The Sales of USASuperCars - Research Paper Example

Business Table of Contents Executive Summary 3 Introduction 4 Normal distribution, mean and standard deviation 4 2. Calculation of probabilities 73. Calculation of probabilities 8 4. HSBC offers to pay a sure sum of $2,150,000 in return for revenue 10 5. Risk averse 11 6. Other risks 11 7. Payment in three months or twelve months 11 9. Value-at-risk 12 10. Other options to the banks 12 Conclusion 12 Reference List 13 Executive Summary The purpose of the report is to critically analyze the sales of USASuperCars and the impact of uncertainties such as exchange rate fluctuation on its revenue. The report addresses viability of trade between the company and its seven customers around the world with the help of different statistical tools such as frequency distribution, mean, medium, mode, quartile, percentile and probability. The main body of the report contains the calculation pertaining to the feasibility of the trade and its implications. The different statistical terms used in preparing the report are explicitly explained so as to make the statements clear and understandable. The findings suggest that the USASuperCars should protect their income by accepting of HSBC from any future adverse exchange rate fluctuations. However, it is observed that HSBC is also benefitted from the deal as it has kept considerable profit margin. Introduction Exchange rate fluctuation is a major issue for companies who deal with foreign clients. The companies trading with foreign customers receive the payments in the home currency of the latter and thus if there is huge variation in exchange rate, the former is bound to encounter loss. Central tendency is such statistical tools that help in ascertaining the average of the events that has occurred during a period of time. In this case, probability of distribution pertaining to any uncertain event can be measured during an uncertain event. Moreover, measure of dispersion helps in determining the risk associated with the transactions received or made by the companies during the uncertain period of time. USASuperCars sells luxury sports cars to the global customer. It has signed a contract with seven customers around the world, where the selling price is fixed; however it has different values with respect to dollar as the local currency of the trading countries are affected by exchange rate fluctuations. Hence, it is important for company to examine whether the trade will be profitable or it has to search for different alternative options to safeguard its revenue. In light of this, the report critically evaluates the risk and uncertainties associated with the contract made by USASuperCars with seven customers around the world. 1. Normal distribution, mean and standard deviation Normal distribution is used for evaluating the present performance of the contract. It is a common type of distribution that is randomly used for examining the probability of occurrence of a certain result. USASuperCars has signed contract with seven customers around the world and is of opinion that they might encounter loss in total revenue because of the uncertainties in the market. This uncertainty can be defined by standard deviation and is denoted by the parameter σ. However, the mean of the events is denoted by µ. The main characteristics of the distribution is that the curve is symmetric and bell shaped; value of the distribution is continuous and lie between - ∞ and + ∞ in order to conceive an interval of real number, whose probability can never be zero (Jackson, 2013; Kothari, 2011; Rubin, 2013). There are independent random variables, which are normally distributed and hence their sum is also normally distributed. The following figure elaborates the different types of normal distribution that can be formed with varying values of mean and standard deviation. Figure 1: Different means and standard deviation (Source: Berenson, 1998) In the above figure three curves are mentioned, which is prepared with respect to different means and standard deviations. The green distribution denotes mean as -3 and standard deviation is 0.5; the red distribution has mean of 0 and standard deviation as 1 and lastly, the black distribution highlights that the mean value is 2 and the standard deviation is 3. The red distribution is generally known as standard normal deviation, where the curve is symmetric and perfectly bell shaped (Black, 2009; Levin and Rubin, 1998; Levine, 2008). The primary and the most significant reason for using normal distribution for evaluating this contract is that mean and standard deviation of each trade are provided. Both the parameters are important for calculating the normal distribution of probability pertaining to the occurrence of an uncertain event. In this case, the mean and standard deviation of each trade with the seven customers are provided, which will assist in calculating the mean and standard deviation of the total revenue in dollars ($). If X1 X2 ......Xn are independent normal random variable them their sum will be normally distributed with the following E(s) = E(X1) + E(X2) + ...... E(Xn) V(s) = V(X1) + V(X2) + ...... V(Xn) Also the random variable θ is defined as: θ = a1X1 + a2X2 + .... + anXn will be normally distributed with E(θ) = a1 E(X1) + a2 E(X2) + ......