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International Financial Management at Navigation Systems - Essay Example

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The essay "International Financial Management at Navigation Systems" focuses on the critical analysis of the major issues on international financial management at Navigation Systems Inc. The spot foreign exchange rate is the rate at which an immediate transaction is carried out…
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International Financial Management at Navigation Systems
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?Running Head: International Financial Management INTERNATIONAL FINANCIAL MANAGEMENT NAVIGATION SYSTEMS, INC. NAME DATE OF SUBMISSION Part 1 Computation of Spot and 1-year Forward Exchange Rates and Repatriation of ROS The spot foreign exchange rate is the rate at which an immediate transaction is carried out and the date used is the spot date, normally denoted as T + 2 days. The spot rates extracted from reliable sources for the foreign currencies are depicted in the following table: Currency Spot Exchange Rates Euro / USD 0.7624 € Yuan / USD 6.3123 Yuan These spot exchange rates were used in computing forward exchange rates which are the rates at which a bank or any party is willing to exchange or trade one currency for another at some prescribed date in the future. The forward exchange rate is a kind of a forward price. This rate is computed with the use of the relationship among the spot exchange rate and the differences in the interest rates between two nations. The formula to calculate a forward exchange rate is as follows: F = S * [(1 + i$) / (1 + ic)] ^ n Where, F = Forward exchange rate, S = Current spot exchange rate, i$ = Interest Rate in the United States, ic = Interest Rate in the foreign country or region, and n = Number of years The interest rates for United States, Germany and China are showed in the following table: Interest Rates Country Interest Rate USA 0.25% Germany (Eurozone) 1% China 6.56% The calculations for 1 year forward foreign exchange rates are as follows: Euro / USD F = 0.7624 € * [(1 + 0.0025) / (1 + 0.01)] ^ 1 F = 0.7567 € / USD Yuan / USD F = 6.3123 € * [(1 + 0.0025) / (1 + 0.0656)] ^ 1 F = 5.9385 € / USD The forward exchange rates computed are depicted in the following table: Currency 1 year Forward Exchange Rates Euro / USD 0.7567 € Yuan / USD 5.9385 Yuan Using the above calculated spot and 1 year forward exchange rates, the ROS will be repatriated in to United States, the computations of which are in the following table (all amounts are in millions of US $): Country After 1 year (In USD) – Using 1 Year Forward Rate Current Forecast (In USD) – Using Spot Rate Change in ROS Operations / Sales ROS % ROS Operations / Sales ROS % ROS In USD In %age USA $300 $30 10.00% $300 $30 10.00% $0.00 0.000% Germany $132.15 $15.86 12.00% $131.16 $15.74 12.00% $0.12 0.748% China $109.45 $8.76 8.00% $102.97 $8.24 8.00% $0.52 6.294% $541.60 $54.61 10.08% $534.14 $53.98 10.11% $7.46 1.179% The above table shows the amounts repatriated into US Dollars after 1 year and on current basis using the spot foreign exchange rates. The main constituent which has been required in this assignment is the repatriation of ROS into United States. Using the forward and spot rates, the change in the ROS is depicted in the last two columns in terms of millions of US $ and percentage. The change in the ROS of Germany and China after one year has come about to be US$ 120,000 and US$ 520,000 which in total comes about to be US$ 746,000 and 1.179%. Discussion of repatriation with respect to: A spot transaction  A foreign exchange spot transaction or widely known as FX spot is a contract between two factions of people to purchase one currency against disposing of another currency at a settled price for settlement on the spot date. The exchange rate at which the spot transaction is carried out is called the spot exchange rate. The computation of the repatriation of the ROS to the United States after the period of 12 months has been done in the previous section. As the total worldwide revenues of Navigation Systems, Inc. amounted up to $500 million have been forecasted for the coming year therefore the transaction is not a foreign exchange spot one but a forward exchange transaction. However, to convert the sales or figures for operations and ROS of the two foreign countries, Germany and China into the currency of United States, the spot exchange rates have been used with US Dollar against German Euro and Chinese Yuan. The spot foreign exchange rates were used to convert all the foreign amounts into US $, the repatriation of the current forecast is depicted in the following table: Country Current Forecast (In USD) - Using Spot Rate Operations / Sales ROS % ROS United States $300 $30 10.00% From Germany $131.16 $15.74 12.00% From China $102.97 $8.24 8.00% Total $534.14 $53.98 10.11% An outright forward  An outright forward currency contract is an agreement with a locked-in foreign exchange rate and delivery date. There was an imperative role of an outright contract in this case of analysis as the time period considered is twelve months or one year and 1-year forward exchange rates had been computed to evaluate the outright contract and come up to the conclusion amounts. The change or variation in the Return On Sales (ROS) on all the three operations after one year was computed with the use of the forward rate which were calculated using the respective spot rates (Investopedia, 2012). A foreign-exchange swap  To note, a foreign exchange currency swap is a foreign exchange transaction which takes into account the exchange of principal and that of interest in one currency for the same in another currency of another country. This is done to gain exchange controls or also to make profits or avoid losses. In other words, this kind of swap, also known as FX swap is a concurrent buy and sales of one currency with another with two differing value dates