How to Avoid Translation, Transaction and Economic Exposures

Part 1 Question a Provide examples of how real world multinational corporations (MNC) reduce their translation, transaction and economic exposures. Translation exposure is the effect of changes in exchange rates on the accounting values of financial statements (Shapiro, 2010, p. 356). The translation exposure arises from the conversion the financial statements denominated in foreign currency from denominated in home currency. The MNCs could reduce their translation by using funds adjustment. For an example, if the devaluation of USD is expected for a Chinese company.The company could use direct funds adjustment such as pricing the exports in RMB and pricing the imports in USD, investing in RMB securities and replacing loans in RMB with the loans in USD. The company also could use indirect funds adjustment as paying out dividens, fees and other expends in advance, and speeding up the payment of accounting payable and delaying the collection of accounting receivable in USD. Transaction exposure measures the exchange gains and losses in cash flows in the value of domestic currency, which is denominated in foreign currency (Shapiro, 2010, p. 57). Multinational corporations often lower transaction exposure by making the contract with bank to lock in a forward exchange rate. For an example, an Australian import company expected to pay to an American supplier 10000 USD for the goods half year later. The company could sign a forward foreign exchange which is fixed at 0. 9 AUD per USD, and it allows carrying on the transaction in contract provision deadline any time, take at that time exchange rate as. So if there would be depreciation of home currency, and the Spot exchange rate is at 1. AUD per USD, the company had the right to convert their AUD into USD at previous exchange rate which is at 0. 9 from bank, so the amount of balance was the financial savings in cash flows. Economic exposure measures the impact of exchange rate fluctuations on the operating cash flows t horough the sales price, sales volume, and production cost (Shapiro, 2010, p. 359). So the multinational corporations could reduce their economic exposures by marketing and production strategies.For an example, in the export business, if the currency is soft in home country, the company should more revenue and profit from product pricing, and they should consider lower price by reducing cost of product, such as expanding their scope of operation for reducing the cost of production, shifting production to home for reducing cost of currency exchange. Conversely, if the home country supplies with hard currency, they could shift production to local with soft currency for reducing cost of production. Question bDefine the international debt, equity and trade financing options available to MNCs. Explain why MNCs use these financing source. International debt financing refers to the fund demanders’ credit behaviours of raising funds directly from the public by issuing various debt or stocks in the international bond market (Shapiro, 2010, p. 464). There are two kinds of foreign bond. The first kind is the bonds denominated in the local currency that are issued in the national bond market, and the second kind is the bonds denominated in the home currency that are issued in the local bond market.The important foreign bonds in the world include Yankee bonds of the US and Swiss franc bonds of Swiss, Samurai bonds of Japan and Bulldog Bond from the London market. International debt financing can have multiple sources of capital from different foreign markets. The international debt can be issued in a great number with low cost, and MNCs only need to pay the interest as required and return the principal on the due date. The company’s business condition has nothing to do with creditors and creditors cannot intervene with the company’s management and operation.The management and decision-making are both subject to the discretion of the company itself. Int ernational equity financing refers to enterprises’ fund-raising by issuing stocks in the foreign markets (Shapiro, 2010, p. 466). Since stocks can only be transferred but cannot be withdrawn, the capital raised by international stock financing is long-term capital. For the MNCs could benefit lots of advantage of the International equity financing. Firstly, the international equity financing could reduce the funding risk.For some large MNCs located in the small countries, the market could not meet the need of huge issues, it is necessary to finance in more market. Then, issuing the overseas shares could attract more overseas investors, so there is an increase of demand for the companys’ shares, thereby the price of share would also increase and achieve the maximization of the wealth. Trade financing refers to the short-term financing or credit facility provided by banks to importers or exporters in relation to the settlement of import and export trade (Shapiro, 2010, p. 36). Trading financing is divided into import and export trade financing. In general, in respect of import financing, a letter of credit is adopted (Shapiro, 2010, p. 638). When the issuing bank has received proper and complete documents as required, the applicant makes the payment under the letter of credit to repay the short-term financing. The letter of credit is easy to operate and makes the approval procedures of the administration of foreign exchange much simpler. At the same time, a sight letter of credit is also used.As a result, importers can have access to the long-term letter of credit financing. The export trading financing could take a packing loan. Before exporting the goods specified in the letter of credit provided by the overseas importer, the packing loan is employed to cover the expenses of goods, materials, production and shipment. When the shipment of the goods is completed, the exporter presents all the documents to the negotiating bank for payment under the t erms of the credit.Upon the receipt of the payment of goods, the packing loan should be paid back (Bank of China, 2012). Part 2 Briefly explain the differences between the foreign direct investments (FDI) and portfolio