The Financial and Economic Environment of a US website business targeting South African students - Essay Example

?The Financial and Economic Environment of a US website business targeting South African Contents Contents 2 Part 4 Introduction 4 Financial & Economic Environment 6 Analysis of Recent Events 7 Part 2: Responses to Chapters 8 Chapter 1 8 Chapter 2 9 Chapter 3 10 Chapter 4 11 Chapter 5 12 Chapter 6 13 Chapter 7 14 Chapter 8 15 Chapter 9 16 Chapter 10 16 Summary & Conclusion 18 References 20 Appendices 24 Part 1 Introduction This project includes an analysis of a new business opportunity in South Africa based on the financial and economic environment and trade relations of US-South Africa. The major indicators, which have been studied, are interest rates, inflation, 10-Year treasury yields, currency exchange rate movements, exports-imports and various economic indicators of US and South Africa such as unemployment and education. The foreign exchange risk has been analyzed if the new business revenue is going to be exposed to various types of exchange rate risks. In the modern world the regional economies, cultures and societies have become integrated through FDI, trade, capital flows and migration. This transnational circulation of languages, ideas, technology and popular culture is known as globalization. USA has world-renowned universities where many students come to pursue higher education from many countries. The popularity of US educational system opens doors for many business opportunities such as online educational counseling services for foreign students. Figures 1 provides the pattern of growth in US educational sectors. Figure 1: Growth in number of Foreign Students in US 1954-2010 Source: (Export.gov, 2011) The new business which has been started is a website named ‘Maneno Educational Consultants’ which aims to provide online counseling and assistance to the South African students who wish to study in the US universities and colleges. In order to attain education in the foreign country it is necessary to have complete and precise information, helpful to students in making right choices. Marketing Mix Product: This is an intangible online service i.e. an online portal which aims to provide the South African students with the career counseling and information regarding the universities and courses. The website’s name is Maneno Educational Consultants. The services provided are universities/colleges details with their respective courses, course details, and online resources, career counseling through emails, telephone and online-conferencing, and student visa assistance. Price: The price charged from the students is based on the type of membership. There are two types of membership- Basic and Premium. The services for the Premium members are in addition to the services which Basic members will avail. The membership fee is US$30 for Basic members and US$50 for Premium members on annual basis. Place: The customer will be able to subscribe and pay online. According to the membership, the customer will be provided with a login id and password from which it can access the services offered to him/her. Promotion: As this is an online service, the target group of customers can be reached out through advertising in career magazines, local newspapers, online via social networking sites, and promotional campaigns setup in the schools and colleges campus. Financial & Economic Environment South Africa has a well-developed financial and legal environment with its stock exchange the world’s 18th largest exchange, ranked 17th with market value $1.013 trillion in 2010. It is one the most advanced developing countries on African continent. It is a middle-income economy with abundant natural resources. The country’s former fiscal policy was conservative mainly focused on controlling inflation and reducing budget deficit. The policies still exist but the recent global recession has put pressure to provide with the basic services to poorer sections and provide for employment guarantees. The unemployment stands at 25% which is high as compared to other economies such as US and UK which are at 107 and 87 respectively. In 2000 population below poverty lines was 50%. South Africa is ranked 30th in terms of Foreign Direct investment at home (CIA, 2011). South Africa’s main trading partners include China, Germany US, Japan and UK. The country was the host for 2010 FIFA World Cup which boosted its business revenues and infrastructure. USA is the market-oriented economy with the most advanced technology. In many previous years the country has been the net importer of the goods and services being the number 1 importer in the world and ranked 4th in exports. Its population below poverty line stands at 15.1% and unemployment rate at 9.6% in 2010. The country is also the largest consumer of oil (CIA-a). The US and South Africa signed a $120 million investment fund protocol under OPIC (Overseas Private Investment Corporation) in 1996 for equity investments in South Africa. The Trade and Development Agency has actively participated in funding feasibility studies and identification of investment opportunities for US businesses in South Africa. From 