basketballs and other sporting goods that were not already popular in Europe to one large sporting goods distributor in Germany; the goods will then be distributed to any retail sporting goods store throughout Europe that are willing to purchase these goods. This distributor will make payments in Euros to the Sports Exports Company. 1. 2. 3. Are there any reasons why the business that has been so successful in the United Kingdom will not necessarily be successful in other European Countries? If the business is diversified throughout Europe, will this substantially reduce the exposure of the Sports Export Company to exchange rate risk? Now that several countries in Europe participate in a single currency system, will this affect the performance of new expansion throughout Europe? Suggested answers are provided below: 1. When this business was first created, it was based on a perception that British consumers would become more interested in basketball, and that it would become a popular hobby in the United Kingdom. However, Jim should consider whether the other European countries have similar characteristics before spreading the business throughout Europe. 2. Yes as more of its sales will be in the home currency. 3. It may make it easier for the distributor to deal with stores throughout Europe, but the Sports Exports Company will still be exposed to exchange rate risk. 14.3 REFLECTION Before you continue to the next study unit, reflect on the following questions: a. Can you confirm you have achieved the learning outcomes of this study unit? 60 b. What did you find difficult? Why do you think you found it difficult? Do you understand it now or do you need more help? What are you going to do about it? c. Will you be able to use the skills you learned in this study unit in your professional life? d. Go to online student resources (http://www.cengage.co.uk/madura_fox/students/stu_title.htm) and test yourself on your understanding of the study unit. 14.4 CONCLUSION The Additional_reading_3 gives a summary of concepts you have learnt. The next study unit is on country risk analysis. 61 STUDY UNIT 15 COUNTRY RISK ANALYSIS LEARNING OUTCOMES On completion of this study unit, you should be able to: identify the common factors used by MNCs to measure a country's political risk identify the common factors used by MNCs to measure a country's financial risk explain the techniques used to measure country risk explain how MNCs use the assessment of country risk when making financial decisions. 15.1 OVERVIEW OF THE UNIT In order to make investment decisions that maximize MNCs' value, financial managers must understand how to measure country risk. The main components of country risk are political risk and financial risk. Chapter 14 of the prescribed text is your required reading. In order to achieve the learning outcomes of this study unit, you are required to read through the following 8 subheadings of the chapter: x Why country risk analysis is important x Political risk factors x Financial risk factors x Techniques to assess country risk x Measuring country risk x Comparing risk ratings among countries x Incorporating country risk in capital budgeting x Reducing exposure to host government takeovers 15.2 ACTIVITIES Self-test Do the self-test questions for chapter 14. Answers to the self-test questions are provided at the end of the prescribed textbook. 62 Case Study: Blades PLC: Country risk assessment Study the case " Blades PLC: Country risk assessment" and answer the questions that follow it. Suggested answers are provided below: 1. Based on the information provided in the case, the political risk for a manufacturer of leisure products appears to be lower for a manufacturer of leisure products such as Blades. This is because the number of licenses and permits required for Blades' industry is relatively few compared to other industries. 2. The level of financial risk in Thailand is higher for a manufacturer of leisure products such as Blades. This is because consumers will first eliminate purchases of these types of products as opposed to more essential products such as food in the event of an economic turndown. Consequently, Blades would suffer more from high levels of interest rates and inflation in Thailand than producers of more essential items. A leisure product manufacturer such as Blades will probably be more affected by financial risk factors than political risk factors in Thailand. Financial risk factors can have a devastating effect on the consumption of \"luxury\" items such as roller blades. Political risk factors will affect Blades if the Thai government imposes controls or restrictions that would make it more difficult for Blades, Inc. to operate efficiently in Thailand, which is currently not the case. 3. Establishing a subsidiary in Thailand will probably result in a higher level of political risk than acquiring Skates'n'Stuff. Asian consumers prefer to purchase from Asian producers. If Blades acquires Skates'n'Stuff and retains the company's management and employees, the acquisition will result in a lower level of political risk than the establishment of a subsidiary. The financial risk associated with Thailand will probably not differ substantially between the two approaches of direct foreign investment. If the Thai economy enters a recession, demand for Blades' products will be affected negatively, regardless of whether it establishes a subsidiary in Thailand or purchases Skates'n'Stuff. 4. (See spreadsheet below.) There is no one correct answer to this question. The estimates provided in the attached spreadsheet are somewhat arbitrary, but students should at least use the information provided to assign a rating. However, because of the higher political risk associated with the establishment of a subsidiary (as opposed to the acquisition of Skates'n'Stuff), the establishment of a subsidiary should result in a higher (i.e., less favorable) country risk rating for the establishment of a subsidiary. 