investment. Then collect the required the data from the Bureau of Economic Analysis (BEA) website and answer the following questions: Foreign direct investment refers to the trade activity of directly entering other countries for production by means of joint venture, sole proprietorship, etc (Shapiro, 2010, p. 198).With direct investment, investors can possess all or part of the enterprise assets and the ownership of operation, and directly perform or participate in the operation and management. Portfolio investment refers to the investment behaviours of purchasing financial securities of other countries to obtain certain proceeds (Shapiro, 2010, p. 198). Compared with direct investment, indirect investment’s investors only have the right to certain proceeds on a regular basis in addition to stock investment, but have no right to intervene with the invitee’s operation and management.Question a List the ten largest recipient countries of US FDI in the years 1990, 2000 and 2010. You need to provide the list of countries as well as the amount of FDI in USD. [pic] Source: U. S. Bureau of Economic Analysis (BEA) website. Question b What factors do you think account for these countries being the largest recipients of US FDI? Firstly, both these countries have strong political stability, because there are no changes of government and wars in recent, and the social condition and the rate of economic development of that country are positive.The positive political stability brings a safe investment environment to MNCs, which effectively enhances their confidence and willingness to invest. Secondly, these countries have reasonable, normative and stable legal systems. The countries could provide enough protection for foreign investors. Then, t hese countries have a good economic outlook in their domestic such as the low inflation, balance-of-payment surpluses and the strong growth rate of per capita GDP. So, the positive economic situation, the less likely it is to face risk that will inevitably harm foreign companies (Shapiro, 2010, p. 30). Question c Has the list of recipient counties changed over the concerned period? What might account for these changes? Yes, the list has changed over the concerned period. For most MNCs, the political and economic risks may discourage investors to invest in the countries. Political risk refers to the possibility of causing loss to investment activities of foreign investors because of the change in investment environment as a result of the change in the political situation of the host country (Shapiro, 2010, p. 277).Generally speaking, the main political risk influenced on the investment decision which includes: War Risk, when a political change or war occurs in the host country, it wi ll bring damage to the sales or profits of foreign-funded enterprises in the host country and even endanger the survival of these enterprises Legal risk, with the unreasonable laws and regulations and the direct legal confrontation between the investment country and host country, host country cannot provide enough protection for foreign investors, the assets of enterprises are more likely to suffer loss.Policy change risk, the change in policies concerning land, tax, market and exchange of the host country may influence the profits and development of enterprises. The government in the host country may set up barriers or impose various pressures for enterprises of the investment country, which often results in loss or bankruptcy for foreign-funded enterprises. Government relations risk, inharmonious government relations will lead to mutual hostility and sanctions in economy.As a result, foreign-funded enterprises are the first to be affected, which generates great risk for investment and operating activities. Economic risk mainly stems from the change in the economic policies and economic situation of the host country (Shapiro, 2010, p. 277), which changes may strike the foreign-funded enterprises and generate risk for their investment and operation. The economic risk mainly includes: Exchange rate risk, foreign investment activities often involve the conversion of different currencies.The change in exchange rate may increase the production cost, reduce the profitability of enterprises. Tax risk, the preference level of tax policy in the host country directly influences the management efficiency of enterprises. Interest rate risk, the fluctuation in the interest rate of the host country will have a direct impact on the financing cost and capital utilization efficiency of enterprises. Question d Do you except a change to the 2010 list over the next decade? Explain.Yes, I think some countries in the Third World and Eastern Europe will come into the list. With the strong economic and growth and rising standard of living, these emerging markets might be so profitable to the investors, and these host governments do recognise the free market oriented situation that it has play the role of economic growth. In the past years, the Third World’s and Eastern European countries are more open to the FDI by setting up free market oriented policies. These countries introduced a number of trade liberalization polices.In the free market system, prices and interest rate are set by market. The countries also have tax reform in the past years, that brought to foreign investors much more preferential taxation. They are accelerating the privatisation programme, it identified that government was willing to accept and support private economic activities, which leads to advance the inflow of FDI. After that, these countries also are trying to move forward is to revamp the entire civil service which could provide enough preferential treatment and protection for foreign investors.References Bank of China, 2012, Packing Loan, International Trade Financing. Accessed on: http://www. boc. cn/en/cbservice/cb3/cb35/200806/t20080627_1324121. html Shapiro, A. C. , 2010, Multinational Financial Management, 9th edn, John Wiley & Sons, New York, p. 198, p. 227, p. 230, p. 356, p. 357, p. 359, p. 464, p. 466, , p. 636, p. 638. U. S. Bureau of Economic Analysis, 2012, U. S. Direct Investment Position Abroad on a Historical-Cost Basis. [pic][pic][pic][pic][pic][pic]