1970s till 1990s the relationship between the two countries were constrained by the racial policies in South Africa which in 2000s have improved to a considerable amount. In 2010, both the countries launched a strategic dialogue to improve the cooperation on issues of mutual interest. Their trade relationships have been strong. The US agency USAID provides assistance in its development efforts (Bureau of African Affairs, 2011). Analysis of Recent Events African Growth and Opportunity Act (AGOA), which was enacted in 2000, is the base of trade and investment between US and African countries. In 2011, South Africa has become eligible for AGOA in addition to qualifying for apparel and textile benefits. The recent meeting on trade and investment of TIFA council was held in June 2011 where the discussion was held on President Obama’s NEI (National Export Initiative), investment challenges, trade barriers etc. The TIFA was signed in 1999. US recognize that South Africa is an important trading partner of US. In 2009, trade in services with South Africa was $3.7 billion with services trade surplus of $752 million. In 2010 South Africa was US’ 38th largest export hub and 35th largest supplier of goods. The goods which are traded include precious stones, mineral fuel, vehicles, iron and steel, and machinery (Office of the United States Trade Representative, n.d.). AGOA will provide favorable environment for the US businesses in South Africa and vice-versa. Part 2: Responses to Chapters Chapter 1 Answer 1: Language: The languages spoken under ‘People and Society’ comprise only 8.2% people speaking English whereas the rest of the South Africans speak Isizulu, IsiXhosa, and Afrikaans etc. As US is English-speaking country, the business can be negatively affected, especially in the promotional strategies. Birth rate/Death rate: South Africa is ranked 92 in birth rate and 3 in death rate which means that the coming decades will see less number of young populations. This may entail long-term risk for the business. Educational Expenditure: Low educational expenditure is directly going to affect the business returns because very few will be able to afford or plan to afford the higher education abroad. Those students who will opt for education in foreign country may not necessarily opt for online counseling. Unemployment Rate: Increasing high unemployment rate means that the younger population is likely to migrate to US for employment rather than studies or a mix of both. This can have mixed impact on the business, most likely positive. Economic Indicators: Taxes are high but the commercial banks’ prime lending rates (PLR) have declined. The national currency Rand has strengthened in 2010 as compared to previous year. This will have bad effect on business in the form of exchange rate risk. The reduced PLR is likely to have positive impact on the business. Communications: South Africa has less number of internet-users which can affect the profitability because the business is internet-based (CIA, 2011). Answer 2: The fact book of the CIA lacked recent data. It also did not give the data on political and economic relations with major developed economies of the world such as US, UK, Japan etc which could have helped with the understanding of the business prospects and threats. Chapter 2 Answer1: The US trade with South Africa is increasing at a steady pace with imports more than exports (U.S. Census Bureau, 2011). Its current account deficit in the second quarter of 2011 decreased mainly due to increase in surplus on services and income (BEA, 2011). The US President Obama has initiated a National Export Initiative (NEI) with a goal to double the US exports by 2015. US currently have Regional Trade Agreements (RTAs) with 15 advanced developing countries including South Africa, where these countries account for approximately 21% of annual US exports. South Africa has 17 RTAs with different countries including US (Refer to Appendix 2). Approximately 21% of South Africa’s imports are from US (Refer to Appendix 3) (Gudicello, 2011). This implies that US is a preferred country for South Africa for imports. Therefore it can be inferred that the trade relations between US and South Africa is likely to improve in the near future which is highly beneficial for the business. Answer 2: The trading activities of a country include exports and imports of goods and services. Based on the trading activities of US and South Africa, it can be inferred that the number of students that might opt for enrolling in the US Universities is likely to increase because of the improved bilateral ties, lenient immigration laws, and easily availed visa. Chapter 3 Answer 1: The South African currency Rand has appreciated by 38.57% since 2009. The South African unemployment rate was 25% in the first quarter of 2011. Also African Reserve Bank, South Africa’s central bank has cut rates to 5.5% by 650 bps since 2008 to fuel economic growth and consumer spending (Everbank, 2011). The current Fed rate is 0.25% which has not changed since 2008 (Refer to Appendix 5). The yield on South African 10-year bond is 8.2% (trading economics, 2011). The yield on 10-year US Treasury note is 