63 (1) Establishment of a Subsidiary in Thailand (1) (2) Rating Assigned by Blades to Factor (within a Political Risk Factor range of 1-5) Attitude of Thai 4 Consumers Capital Controls 4 Bureaucracy 2 (3) Weight Assigned by Blades to Factor According to Importance 30% 40% 30% 100% Financial Risk Factor Interest Rates 5 Inflation Level 3 Exchange Rates 4 (1) Category Political Risk Financial Risk (4) = (2) (3) Weighted Value of Factor 1.2 1.6 0.6 3.4 35% 30% 35% 100% = Political rating 1.75 0.9 1.4 4.05 (2) (3) Rating as Determined Above 3.4 4.05 Weight Assigned by Blades to Each Risk Weighted Category Rating 40% 1.36 60% 2.43 100% 3.79 (2) Rating Assigned by Blades to Factor (within a Political Risk Factor range of 1-5) Attitude of Thai 3 Consumers Capital Controls 4 Financial rating risk (4) = (2) (3) (2) Acquisition of Skates'n'Stuff (1) = risk (3) (4) = (2) (3) Weight Assigned by Blades to Factor According to Importance 30% 40% 64 Weighted Value of Factor 0.9 1.6 = Overall country risk rating Bureaucracy 1 30% 100% Financial Risk Factor Interest Rates 5 Inflation Level 3 Exchange Rates 4 35% 30% 35% 100% 0.3 2.8 = Political rating 1.75 0.9 1.4 4.05 (1) (2) (3) Category Political Risk Financial Risk Rating as Determined Above 2.8 4.05 Weight Assigned by Blades to Each Risk Weighted Category Rating 40% 1.12 60% 2.43 100% 3.55 risk = Financial risk rating (4) = (2) (3) = Overall country risk rating 5. Establishing a subsidiary should utilize a higher discount rate in the capital budgeting analysis. This would reduce the NPV associated with establishing a subsidiary in Thailand. Since the capital budgeting analysis indicated that establishing a subsidiary would be preferable to the acquisition of Skates'n'Stuff, this adjustment would weaken the tentative decision of establishing a subsidiary in Thailand. 15.3 REFLECTION Before you continue to the next study unit, reflect on the following questions: a. Can you confirm you have achieved the learning outcomes of this study unit? b. What did you find difficult? Why do you think you found it difficult? Do you understand it now or do you need more help? What are you going to do about it? c. Will you be able to use the skills you learned in this study unit in your professional life? d. Go to online student resources (http://www.cengage.co.uk/madura_fox/students/stu_title.htm) and test yourself on your understanding of the study unit. 15.4 CONCLUSION The end of Chapter 14 gives a summary of concepts you have learnt. The next study unit is on multinational cost of capital and capital structure. 65 STUDY UNIT 2 INTERNATIONAL FLOW OF FUNDS LEARNING OUTCOMES On completion of this study unit, you should be able to understand the key components of the balance of payments (BP) understand how the international trade flows are influenced by economic and political factors understand how the international capital flows are influenced by country characteristics outline the factors affecting direct foreign investment and portfolio investment identify and describe the major roles played by the key agencies that facilitate the international flow of funds describe how the international flow of funds can have an effect on the value of MNCs understand why an understanding of the BP accounts is important to the financial manager. 2.1 OVERVIEW OF THE UNIT This study unit provides a brief, general overview of the international environment in which MNCs operate. Although the material discussed here is relevant to the financial manager of MNCs, it should give you some background on general concepts and issues. Those of you who wish to gain an in-depth understanding of these concepts and issues should consult a source in macroeconomics. Why is a good understanding of the BP accounts important to the financial manager? By definition, the financial manager's job depends on his/her ability to foresee future developments and take appropriate action. Trends in various account balances could reveal new business opportunities or loss of existing opportunities, both in the parent's home country and abroad. Such change in opportunities could be direct as relative costs rise or fall as a result of government intervention (e.g. change in interest rates). Or, they may be indirect as countries restructure their policies towards MNCs, helping some but hurting others. For example, while a weaker local currency could help export-oriented businesses, it could be detrimental to import-oriented businesses. As such, any information that can be gleaned from study of BP accounts could enhance the quality of decisions made by financial managers. 9 Chapter 2 of the prescribed text is required reading for this study unit. In order to achieve the learning outcomes of this study unit, you are required to read through the following seven sub-headings of the chapter: x x x x x x x x 2.3 Balance of payments International trade flows Updated trade and investment conditions Factors affecting international trade flows Correcting a balance of trade deficit International capital flows Agencies that facilitate international flows How international trade affects an MNC's value ACTIVITIES Self-test Do the self-test questions for chapter 2. Answers to the self-test questions are provided at the end of the prescribed textbook. Internet application Use the website of the South African Reserve Bank to assess the trends in exporting and importing by South African firms: http://www.resbank.co.za. The following are guiding questions. a. How has South Africa's balance of trade changed over the last two years? b. What are some reasons for these changes in South Africa's balance of trade? Case Study: Exposure to International Flow of Funds Assume the position of Ben Holt, CFO of Blades. Study the case "Blades, PLC: Exposure to International Flow of Funds" and answer the questions. Suggested answers are provided below: 10 1. A high level of inflation in Thailand relative to the UK could affect Blades favorably. Generally, if a country's inflation rate increases relative to the countries with which it trades, consumers and corporations within the country will most likely purchase more goods overseas, as local goods become more expensive. Consequently, Blades' sales to Thailand may increase. 