Some Issues of Global Finance - Assignment Example

Global finance Question one a) The key features of Floating rate: According to Madura, J. (2003, p. 63) the main feature here is the automatic readjustment of a currency price to the level required in order to equal the supply and demand for the currency. In this way, it clears the market. This creates an automatic equilibrium in the balance of payments; the capital account balance offsets the current account balance. Normally, there are no risks of exchange rate crises and the system does not need government intervention in achieving the outcomes. They are normally variable since sometimes bandwagons and other speculative behavior drives and determines demand. It can also be so because exchange rates sometimes overshoot their long-run values. The market corrects the rate automatically reflecting inflation and other market conditions influencing the economy. Crawling peg: In this system, a currency links its value to another but gives it fluctuation limits and is immensely valuable if a currency linking itself has expectations of being volatile exceptionally, hence allowing itself to fluctuate to a level acceptable under the conditions. In this system, the authorities determine the value around which the currency can fluctuate. Fixed exchange rate system Here, a currency has a direct convertibility towards another currency with the government trying to keep the value constant against the other currency. The government decrees the worth of its currency against the value of another, plus rules of the exchange. b) Advantages and disadvantages of Floating rate exchange system Advantages Flexibility, which enhances the capability of the country market economy to pick up and adjust quickly to the changing market conditions, is the main advantage of this system. In case of a violation of the balance of payments deficit, this system of exchange allows for adjustment of outflow and/or inflow making either domestic or foreign goods more competitive depending on whether there was appreciation or depreciation in the currency market. Another advantage is the automatic determination of interest rates within the country, allowing efficient control of the economic balance. A country gets insulated from unemployment problems in other countries. This is because currency exchange rate adjustments normally serve as protection against exportation of financial problems to other countries. Disadvantages This system does not stimulate trade development and production, hence leading to market instability. Further, it destabilizes the financial situations and leads to economic crises. This causes uncertainty in trade; it may be uncertain to entrepreneurs the amount of money they get by selling their goods abroad or their prices in foreign countries. Likewise, importation will be uncertain since they may never know the cost of importing foreign goods. Another disadvantage is that the uncertainty it causes may discourage investment either internally or externally. Additionally, it leads to speculation which is a serious economic destabilization since the speculative flows may contradict the trade flow patterns. Fixed rate Advantages This system offers exceptional economic stability for ventures, besides stimulating multinational trade. This is because the exchange rates remain on the same level making the importers and exporters plan their business policies without speculations of depreciation or appreciation of the money. This system also makes producers disciplined since they oblige to keeping up the pace and quality of their production; controlling the cost of their production and staying internationally competence (Madura2003, p. 304). Additionally, this system stimulates reduction of worldwide speculation if the exchange rate is profitable to both foreign and domestic investors. Disadvantages This system is highly vulnerable to speculative attacks. It may cause inability to cover gaps between existing resources and demand in case of excess supply and demand in either internal or foreign currency. This minimizes the positive effects of this system, hence decreasing the credibility of the currency. Further, it does not make the development of a country’s economy efficient in comparison to other systems. This is because the government controls and supports the system and does not adjust to suit changes in economic situations. Interest rates depend on current exchange rates and may stop possible economic growth in case of their market needs disparity. Additionally, the fixing of a country’s currency relative to a foreign country makes it be dependent on the economic stability of the foreign country. This forces the country to participate in solving economic problems in the foreign countries. This creates a situation of economic exploitation and destabilization of the financial markets in the dependent countries. Crawling Peg Advantages In this system, the country has the powers to moderate pressure for domestic price vacillations and designate a hint of dependable financial policy. Besides, the country can minimize inflationary anticipations and stabilize commodity prices; both imports and exports. In response to large financial shocks, a government can decide to de-appraise its currency as a response, and this system limits inflation since it minimizes the government’s ability to issue money in the absence of foreign exchange reserves. Disadvantages The link in monetary policy to foreign nations makes fluctuations a common problem between the home country and the foreign country. This makes the home country’s central bank to lose its financial independence. Another disadvantage is that this system may lead to misalignment