2.06% (Marketwatch Inc, 2011). This means that the investors will continue to buy South African Government bonds till the yield remains higher than Treasury yield of US bonds. In the current year foreign investors have been net buyers of 41.9 billion rand of the country’s bonds (Cohen, 2011). This is likely to have an impact on the appreciation of currency which is evident from the 38.75% rand appreciation. Although one of the major threats is the higher annual inflation 5.699% in South Africa as compared to US annual inflation of 3.868% (global-rates.com). With the appreciating currency and decreasing interest rates, South African student will find it easy to finance higher education abroad. However the South African monetary policy may tighten if the inflation increases. Answer 2: FTSE JSE All Share Index is a market capitalization-weighted index and the companies included in this index comprise 99% of the total pre-free float market capitalization of Johannesburg Stock Exchange. S&P 500 index is market capitalization-weighted index including 500 stocks from all major industries. Both the indices have moved similarly since August whereas in the earlier months there was a wide gap between them (refer to appendices 5). However the volatility in the stock market has increased which is not favorable indicator for the businesses both in South Africa and US because a volatile stock market impairs the proper functioning of financial system. It also affects the consumer spending and business investments. The effect of stock market volatility on consumer spending is related through wealth effect as it weakens consumer confidence. This implies that the doing business in South Africa has become risky because the potential customers are likely get affected by the volatile stock markets. Chapter 4 Answer: South African rand has depreciated by 10.9% in the last 1 year (refer to appendix 4). The inflation in South Africa is 5.7% and in US is 3.9%. The inflation in South Africa was high in 2008 which reduced in subsequent years and in 2011, it has increased slightly. The US inflation rate was negative in early 2009 and then it has increased at a fast pace in late 2009 and early 2011. Assuming that the inflation in US remains stable, rise in inflation in South Africa will lead to the declined demand for the South African currency as exports will decline and imports will rise. This will put downward pressure on the ZAR. Chapter 5 Answer 1: The ZAR/USD futures rate of March 2013 contract is US$0.119025 (CME Group, 2011). The ZAR/USD spot rate is US$0.125700. Applying the formula to calculate premium/discount for an indirect quote, [{Spot Price (ZAR/USD) - Futures Price (ZAR/USD)} ? Futures Price (ZAR/USD)]*(12/17)*100 (Ajami & Goddard, 2006) The ZAR against USD is in discount, which is 0.0396 or 3.96%. Data from appendix 3 shows that both U.S. and South Africa are involved in large volumes of international trade. Assuming that both the countries involve in minimal capital flow transactions, ZAR should be affected by mostly trade-related factors such as inflation differential, income differential and trade restrictions. Whereas if the countries are involved more in capital flow transactions, factors which affect the exchange rate are interest rate differential and capital flow restrictions. Therefore the changes in inflation and interest rates in U.S. and South Africa are, Table 1: Interest rate differential & Inflation differential The rand should be influenced by inflation differential when compared with dollar. The increase in inflation in US in the last one year is more than the increase in inflation in South Africa which will put upward pressure on rand. Answer 2: Assuming that the futures price of ZAR is representative of future spot price, converting ZAR into USD will be cheaper at the prevailing spot rate than converting it at future rate. Chapter 6 Answer: According to the Bank of International Settlements website, South African Reserve Bank uses Independent Floating exchange rate regime (Gudmundsson, 2006). The South African central bank, on behalf of finance minister is responsible for daily administration of exchange controls. The regulations governing exchange control are the legal provisions which prescribe the limits on funds transfer abroad by South African residents and companies. The Governor, Deputy Governor and Deputy General Manager from Financial Surveillance department have been delegated the functions, power and responsibilities under Exchange Control Regulations. Certain South African banks act as authorized dealers in foreign exchange and are subject to limits and conditions imposed by the Financial Surveillance Department. The central bank acts as an advisor to the finance minister and implements the exchange control policy decisions. The central bank has also issued an exchange control manual which guides the exchange control regulations, rules, norms and policies. The financial surveillance department updates the manual to reflect current policies and norms (South African Reserve Bank, 2011). The regulations imposed by the minister of finance in South Africa imply that currency is regularly monitored despite independent float