Posted: August 29th, 2013
The Multinational Company requesting for financial assistance is located in Washington D.C. The plant to be financed is in Mexico. The basic things to consider are the amount of money needed and the security of investing in that plant. Other factors to consider are those influenced by investing abroad. Among them is foreign risk. These are the risks the challenges faced by investors when exchange rates fluctuate. It mostly affects those countries that are involved in exports. If a company is making trades abroad, it will realize that the profits change according to the exchange rates. The most important thing to do when dealing with this problem is to study the exchange rate of the trading country. If a country’s economy is stable, the currency will also be steady. In case of any negative fluctuations, the investor should calculate what cost it will incur (Shamah, 2003).
Another important factor to consider is how to hedge foreign exchange. This has to be done because it protects the company from foreign risks. There are three ways of hedging. They include, using forwards, options and futures. When using forwards, an agreement is made between two parties to use a fixed rate. This becomes convenient because in case there will be any unforeseen fluctuations, the company exporting will not be affected. However, this measure can only be used up to bearable extents. If the currency would change with such significance difference, there will be negotiations.
Hedging with futures was introduced to close the gap left by forwards. It is an agreement between the buyer and seller. They agree on trading a currency in the future, at a certain fixed price. Weisweiller adds that (2009) it is very similar to the forward contract, but this one is more liquid than forward. The futures have standard contracts hence, traded like the shares. Futures are bought if the risk is about appreciation of value. If the value has depreciated, then they should be sold.
A company can find it most convenient to use options for hedging. Options are not abiding because the buyer can decide to buy or sell a certain currency at a given exchange rate at a specific date or before that. There are two types of options namely call and put. Call options facilitate the buyer with the right to buy a given currency at a specific exchange rate, at a certain day or before. Put options make provision for buyers to sell a certain currency at a given exchange rate and time. Depending on the nature of the company, it should choose the best way to hedge foreign risks (Wang, 2009).
There is need to consider the foreign exchange instruments that will be used. They are important because they assist in curbing foreign risks. If a certain currency is experiencing any problems, this can be avoided by using a foreign exchange instrument. The most common instrument is spot. It is the exchange of one currency to another, at a settled rate. This should be done within two days of working. Spot makes provision for two alternatives only (Weisweiller, 2009). The first one is value today, and it allows settlement on the same day of trading. The second alternative is called value tomorrow. The settlement can be done one day after the trading day. Futures, forwards and options are used for hedging but can also be instruments as well. This is because foreign exchange instruments have similar duties to those of hedging.
There are certain government rules and regulation that the multinational company will have to consider. The main one is paying revenue to the authorities. The revenues involved are all types of taxes that the government has imposed. Evading these revenues is a punishable crime, so they need to find out all the taxes they require paying. Some types of taxes are sales tax and the tax imposed on export goods. The multinational company should stay alert about elements like inflation and the rates of interests. These two have a significant effect on foreign exchange (Shamah, 2003). Inflation is a decrease in the value of money when purchasing, which is accompanied by an overall increase in prices of commodities. This means that when there is inflation, the currency depreciates and the company has to pay more money. Inflation will lead to increase in interest rates, which will affect the exchange rates. This happens because rise in interest rates influences the demand and supply of currencies (Wang, 2009).
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