International Finance

INTERNATIONAL FINANCE MANAGEMENT
Student’s Name
Course
Instructor’s Name
Institution
Date
TABLE OF CONTENTS
 TOC \o "1-3" \h \z \u HYPERLINK \l "_Toc385337717"1.0 Introduction  PAGEREF _Toc385337717 \h
3
HYPERLINK \l "_Toc385337718"2.0 Macro-Sovereign Risks and Potential Issues  PAGEREF _Toc385337718 \h
4
HYPERLINK \l "_Toc385337719"2.1 Risk profile  PAGEREF _Toc385337719 \h
4
HYPERLINK \l "_Toc385337720"2.2 Hedging  PAGEREF _Toc385337720 \h
4
HYPERLINK \l "_Toc385337721"Exchange rate risk  PAGEREF _Toc385337721 \h
5
HYPERLINK \l "_Toc385337722"Commodity Price Risk  PAGEREF _Toc385337722 \h
6
HYPERLINK \l "_Toc385337723"3.0 Valuing the Two Potential Investments  PAGEREF _Toc385337723 \h
7
HYPERLINK \l "_Toc385337724"4.0 Operations Management  PAGEREF _Toc385337724 \h
9
HYPERLINK \l "_Toc385337725"4.1 Investment Choices  PAGEREF _Toc385337725 \h
10
HYPERLINK \l "_Toc385337726"4.2 Financing choices  PAGEREF _Toc385337726 \h
11
HYPERLINK \l "_Toc385337727"4.3 Insurance  PAGEREF _Toc385337727 \h
11
HYPERLINK \l "_Toc385337728"5.0 Conclusion  PAGEREF _Toc385337728 \h
12
HYPERLINK \l "_Toc385337729"References List  PAGEREF _Toc385337729 \h
13

International Finance Management
1.0 Introduction
QuickNourish, Plc, is considering new developments outside the United Kingdom. Its prime candidates are the United States and India. To manage risks in international business, QN has to understand the risks that it is exposed to. The process of developing a risk profile requires examination of both product market dynamics and the immediate risk from competition (Wang, 2009, p. 387). In addition, the company has to examine indirect effects of macro-economic forces. There are ways in which the company can develop risk profile by outlining the risk that the company may be exposed to, in either the United States or Indian market. In this line, there is the need to identify the macro-sovereign risk and potential issues, as well as their potential effect on the company’s competitive advantage, and further addressing the problem of valuing the two potential investments (Wang, 2009, p. 388). The company can manage its operations without the need to be at the marketplace to purchase derivatives meant to protect it from various risks while protecting the position of its business in India given that interests are higher, in the country.
2.0 Macro-Sovereign Risks and Potential Issues
The term sovereign risk refers to threats or pressure of operating a business within the legal jurisdiction (Wang, 2009, p. 389). Managers and shareholders often have strong viewpoints regarding the potential risk in certain jurisdictions, which are integrated into the analysis of opportunities. Further, Wang (2009, p. 389) defines sovereign risks as the risks that a sovereign power or a host government is likely to default to settle payments by unilaterally rebutting its foreign obligations or stopping local entities from meeting their foreign obligations. The identification of sovereign risks is critical because the risks are incorporated into the valuation of opportunities.
2.1 Risk profile
Every business faces risks and the critical step in managing risks is to create and inventory of the potential risk that the business face as well as getting a metric of the exposure to each risk. According to Wang (2009, p. 375), there are four key steps involved in risk profiling. The first step involves listing the risks that the company is exposed to from various sources without concentration on any risk. In the second step, these risks are categorised. Analysis of the risk is handled in the third step. Lastly, the company examines the alternatives that can be used to manage each risk.