persistence especially in case of higher inflation rates in pegged countries. This overprices the home currency and makes it uncompetitive. This system is normally a target for speculative attacks. Furthermore, it is not maintainable in small countries with large capital streams since it may lead to crisis in steadiness of recompense. It may also be difficult to sustain the system in countries or markets with full capital mobility. c) The concept of impossible trinity Impossible trinity is an international economics jargon stating that it is not possible to have all the three currency systems at the same time. The three include a fixed exchange rate, free capital movement and an independent financial strategy. This is because of the visibility of between pegged exchange rates and different financial policies. According to Valdez and Wood, (2003, p. 72), Robert Mundell and Marcus Fleming hypothesized this and came up with a Mundell-Fleming model. This was after capital controls were broken down in many countries hence creating conflicts in the economic world. A version of the trinity focuses on the extreme case which has a fixed exchange rate and perfectly opens capital account with a country having no autonomy in money policy. The capital controls are loose making the exchange rate great in rigidity and less autonomy in financial policy. Question Two a) (i) Equity sources of finance refer to the investor’s personal input without having to repay with interest. It also entails finances from other investors in exchange of ownership shares in the investment. These finances may be from family, friends or other wealthy people in the name of angel investors. This has an advantage in that the business has no repayment obligations. The hope of future profits is the only gain the investors have in this system. The prospects in credibility improvement can get high with the involvement of high profile investors. However, it has a limitation in that the investors become partly owners of the business. This gives them decision making rights, and there is no autonomy and control. (ii) Debt sources of finance refer to a system where a business entrepreneur borrows money from other areas with a promise to repay with interest over time. It mostly refers to loans, either long term or short term from banks or government agencies and bonds. This system has a tax advantage since there is normally a deduction on the interest on loans. Since the lender has no ownership share in the business, the system limits the future loan repayment obligations of the business. New businesses have irregular cash-flows, and this may make it difficult to repay the loans regularly. This leaves the business to be vulnerable to economic recessions and/or interest rate hikes. This may also make investors shy off from the business since it carries too much debt and presents a risk perception. b) The risk can be because the exchange rates in USA may change leading to overseas profit changes. In the same way, Jupiter plc may find an increase in the Canadian currency may imply that their sales will fall, since their prices depend on their customers’ currency, or its gross margins will shrink. It may also mean both; in that depreciation in the home currency will have the contrary effect In this case, the two risks will hedge each other in that the value of the value of the firm will decline if the Canadian currency falls against the United States dollar. In this way, a decline in the value of the Canadian currency will reduce the value of the shares of Jupiter plc in terms of the USA dollar for a given share price in Canadian currency. If the Canadian currency depreciates, the share price raises since the value of shares in Canadian currency of the dollar sales rises. In the end, it hedges itself. Jupiter plc would be diversifying its currency holdings through monitoring and covering themselves against exchange rate risks and mainly translational risks. In essence, it would be having currency hedging. Jupiter plc would have customers across the boarders; from USA and Canada, some of whom may cause commercial risks like bankruptcy and default. One has to remember that foreign companies operate under diverse regulations and relationships from their governments. By raising finances in either country, Jupiter plc would hedge itself from some of the commercial risks. Another advantage of Jupiter raising finances in either country is that it is left with the option of having forward exchange contract with the foreign country. This is because the currencies move in different directions, one gain may mean a loss in another currency. With the forward exchange rate contract in the foreign country, Jupiter plc will only have to worry about the currency fluctuations in its home country, Canada. By diversifying its currencies in USA, Jupiter plc protects itself from currency inflations in Canada, since it will devalue the Canadian currency purchasing power. This means that raising foreign currency, Jupiter protects its business investment. At the same time, increasing the currency number rids Jupiter plc of forex exchange risks. c) Jupiter can raise its financial needs through exploiting the vulnerability of the Canadian market. This is because of the foreign exchange rates which in comparison with the United States dollar which earns more if the company increases its Canada market shares. Jupiter plc can use the financial markets in Canada to raise the finance it needs by using intermediaries like banks; through borrowing in form of loans to finance its needs. Apart from loans from banks, Jupiter plc can get money from the stock exchange through selling of their shares to investors, who will in turn own stocks in the