and hence it is going to be stable. This shows less risk for the business as the exchange rate plays an important role in determining returns. A fluctuating exchange rate system poses high risk for international business. Chapter 7 180-day Treasury bill rate in South Africa = 5.59% p.a. or 2.79% 180-day Treasury bill rate in US = 0.03% per annum or 0.015% semi-annual. Interest rate differential = 0.03-5.59 = -5.56% Futures Rate KRW/USD for March 2013 contract = US$0.0008858 (CME Group-a, 2011) Spot Rate KRW/USD = US$0.000887516 (X-rates, 2011) Premium/Discount for Indirect quote = [{Spot Price (KRW/USD)-Futures Price (KRW/USD)} ? Futures Price (KRW/USD)]*(12/17)*100 = 0.14% The South Korean Won KRW against USD is in discount by 0.14%. The reciprocal of indirect quote is, Futures Price in Direct Quote USD/KRW = KRW1128.92 Spot Price in Direct Quote USD/KRW = KRW1126.74 Answer: Interest rate parity says that the investors should earn similar returns from interest-bearing investments in all the countries after the risk-adjustment. This relationship is shown by futures exchange rate, spot rates and interest rates. Future Exchange rate / Spot Exchange rate = (1+Rh) / (1+Rf) (Brigham & Houston, 2009). > 0.119025/0.1257 = 1.00015/1.0279 = 0.9 (Approximately) The interest rate parity holds. Furthermore, according to interest parity, a foreign currency with high interest rate should have discount in its futures price which is true as ZAR is in discount in its futures price (from question 5). Chapter 8 The Purchasing Power Parity (PPP) theory explains that if the two countries produce substitute products, the products’ demands adjust with differing inflation rate. The inflation in South Africa is 5.7% and in US is 3.9%. Assuming that the inflation rate in US is relatively stable and the relatively high inflation in South Africa should cause the South African consumers to increase their imports which would cause the upward pressure on USD and downward pressure on ZAR. This is not true as ZAR has depreciated by 10.9% in the last 1 year (refer appendix 4). Therefore the ZAR movement can partially be attributed to PPP theory. ef = (1+Ih) / (1+If) (Madura, 2008) > [{(1.039) / (1.057)} – 1] > 0.983 – 1 > - 0.017 or – 1.7% If ZAR depreciates in future, it will likely offset the adverse exchange rate effects on the cash flows in USD as high Korean inflation will lead to dollar appreciation and ZAR depreciation. The number of South African rand per dollar will increase. Chapter 9 Direct Quote futures price USD/ZAR = ZAR8.4016 Direct Quote spot price USD/ZAR = ZAR7.9554 The direct quote for futures price reflects premium for USD against ZAR. If the futures rate is used to forecast the future value of ZAR, it will be depreciated. When the exchange rates are expressed in direct quotes then the premiums are added to the spot rate and discounts are subtracted from the spot rate to arrive at the forecasted rate. Therefore the premium will be added to the spot rate and the ZAR will depreciate. Chapter 10 Exchange rate risk is the risk a company faces while doing business in other countries due to fluctuations in the exchange rate. The exchange rates are usually very volatile and due to this the business receivables and payables can be affected substantially. Overseas business is commonly subject to three types of exposures – Transaction exposure, Economic exposure, and Translation exposure. When the value of a business’ future transactions in foreign currency is affected by the exchange rate fluctuations, the business is exposed to transaction exposure. When the value of a business’ cash flows is affected by the exchange rate movements and is exposed to foreign competition, it is called economic exposure. When an MNC conducts business overseas it prepares its consolidated financial statements, which includes the financial information related to its subsidiaries overseas. But the translation of the business conducted through foreign subsidiaries in foreign currencies exposes the MNC to exchange rate uncertainty. This is known as translation exposure. Answer 1: Business done with South African students has its risk in terms of exchange rate fluctuations. The business is exposed to transaction risk because the revenue denominated in rand will have to be converted into dollars and if rand appreciates, the revenue in dollars will decline. Answer 2: South Africa is the most developed region in the African continent. It has many RTA and FTA partners such as China and EU that are preferred trading partner for the country. Economic exposure stems from the competition from other competitor businesses in the region as well. Therefore the US companies face stiff competition from other foreign companies that might be established in South Africa. Answer 3: The online services are priced in dollars but the receipt will be in rand. Hence the effect on the revenue from depreciation of ZAR will be positive due to transaction exposure. Answer 4: If the cost of advertising and promotion is denominated in dollars then there will not be any effect from the changes in ZAR. Answer 5: If the ZAR depreciates, it will be favorable to the business in terms of increased revenues. However