International Finance Airbus and Boeing - Essay Example

? International Finance Compare and contrast the impact of foreign exchange risk on the two contrasting firm (Airbus and Boeing), and discuss how these firm should manage these risks. Boeing Company is the largest aerospace company of US. Its operations are in more than 90 countries. The commercial airplane division is the most prominent of all divisions. The company is headquartered in Illinois and known as premier US aircraft manufacturer. Boeing's revenue in the year 2010 was $64.31 billion and first-half revenue in 2011 was $31.45 billion. The company is subject to foreign currency exchange risk for company's revenue comes through its operations in various locations and company also makes payments to suppliers in foreign currencies. The company needs to manage foreign currency risk by entering into the foreign currency forward contracts, hedging the price risk associated with receipts and payments with respect to current business. The forward contracts neutralize the effect of any negative exchange rate fluctuations and safeguard the company. Airbus is headquartered in Toulousse and owned by EADS. Airbus' operations are spread throughout the world with total workforce of more than 119,000. The company's costs are made in euro but bulk of the revenues comes in US dollar. Airbus has long delivery periods for the order received today for the aircraft the delivery will be made only after 4-5 years. In view of this, they need to enter into forward contracts to lock currency exchange rates to safe guard themselves because they should not lose when the final payments are made to them on delivery. The company’s half of the cost are paid in Euros and the company needs to hedge for at least two years at the appropriate rates against dollar for bulk of its revenue comes in dollars. The company should also make its European suppliers to bill them in dollars so that currency risk is passed on to them. Discuss a framework a firm might adopt for capital budgeting internationally. A multinational or for that matter any firm operating internationally is always worried about the revenue streams or cash flows that their investments in some other country will bring. The conversion value fluctuations between host and home currencies may make all the difference in budget and actual cash flows received after implementation of the project. 1. An international firm may adopt a simple approach as per the following. 2. Estimating future cash flows in host country currency where investment has been made. 3. Estimating an appropriate discount rate in foreign currency based on the interest rate and prevailing inflation rate in that country. 4. All revenues streams for the expected life of the project are calculated in the foreign currency of the country of operation and the same are converted to Net present value (NPV) using the discount rate also called cost of capital. 5. Converting the foreign currency NPV as calculated above into own currency using the spot exchange rate In another approach, a firm may first convert the foreign cash flows into own currency at the exchange rate expected to prevail. Then the firm may calculate its NPV based on the cost of capital prevailing in its own country. Any of the above approaches will bring the same results. Again, in order to safeguard and mitigate the risk involved with the capital invested at international shore, the company needs to enter into a suitable forward currency contract as per the cash flows available to them for remittance to own country. Critically assess the work of the credit rating agencies and suggest possible reforms to improve their functioning. Briefly discuss whether your reforms could have prevented the “Credit Crunch”. The credibility of credit rating agencies has gone downhill after subprime crisis. The high ratings they awarded to residential mortgage-backed bonds facilitated commercial transactions across all financial markets in US and Europe. At times, their action raises host of doubts in the investor's mind. The Enron case reminds us how rating agencies such as Moody's, Standard & Poor's failed to detect financial fraud at Enron and provided Enron with a good credit risk until 4 days before the company filed papers seeking protection under bankruptcy law. None of the rating agency cautioned investors by downgrading Enron to below investment grade before that. Surprisingly, rating agencies did not use their special rights provided by the government in accessing the books and finding their financial jugglery. The reforms are needed as there is not enough transparency regarding the approach and methodologies adopted by the rating agencies. They need to tell people what rating model they use to assess the risk and how they arrive at certain rating. They should be made accountable and they should also be rated for their misdeeds and failures in judging the entity and instruments. They also need to be regulated under some rules and laws. Why should only three large agencies control five sixths of the world market in providing rating services? The more players will infuse competition and overall quality in the ratings. The reforms in right direction can help prevent the credit crunch in future and safeguard the investments of all in the financial market. After all, credit rating business needs to evolve based on the past experiences. Discuss the significance of “marked to market” and its role in limiting the risks of using derivative instruments. Derivative instruments are long term hedging instruments that lasts for a month or more. They are usually employed to protect the investment in the underlying. Many international business entities and financial institutions use derivative instruments to hedge their risk portfolio such as foreign exchange risk, interest rate risk, commodity purchase and payment risks. This is basically to protect their underlying asset or profit from any unexpected fluctuations due to any reasons whatsoever. These instruments are settled on daily basis on the exchanges where the contract has been entered into. In order to mitigate the risk, the exchange norms make it compulsory that losses or profits are debited or credited to the margins as available on daily basis. This is known as risk mitigation based on marked-to-market criteria. The difference between closing price and contract price will tell about the profit and loss values on daily basis. Contracts are entered with initial margins but they are carried forward through this mechanism until the expiry date. Virtually all the derivative contracts in all the exchanges whether they belong to commodity market or currency exchange market follow this route. This is the safest way to run the derivatives market in smooth way so that insolvency issue of one party does not make other party to suffer. Discuss the techniques for managing the main sources of country risk for corporations operating across borders. It has been quite common for the companies in view of the globalization and ever expanding available opportunities to cross borders and establish business operations. At the same time, it has been essential to assess the country risks such as political stability, law and order risks, business risks such as competition, availability of work force, transportation and other relevant infrastructures, financial risk. Hood (2004) defined country risk in terms of socio-political and economic factors that are necessary to assess, monitor and manage to conduct any business. The need for proper risk management techniques is now well established. Corporations need to take methodical approach to address and mitigate the associated risk. The risk analysis and risk evaluation helps formulate risk mitigating techniques that lead to appropriate actions based on the given situation. Law and order situation and political unrests are two major risks that are difficult to manage later on so they should be assessed thoroughly before entering into the country for the business operations. It will be appropriate to employ following techniques to manage the country risk. a. By local participation such as suppliers, jobs, equity and through socio cultural events. b. By integrating production in host country to home country c. By spreading risk within the host country d. By regular remittance of profits to reduce sovereign or transfer risk e. By building research and development, Intellectual property in home country f. By involving host government in concessions and taking appropriate guarantees reducing political risk. References Hood, J., Nawaz, M.S. (2004), Political Risk Exposure and Management in Multi-national Companies: Is There a Role for the Corporate Risk Manager? Risk Management: An International Journal. Waring, A., Glendon, A. (2001). Managing Risk: Critical Issues for Survival and Success into the 21st Century, 3rd ed., Thomson, London How to Manage Country Risk, [Online] available at http://peligotraining.com/CourseDetails/SIB%20China%20Vietnam%20Sample%20Slides.pdf [Accessed 9 August 2011] Eun and Resnick (2007), International Financial Management, Chapter 18, Fourth Edition, the McGraw-Hill Companies Read More