2. Blades would be favorably affected relative to Thai roller blade manufacturers and relative to other UK roller blade manufacturers with operations in Thailand. Both groups of firms will likely be forced to raise their prices if they want to maintain the same profit margin should inflation in Thailand increase. This is especially true if both groups of firms source their supplies directly from Thailand, so that the prices of these supplies are subject to the higher inflation in Thailand. Conversely, Blades' cost of goods sold incurred in Thailand is relatively small. Consequently, costs will not be subject to the higher level of inflation in Thailand to a great extent and Blades will probably not have to raise its prices to the same extent as Thai roller blade manufacturers or UK manufacturers with operations in Thailand. 3. At first glance, it would appear that a decreasing level of national income in Thailand could hurt Blades financially, as Thai consumers will have less money to spend. Furthermore, this effect may be magnified because Blades manufactures a leisure product, which is probably one of the first products Thai consumers will stop buying. The arrangement Blades has with its primary Thai importer mitigates this effect somewhat, since the latter has committed himself to the purchase of a certain number of \"Speedos\" annually. Nevertheless, the importer may not offer to renew this arrangement in excess of the original three years if the Thai economy does not improve. 4. A continued depreciation of the Thai baht would hurt Blades, especially because the firm invoices its roller blades in baht. A continued depreciation of the baht means that the baht-denominated revenue in Thailand will convert to fewer UK dollars. Blades also has some expenses in baht, but this amount is less than the revenue denominated in baht. Although Blades would be hurt by a depreciating baht because its exports are denominated in baht, the demand for Blades's products may increase relative to that of its UK competitors exporting to Thailand. This is because most of the UK firms exporting roller blades to Thailand invoice their products in UK pounds. If the baht depreciates, Thai importers will have to convert more baht to pounds in order to pay for the pounddenominated exports. 5. An agency extending direct loans to corporations involved in international trade is the International Financial Corporation (IFC). Besides extending loans, the IFC may also purchase stock in a corporation, thereby becoming part owner. 2.3 REFLECTION Before you continue to the next study unit, reflect on the following questions: a. Can you confirm you have achieved the learning outcomes of this study unit? b. What did you find difficult? Why do you think you found it difficult? Do you understand it now or do you need more help? What are you going to do about it? 11 c. Will you be able to use the skills you learned in this study unit in your professional life? d. What did you find interesting in this study unit? Why? 2.4 CONCLUSION The end of Chapter 2 gives a summary of concepts you have learnt. In the next study unit you are going to learn about how international business is facilitated by markets that allow for the flow of funds between countries. Recommended further reading Antrs, P., Desai, M. and C. F. Foley .2009. \"Multinational Firms, FDI Flows and Imperfect Capital Markets.\" Quarterly Journal of Economics 124(3), p.1171-219. Millman, GJ. 1999. Financing the uncreditworthy: new financial structures for LDCs. Journal of Applied Corporate Finance, Winter: 83-89. Odedokun, Matthew O. 1993. An Econometric Analysis of Sectoral Financial and Expenditure Flows in LDCs: Evidence from Flow-of-Funds Data. Indian Economic Review 1-24. Ohmae, K. 1991. Lies, damn lies and statistics: why the trade deficit doesn't matter in a borderless world. Journal of Applied Corporate Finance, Winter: 98-106. 12 STUDY UNIT 3 INTERNATIONAL FINANCIAL MARKETS LEARNING OUTCOMES On completion of this study unit, you should be able to explain motives for using international financial markets describe the operation of spot and forward markets interpret foreign exchange quotations distinguish between "direct" and "indirect" quotes compute cross-rates understand how currency futures and options markets describe the operations of the international money market describe the operations of the international credit market describe the composition, development and operations of the Eurobond market understand the role of international stock markets compare and contrast these different components of the international financial market understand the relationship between international financial markets and MNCs 3.1 OVERVIEW OF THE UNIT The growth in international business and investment has lead to a large increase in the size and variety of international financial markets whose functions include facilitating borrowing, lending and risk reduction. The exchange rate distinguishes the operation of international financial markets from domestic markets. Financial managers of MNCs operate effectively if they have a good understanding of how international financial markets operate. Chapter 3 of the prescribed text is required reading for this study unit. In order to achieve the learning outcomes of this study unit, you are required to read through the following seven sub-headings of the chapter: 13 x x x x x x x x x Motives for using international financial markets Foreign exchange market International money market International credit market International bond market Comparing interest rates among currencies International stock markets International financial marke