the business might be affected by reduced number of potential customers because they will have to pay more for the services if their currency depreciates. Answer 6: As per the question asked, assuming that the revenue will be denominated in ZAR and that the annual revenue is ZAR1450000, following are revenues in USD for different time periods: Table 2: Revenue in USD Assuming that the revenues received are denominated in ZAR, the dollar revenues would have changed considerably based on the rates given in table 1. Answer 7: Assuming that the ZAR depreciates by the same percentage as from the previous year and the futures price USD 0.119025, to sell futures on ZAR will hedge the exchange rate risk because this means that for every one rand sold at the futures price will be worth $0.119025 instead of $0.0715. Summary & Conclusion Globalization has led to the convergence of trade and business across countries. The US educational system has encouraged the students to enroll in American universities. This has opened for new business opportunities such as online educational and career counseling. The trade relations between US and South Africa have improved considerably with both the countries’ governments making efforts in increasing trade of goods and services through initiatives such as AGOA, TIFF and USAID. The USA accounts for 25% of South Africa’s imports. This opens up doors for US businesses to provide online services. The new business Maneno Educational Consultants is an online portal to provide the South African students with the career counseling and information regarding the universities and courses. The South African Reserve bank has kept the bank rates low and inflation under control. The currency has appreciated by 38% in the past two years. The bank allowed the rand to float freely but it also monitors the currency closely and puts limits on trading in the currency by the banking institutions. The US export-import with South Africa has increased steadily with the net imports. The major challenges to the business in South Africa are the Low English-speaking population, low Internet penetration, and low household expenditure on education, rand fluctuations and high unemployment. Other threats include the Chinese and European penetration of South African market, which increases competition in the African continent. The transaction risk will affect the revenues of new business in positive manner if ZAR depreciates and in negative manner if ZAR appreciates against USD. Then hedging by selling futures on ZAR is a good option. This project was an analysis of a new business opportunity of a US-based website targeting South African students who wish to pursue higher education in US. The analysis was based on the financial environment, economic environment, trade relations and macroeconomic indicators such as interest rates, inflation, 10-Year treasury yields, currency exchange rate movements, exports-imports unemployment and education of the two countries US and South Africa. The foreign exchange risk has been analyzed if the new business revenue is going to be exposed to various types of exchange rate risks. Based on the analysis, the business is a viable option as South Africa is an advanced developing country and trade relations between the two countries have improved. The US economy under policies from President Obama’s administration is trying to overcome recessionary phase. In the globalised economy the only way to do this is to improve bilateral trade with other fast growing economies such as South Africa, China, Brazil, Russia and India. References Ajami, R.A. & Goddard, G.J. International business: theory and practice. M.E. Sharpe. 2006. BEA. U.S. International Transactions: Second Quarter 2011Current Account. 2011. News Release: U.S. International Transactions. November 11, 2011 http://www.bea.gov/newsreleases/international/transactions/transnewsrelease.htm. Bloomberg. Interactive Chart. 2011. FTSE South Africa All Cap Index (ACZAF:IND) Index Performance - Bloomberg. November 12, 2011 http://www.bloomberg.com/apps/quote?ticker=ACZAF:IND. Brigham, E.F. & Houston, J.F. Fundamentals of Financial Management. Cengage Learning. 2009. Bureau of African Affairs. Foreign Relations. 2011. South Africa. 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Appendices Appendix 1: US Export-Imports with South Africa in 2011 Source: (U.S. Census Bureau, 2011) Appendix 2: Number of RTA Partners of 15 US RTA partners Source: (Gudicello, 2011) Appendix 3: Share of Imports from US and other RTA Partners Source: (Gudicello, 2011) Appendix 4: Currency Exchange Rate of South African Rand for 2010-11 Source: (Oanda, 2011) Appendix 5: Central Banks' Interest Rates Source: (global-rates.com-a, 2011) Appendix 6: Changes in SARB from 2008-10 Source: (global-rates.com-b, 2011) Appendix 5: Comparison of S&P 500 and FTSE South Africa All Cap Index-1 Year Source: (Bloomberg, 2011) Appendix 6: Change in Inflation in South Africa 2008-11 Source: (Trading Economics-a, 2011) Appendix 7: Appendix 6: Change in Inflation in US 2008-11 Source: (Trading Economics-b, 2011) Appendix 8: ZAR Movement for last two years Source: (Yahoo Finance, 2011) Read More