+ anE(Xn) +b V(θ) = a12 V(X1) + a22 V(X2) + ......+ an 2 V(Xn) In this case, the exchange rate of UK, Japan, South Africa, USA and Canada are independent. The mean of the total revenue of the 7 consumers is E (total revenue) = aUK E(UK) + ajapan E(Japan) + aCanada1 E(Canada 1)+ aCanada 2 E(Canada 2)+ aSouth Africa E(South Africa) + 100000. Hence, E (total revenue) = (12*575000*1.405) + (5*8400000*0.00907) + (3*9000000*0.00907) +(1*97000*0.8249) + (3*100000*0.8249) + (2*4100000*0.0211) + 100000 = $ 2195785.30 V (total revenue) = aUK2 V(UK) + aJapan2 V(Japan) + aCanada 12 V(Canada 1) + aCanada 22 V(Canada 2)+ aSouth Africa2 V(South Africa) = (12*57500)2 * 0.0412 + (5*8400000)2 *0.000452 +(3*9000000)2 * 0.00452 +(1*97000)2 * 0.03422 + (3*100000)2 0.0.3422 + (2*4100000)2 0.000832 = $ 199509402 SD (total revenue ) = $ 44666 The standard deviation of the currency exchange is $ 44666 whereas the mean is $2195785. The table highlights the variance of the total revenue i.e. 0.00402. 2. Calculation of probabilities a) The standard normal random variable, Z is regarded as the normal variable with the mean, µ = 0 and standard deviation = 1. Z ˜ N(0,12) In this case transformation of X to Z is needed. The area covered within kα of the mean is equal for all normal random variable. Thus, the areas covering the normal distribution are equivalent to the area under the standard normal. The transformation of X to Z; Z= (X-µx) / αx X˜ N(µ,α2) X˜ N(2195785, 446662) P(X > 2200000) = P(Z> 2200000 -2195785/44666) = P (Z> 0.094) = 0.4641. b) P(X > 2225000) = P(Z> 2225000 -2195785/44666) = P (Z> 0.654) = 0.2578. 3. Calculation of probabilities a) P(X > 2160000) = P(Z> 2160000 -2195785/44666) = P (Z 2130000) = P(Z> 2130000 -2195785/44666) = P (Z< -1.472) = 0.0708. Exchange rate changes are significant for any company as it affects trade to great extent. It can affect the company both positively and negatively and as a result it cannot be predicted whether it will encounter profit of loss from a trade. The major advantages of exchange rate are as follows: 1) Economic prosperity and stability: The short run fluctuation in exchange rate can have severe impact on the overall output of a country, which can be seen in the business cycle. It also decreases the volatility in a particular output, which may lie within the stable price range. The price stability and the unpredicted change in price level act a major contributor for development of an economy. The producers or manufacturers or exporters get the opportunity to trade in an uncertain situation where they can have the scope of earning more profit if the fluctuation is favourable. After reviewing the standard deviation of exchange rate of the seven customer countries, it can be ascertained that USASuperCars will not be affected by the changing exchange rate (Isard, 1995). 2) Stability of price: The price stability indicates the fact that changes in the price level are significantly less and gradual than expected or predicted. This situation is quite favourable for the companies exporting to foreign customers. The most significant factor influencing price stability is the monetary policy. 3) Fixed exchange rate can reduce uncertainty in portfolio flows and international trade: Exchange rate is regarded as a huge obstacle in the international business. However, according to fixed exchange rate system scare resources are not employed for forecasting exchange rate for next year. 4) The fixed exchange rate helps in adjusting and maintaining the external and internal balance of payment: The price flow mechanism takes into consideration the imbalances that occur between different countries and their price levels. Whenever, a country encounters current account surplus and price increases and as a result the goods becomes expensive to the foreign customers. Hence, this situation helps in reducing current account surplus in home country and also decreases the current account shortage in foreign country (Cencini, 2005; Salvatore, 2004). 5) When the money supply of the central bank increases it exerts a downward pressure on the interest rate of the home country. This makes the assets more attractive to the foreign customers (MacDonald, 2007). From the above mentioned advantages it can be clearly identified that the changes in exchange rate can also act as a contributor to the companies, who are engaged in export and import. USASuperCars have signed the contract to sell luxury cars to sever customers in UK, Canada, Japan and South Africa. The exchange rate has the ability to affect the sales revenue, which will simultaneously decrease or even increase the profit of the company. The standard deviation of the exchange rates of different countries is observed to be quite significant as it is symmetrically distributed along the normal distribution curve. However, its affect on the sales revenue of the company will be negligible at the total standard deviation can be nullified. If the estimated