2.2 Hedging
Hedging is a form of collective insurance that companies employee to protect their money. It protects the company against theft, fire and other unforeseen disasters. Having listed all the risks that QN is exposed to, the company has to decide on the risks that it wants to hedge against and those that it intends to exploit or pass through to its investors. To make good decisions, the company should consider the benefits of hedging and the potential costs, and as of consequence, QN should hedge the risks where the benefits exceed the costs. Protecting the business against risk is not a costless process (Lhabitant, 2011). For example, in the case of procuring insurance services, the costs are explicit. In the case of forwards and futures contracts, hedging costs are implicit. In essence, a well-structured hedging program reduces both costs and risks. Hedging can free up the available resources and help QN’s management team to focus on the core aspects of the company in which it has a competitive advantage by reducing the risks that are not core to the main business. As of consequence, hedging improves shareholder value by stabilizing earnings and minimising the cost of capital (MCX India, 2013, p. 10).
QN has to pay insurance premiums to get protection. However, the cost of insurance is proportional to the magnitude of the risk. If QN locates its business in coastal Florida, it would have to incur immense costs on insuring against hurricanes and floods. If QN uses forward and future contracts, it would face implicit hedging costs. Some of the most widely hedged risks in India and U.S include commodity price risk and exchange rate risk.
Exchange rate risk
Researches consistently indicate that the currency risk is the most widely hedged risk in India and the United States (Wang, 2009, p. 34). One of the explanations to this phenomenon is that the exchange rate risk is ubiquitous. Both small and large firms are exposed to exchange rate risk. QN derives its revenues from inputs that have been imported from foreign markets, thus the company is exposed to exchange rate risk. To provide a wide variety of products in its globalised chains, the company is exposed to variation in U.S. dollar. Indian Rupee, U.S dollar/Euro or U.S. dollar/Pound exchange rate. The second explanation to this phenomenon is that exchange rate risk affects the earnings of a company. Accounting standards force companies to reflect the impact of foreign exchange movements on the income or revenues within a period in which they occur. According to Multi Commodity Exchange of India Limited (2013, pp. 25-27), globalisation interactions in the business world require conversion between the International Financial Reporting Standards (IFRS) and the United States of America Generally Accepted Accounting Principles (U.S. GAAP). This implies that, the earnings of a company that does not hedge based on the used accounting standards are more volatile than companies that hedge (Harris, Jermakowic & Epstein, 2014, p. 23). Consequently, companies recognise the effects of the exchange risk. Lastly, exchange rates are easy to hedge. This risk can be managed both cheaply and easily. QN can use an array of market-traded instruments such as future contracts and options to eliminate or reduce the effects of the exchange rate risk in these economies.
The hedging of exchange rate risk is justified by the fact that exchange rate movements are likely to induce variability in earnings of QN, particularly in India (MCX India, 2013, p. 26). This may affect the company’s capacity to pay dividends and expand its operations since the Indian market could not be able to highlight the difference between revenue drops that can be linked the management of the business and those that resulted for exchange rate risk. A fall in revenues caused by adverse exchange rate movement in India could cause the company’s stock price to drop, in turn, making it challenging to raise extra capital to cover the company’s needs.
Commodity Price Risk
Although most firms within these two economies hedge against exchange rate risk than product risk, a substantial percentage of companies are exposed to commodity price risk. Most supermarkets hedge, to smoothen out the earnings that they expect on their output. For example, QN can employ futures contracts on sugar to minimise uncertainty about its costs in the future. In addition, QN can use derivatives to manage the companies exposed to fuel price risk in India. Passing increases in the fuel prices to customers would negatively affect the QN’s competitive advantage on its affordable pricing strategy. Additionally QN can use a combination of futures, swap and options to hedge the movements of oil prices and report these activities on relevant financial statements.
3.0 Valuing the Two Potential Investments
The amount of Foreign Direct Investment directed to the United States is much greater than that going into India. This suggests that the more multinational corporations (MNCs) have been exposed to the American business environment compared to that of India. In addition, a recent report World Bank on Economy Rankings (2013, p 1) position the US at number 4 and India at position 134 in terms of the ease of doing business. This implies that the political, social and economic climate in India is less favorable for business. Practically, defining sovereign risk is a complex process and the real risks of company investments la...