which is normally from spot to forward. With respect to the current case being analyzed, there are transactions which have two legs; a spot and forward foreign exchange transaction which is exactly what occurred here. First, the amounts in foreign currency were repatriated in local US currency using the spot rate and then to compare, the values after one year were converted back into US$ using the 1-year forward exchange rate. But the thing to be noted here is that there was no formal agreement of a FX swap carried out, there was repatriations done to compare the total value of ROS of Navigation Systems, Inc (The Free Dictionary, 2012). Uses and benefits of using currency options or currency swaptions There would be use if NSI would have used a currency swaption as this would have entered the company into a formal agreement but the disadvantage here would have been the transaction fees or commission which would have arose. Considering the currency option, it would have been given the company the right but not the obligation to purchase or dispose of currency at a prescribed exchange rate within a specified span of time. Moreover, a premium would be paid to the intermediary such as a broker according to the contract size (Option Trading Tips, 2005). In this case, there are neither any U. S. corporate taxes being considered nor any tax holidays taken into account for tax considerations for repatriation of profits. How would you advise the company to handle the repatriation? The company’s financial department should try to analyze the situation carefully and calculate the necessary exchange rates for the period of one year. It should first calculate using credible and concrete knowledge depth, the 1-year forward rates using the current spot rates. This will give them an idea about the trend which each of the other two currencies will depict within the course of twelve months. If there is a rising currency trend, the company should plan to buy the foreign currency now and sell it after one year to repatriate back into US$ for a favorable position. If the situation is vice versa, the company should go for a currency swaption or a currency option to lock up its rate and avoid incurring losses at the end of one year. References – Part 1 Investopedia, 2012. Outright. Retrieved April 04, 2012 from Option Trading Tips, 2005. What are Currency Options? Retrieved April 04, 2012 from The Free Dictionary, 2012. Foreign Exchange Swap. Retrieved April 04, 2012 from Part 2 Existence of Currency Exchange Rate Risk Yes, in both of the alternatives or scenarios, there is an existence of a currency exchange rate risk but that is for Auxiliary Aircraft in Brazil only. To support this statement, a spot exchange rate in terms of USD and Brazilian Reals has been extracted from reliable sources and with the help of this; a 1-year forward rate has been computed as well using the interest rate of Brazil. The details and rates are listed in the table on the right below: From these computations and details, it can be seen that NSI will receive more dollars after one year (Trading Economics, 2012). Tariff - Its implementation and collection A tariff is a type of tax imposed on imported goods and this is done in countries according to their respective regulations. Tariffs are implemented either to promote imports so as to fulfill domestic demand or enhance the quality of goods or the either way to restrict imports in order to promote local demand and avoid excess supply. It is collected by the federal government at every instance when imports are carried out by companies in a country and they are deposited in the federal funds as tariff income (Wise Geek, 2012). Total amount of money NSI would receive from each scenario  Assuming that NSI would receive a total lump sum payment after 10 years from Auxiliary Aircraft, the amount of US$ 400 million will be converted using the 10-year spot exchange rate into Brazilian Reals and then back into US Dollars using 10-year forward exchange rate. The calculations are as follows: 1st Scenario Total Amount = US$ 40 * 10 = US$ 400 million Computation of 10-year forward exchange rate = 1.826 * [(1+0.0025) * (1+0.0975)] ^10 = 0.7220 Calculation of 10-year spot rate for starting year S = F / [(1+i$) * (1+ic)] = 0.7220 / [(1+0.0025) * (1+0.0975)] = 0.7904 1st Scenario Converting US$ 400 million into Brazilian Reals using 10-yr spot rate = 400 million * 0.7904 = R$ 316.1695 million Converting back into US $ using 10-yr forward rate = 316.1695 / 0.7220 = 437.91 million Gain = US$ 37.91 million 2nd Scenario Total Amount after 10 years = 46 * 10 = US$ 460 million Using the same pattern as in the 1st scenario, following results were found: Total Amount repatriated into US$ = 503.59 million Gain = US$ 43.59 million 2nd Scenario seems more profitable with a higher gain. Effect of FTAA and other regional integrations Free Trade Agreement of the Americas (FTAA) has promoted trade in the Americas and trade barriers have been made lenient; this will have a positive effect on both the scenarios especially on the first one in which the import tariff imposed will be eased or eliminated (Foreign Affairs and International Trade Canada, 2008). Other factors that would affect either scenario Other factors that would affect either scenario include any export barriers that could be imposed by the American government that would affect both the scenarios and NSI. The purpose of this could be to export less of the domestically produced goods to foreign countries and retain more for local consumption in the market. References – Part 2 Foreign Affairs and International Trade Canada, 2008. Free Trade Area of the Americas (FTAA). Retrieved April 05, 2012 from < http://www.international.gc.ca/trade-agreements-accords-commerciaux/agr-acc/ftaa-zlea/about_ftaa.aspx?view=d> Trading Economics, 2012. Brazil Interest Rate. Retrieved April 04, 2012 from Wise Geek, 2012. What is a Tariff? Retrieved April 05, 2012 from Read More
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