standard deviation of the exchange rate remains the same for the year then it is expected that the USASuperCars will not encounter loss in the near future. However, it is expected that it has the probability to gain more profit if the exchange rate change is favourable for the home country i.e. the US. Despite the advantages, there are various disadvantages of exchange rates, which are discussed below: Countries do not have the power to implement autonomous monetary policy; the exchange rates are affected by the inflation and unemployment rates. It is observed that if the inflation rate increases by keeping the exchange rate fixed, the consumers import the goods from foreign manufacturers. This affects the business of the local companies. However, if the country encounters lower growth in output and rise in unemployment level then the customers purchase less from foreign countries, this may affect the employment and output of the other country (Dornbusch, 1995). 4. HSBC offers to pay a sure sum of $2,150,000 in return for revenue HSBC would like to accept the offer $2150000 when USASuperCars have revenue less than $2150000. Hence, it will be benefit. P(X> 2150000) = P (Z> 2150000 -2195785/44666) = P(Z< -1.03) = P(Z> 1.03) = 0.1515 The revenue of USASuperCars is less than $2,150, 000 by 15.15%. Hence, the offer is acceptable. 5. Risk averse The sales manager is willing to accept the offer provided by HSBC and thus he is positive toward taking the risk. If the order is accepted then the company will actually encounter a loss as the estimated revenue is $ 2,195,785.30; however, if the exchange rate changes are taken into consideration it can be noted that the standard deviation may increases affecting the sales revenue. Hence, according to the notion of the sales manager it is wise enough to safe guard the income of the company to some extent. The CEO of USASuperCars is reluctant to accept the offer and thus he is risk averse. Nevertheless, it is worth mentioning that the company is not considering the offer so that it does not have to encounter the effect of change in exchange rate. 6. Other risks Apart from the risk pertaining to exchange rate, the bank is also involved in interest rate risk as well as default risk. HSBC may encounter default risk if the contract gets terminated and the foreign countries are unable to pay the amounts to the bank. 7. Payment in three months or twelve months If the payment by the bank to USASupoerCars is made within three months instead of 12 months, then it is profitable for the company as during the period of remaining nine months it can earn interest on the principle amount. This will help in generating profit in an indirect way. The banks and the company will prefer the payment when the exchange rate is stable for few moths and the fluctuation is not significant. 9. Value-at-risk The value-at-risk defined by the bank occurs at the 5th percentile of uncertain revenue or 5% left tail of the distribution. The value-at-risk of the bank is set at 5% of $ 2,195,785.30= $ 1, 0 9, 789 and the expected profit of the bank is $ (2,150,000- 1, 09,789) = $ 2,040,211. 10. Other options to the banks There are few options to the banks rather than converting some of the currencies received from the customers of USASuperCars such as investment in shares of the companies in those foreign countries. This will help in avoiding the effect of exchange rate on amount that will be received by the bank after converting in to home currency. Conclusion The issue pertaining to fluctuation in exchange rate cannot be avoided by the companies operating worldwide rather they can safe guard their income by employing different derivatives. USASuperCars should initially accept the offer of HSBC by contemplating the fact that the future exchange rate fluctuations can adversely affect their revenue and profit. Moreover, the deal is also profitable for HSBC as the value-at-risk is only 5% of the revenue. Thus, the exchange rate fluctuation can affect the financials of both the company and bank adversely. Reference List Berenson, M. L., 1998. Basic business statistics: Concepts and applications. New Jersey: Prentice Hall. Black, K., 2009. Business statistics: Contemporary decision making. New Jersey: John Wiley & Sons. Cencini, A., 2005. Macroeconomic foundations of macroeconomics. Oxon: Routledge. Dornbusch, R., 1995. Exchange rates and inflation. Massachusetts: MIT Press. Isard, P. 1995. Exchange rate economics. Cambridge: Cambridge University Press. Jackson, S., 2013. Statistics plain and simple. Connecticut: Cengage Learning. Kothari, C., 2011. Research methodology: Methods and techniques. New Delhi: New Age International. Levin, R. and Rubin, D., 1998. Statistics for management. New Delhi: Pearson Education Inc. Levine, D., 2008.Business statistics: A first course. New Delhi: Pearson Education Inc. MacDonald, R., 2007. Exchange rate economics: Theories and evidence. Oxon: Routledge. Rubin, A., 2013. Statistics for evidence-based practice and evaluation. Connecticut: Cengage Learning. Salvatore, 2004. International economics. New Jersey: John Wiley & Sons. Read More