company. d) By expanding into Canada, Jupiter plc will hedge some of it’s looses since it will reduce its total risks of foreign exchange. This is because much of the capital will be from the Canadian currency, hence will not need exchange (Valdez & Wood, 2003). Through expansion into Canada, Jupiter would be gaining more confidence in the market, and this would enable it to get more investors who would buy their shares, hence raise more finances. e) Forward contract can hedge transaction risks since it will not lead to increased expenses. It will secure market for future goods at no additional costs. Jupiter plc will be safe from expenses since the forward contract does not cost anything. Question Three Emerging Market An emerging market refers to an economy with middle and low per capita income, but they are viewed as emerging because of their developments and economic reforms. The countries in this category have very fast growing economies. The economy is transitional from a closed to an open market with emphasis in building avenues of accountability in the systems. The countries have programs that aim at creating a strong and responsible economic level. They also aim at boosting efficiency on the capital market. This is because of the local currency gaining stability, hence building confidence in the economy. This woos foreign investment. This system reforms the exchange rates, hence reducing the urge for local investors to invest in foreign countries. Asia as an emerging market The Asian market was estimated to be $111.5 billion in the year 2008 with an expectation to reach $174 billion by 2012. The countries are responsible for 25% of the prosperity in the IT market in Western Europe. In 2008, the percentage of the Asian pacific IT was 38 among the emerging markets with as growth projection of 48% by the year 2012. The aim is the technology markets with over 100 employees in the pacific countries alone. This makes Asia the leading ICT provider around the emerging markets. The aim is to meet needs of country sales and marketing managers for succeeding in the ICT market place. China as an emerging market Like any other region, the Asian policies are the key to a strong economic performance even in the difficult international environment. With several inventions across the continent, Asia has prospects of becoming a world class economy in future. Biotechnology In May 2011, the Chinese President said that biotech was one of the emerging industries in the country in the next decade. This was part of the China’s 12th year development plan between 2011 and 2015.the state will provide about $615 billion to fund several projects including next generation IT, clean energy vehicles, high-end equipment manufacturing, biotechnology, among others. In total, they will comprise of a total of up to 8% of the gross domestic product by the year 2015 which will rise to 15% by 2020. There are other indigenous innovations that will also play a role in economic boosting. The fact that china is a powerhouse in manufacturing challenges the potential tapping, hence the need to focus more on innovations. This creates the need for the biotech push. The only thing that stands in china’s way to becoming a world economy is in the fact that they do not have the world privileges shared by Japan, Europe and the United States. In Asia, there are other innovations besides the china’s biotech push. This enhances establishment of R & D and other operations involving manufacturing. There are innovative firms like the Chinese pharmas, who are in drug research; here, process development and growth comes from the efforts to improve drug formulation. Investing In Emerging Countries Benefits It is possible for investors to evade possible losses since they provide markets to developed countries. This acts as a security measure against losses in home countries. Another advantage is that the countries have a substantive political stability, especially those that have unstable pasts like the former third world countries. They have upward moving markets which meet local and international needs. The fact that many of the emerging market economies are not yet in debt as opposed to their developed counterparts makes them better for cash and bonds. The emerging markets allow the foreign investors to cash in on goods. The increased capitals make it easy and beneficial in emerging markets. Risks According to Valdez and Wood (2003, p. 113), there are several risks in investing in emerging markets. To start with, there is the risk of the foreign exchange. This comes in because returns come in terms of the local currency, forcing them to convert the local currency to their home currency. This means that fluctuations in currency can have a serious impact on the total investment returns. Another risk is the non normal distribution in the returns. This is because valuation of emerging markets using the mean-variance analysis is not easy. Partly, this is because of the constant changes on the emerging markets making it difficult to apply historical information in drawing proper relations between events and returns. Valdez and Wood (2003, p. 137) write that another major risk is the absence or inactiveness of strict trade rules which may lead to market inefficacies leading to a deviation in equity prices from their intrinsic value. This subjects the system to speculation and makes it vulnerable to be controlled by the ones with beneficial information. Emerging markets have a characteristic of being imperfect. This is because they are less liquid leading to high broker fees and uncertainty in price. Brokers try to get counterparties for trade and end up charging high commissions. In the end, the investors do not realize the benefits of fast transactions. Other disadvantages are that it is not easy to raise capital in emerging markets since there is no proper access to financing. This is because the attained capital is accessible at high rate of return, hence increasing the investor’s weighted mean capital cost. The emerging markets have underdeveloped corporate governance structures since they have restricted corporate takeovers. Additionally, there are increased chances of bankruptcy in emerging markets since there are poor systems of checks and balances. There is a tendency of issuing bonds with high rates of interest leading to debt burden. In the end, this increases the costs of borrowing leading to potential liquidation. Question Four Participants in global finance According to Valdez and Wood, (2003, p. 79).This is the financial system that consists of institutions and other supervisors acting at the international level. The main players include global institutions like the international monetary fund, the bank for international settlements, national agencies and national departments like the national central banks. Others include finance ministries, institutions that act on the global scale, like banks. Categorically, they are four, namely international institutions like the IMF, the World Bank; Government institutions through the government finance ministry; private participants like commercial banks; and regional institutions like the North American Free Trade Agreement. The Role of IMF The international monetary fund monitors the international payment balances for the member states. It is the last resort lender for its members under financial grief. Countries in financial crises and other problems meeting the balance of payment while in insufficiency and debit default refer to this body for help. Further, the international monetary fund creates conditions that are market oriented for growth and encourages partnership with the private sector, calling for the significant mode of operation and clarity in the engagement principles. The International Monetary Fund gives strategic advice to its members facing economic difficulties and works with second world members to aid them achieve their stability macro-economically, hence reduction of poverty. It achieves this by helping countries to benefit from globalization. Majorly, the IMF provides strategic advice to member governments and their central banks on monetary issues. This is after scrutiny of the international economic trade and inter-country experiences. After tracking the world, regional and individual market economies, the International Monetary Fund provides research statistics, analysis and forecasts on the global financial market. Finally, the IMF offers methodological aid and training in helping the member countries to advance their economic management (Valdez & Wood, 2003). The Role of World Bank Its function is to provide funding and taking up the risks through giving favorable terms to development projects in countries. The countries here are those which may not access funding from the private sector. In poverty reduction in developing countries, the bank has strategies that combine a cross section of local groups which analyze the country in question. The government identifies the priorities and its poverty reduction targets before aligning its efforts towards the country. The Bank has procurement notices for awarding contracts and approving projects. Through this, publications for major banks and agencies get their development funding, although it requires subscription. Transformation of the global situation, this is through globalization in that it facilitates foreign trade and private capital to play a greater role in economic development. It also necessitates a shift towards a private and market based approaches to global finance. This has led to private sector and private international finance becoming major agents in economic development. Washington Consensus The views in this consensus include the discipline in the fiscal strategy with avoidance of massive relative deficits to the gross domestic product, growth oriented provision of main pro growth services like primary health care, infrastructural investment and education through redirection of public spending from grants, tax reforms through adoption of moderate subsidiary rates. The consensus recommends positive and real term market determined interest rates, exchange rates that are aggressive and liberal trade especially in importation through elimination of quantity restrictions. Inward foreign and direct investment liberalization, besides state enterprise privatization is also in the consensus. The consensus also emphasizes on abolition of laws and restrictions that impede market entries, hence restricting competition in exception to those seeking safety, consumer and environment protection. Finally, the consensus proposes a legalization of property rights. Social Democratic Front This system has the view of supporting collaboration among classes towards achieving socialism through creation of legal reforms and economic redistribution. This is to get rid of economic disparities. It calls for economic democracy through enhancement of collaborative business organizations rather than private enterprises. NeoMarxists They believe that economics has a connection to dependency and world systems theories. They prefer the external exploitation rather than the internal one. Work cited Madura, J. (2003). International financial management (7th ed.). Mason, Ohio: Thomson/South- Western. Valdez, S., & Wood, J. (2003). An introduction to global financial markets (4th ed.). Houndmills, Basingstoke, Hampshire: Palgrave Macmillan. Read More