Budgeting and Planning in USA Supercars - Essay Example

? DeCISIONS IN USA SUPERCARS al Affiliation) Key words: Super Cars, Exchange rates Executive Summary The paper analyses the risks in foreign currency that USASupercars face in their daily operation. This is achieved by examining the contract that is aimed in selling in one year from now. The company is planning to sell a collection of cars to various clients around the world in various currencies. The market of foreign exchange is always unpredictable. Their uncertain fluctuations in the rate of foreign exchange over a given duration of time, thus it is good to manage the risk exposure tentatively. The uncertainty of a given amount of revenue that may be gotten, after the perspective order in various currencies are converted to $ are computed. This provides estimation of the anticipated future revenue, to help the company in budgeting and planning processes. Consequently, the HSBC offer will be discussed to explore the disadvantages and advantages of handling the decision from the CEO and Sales manager point of view. Consequently, the paper discusses the Value at Risk of the bank, alternative options, and the historical performance of exchange rates. The conclusions from the paper will be helpful in directors and managers of USASuperCars to make proper decision in reference to the perspective future revenues, and proper ways to deal with the fluctuation in exchange rates. Introduction USASuperCars is a company that sells luxury sport cars. The company has signed a contract with seven clients around the globe to sell cars in a year’s time. The selling prices are always constant and are in domestic currency at the prevailing market’s selling price at the delivery time (Sarno & Taylor, 2002). One of the problems that the company faces is the uncertainty of the exchange rates, to cope with the uncertainty. The company has come up with standard deviation and estimates from the Bank of America to curb the uncertainty. The accompanying report concluded that the rates are independent and evenly distributed. Question 1 Table 1: The Total Revenue in Dollars Worldwide Orders     Exchange Rate       Customer Quantity SP SP ($) Revenue ($) Mean SD Mean ($) SD ($)   UK 12 ?57000 91006.2 1092074.4 $ 1.41/? $0.041/? 80370 2337   Japan 1 5 Y 8500000 85442 427210 $0.00904/Y $0.00045/Y 76840 3825   Japan 2 3 Y9000000 90468 271404 $0.00904/Y $0.00045/Y 81360 4050   Canada 1 1 CAD 97000 92447.86 92447.86 $0.824/CAD $0.0342/CAD 79928 3317.4   Canada 2 3 CAD 100000 95338 286014 $0.824/CAD $0.0342/CAD 82400 3420   South Africa 2 R4 100000 9654.65 19309.3 $0.0211/R $0.000083/R 2110 8.3   USA 1 $100,000 100000 100000           Total Revenue     564356.71 2288459.56     403008 16957.7   The table shows the revenue conversion from foreign countries converted into domestic currency. In the table above, it shows that the mean revenue is 2,288,459.56 dollars. Using the figure, the standard deviation is calculated as 338350.8071. The estimated probabilities for different situations are stated below Question 2 2 (a) Worldwide Orders         Exchange Rate     Customer Quantity SP SP ($) Revenue ($) Mean-Revenue Squared Mean SD Mean ($) SD ($) UK 12 ?57000 91006.2 1092074.4 765151.6057 5.85457E+11 $ 1.41/? $0.041/? 80370 2337 Japan 1 5 Y 8500000 85442 427210 100287.2057 10057523630 $0.00904/Y $0.00045/Y 76840 3825 Japan 2 3 Y9000000 90468 271404 -55518.79429 3082336519 $0.00904/Y $0.00045/Y 81360 4050 Canada 1 1 CAD 97000 92447.86 92447.86 -234474.9343 54978494808 $0.824/CAD $0.0342/CAD 79928 3317.4 Canada 2 3 CAD 100000 95338 286014 -40908.79429 1673529450 $0.824/CAD $0.0342/CAD 82400 3420 South Africa 2 R4 100000 9654.65 19309.3 -307613.4943 94626061867 $0.0211/R $0.000083/R 2110 8.3 USA 1 $100,000 100000 100000 -226922.7943 51493954566         Total Revenue     564356.71 2288459.56         403008 16957.7 Mean       326922.7943             Variance           1.14481E+11         SD           338350.8071         Probability           2.61096E-13         2 (b) Worldwide Orders         Exchange Rate     Customer Quantity SP SP ($) Revenue ($) Mean-Revenue Squared Mean SD Mean ($) SD ($) UK 12 ?57000 91006.2 1092074.4 765151.6057 5.85457E+11 $ 1.41/? $0.041/? 80370 2337 Japan 1 5 Y 8500000 85442 427210 100287.2057 10057523630 $0.00904/Y $0.00045/Y 76840 3825 Japan 2 3 Y9000000 90468 271404 -55518.79429 3082336519 $0.00904/Y $0.00045/Y 81360 4050 Canada 1 1 CAD 97000 92447.86 92447.86 -234474.9343 54978494808 $0.824/CAD $0.0342/CAD 79928 3317.4 Canada 2 3 CAD 100000 95338 286014 -40908.79429 1673529450 $0.824/CAD $0.0342/CAD 82400 3420 South Africa 2 R4 100000 9654.65 19309.3 -307613.4943 94626061867 $0.0211/R $0.000083/R 2110 8.3 USA 1 $100,000 100000 100000 -226922.7943 51493954566         Total Revenue     564356.71 2288459.56         403008 16957.7 Mean       326922.7943             Variance           1.14481E+11         SD           338350.8071         Probability           0.999999985         Question 3 3 (a) Worldwide Orders         Exchange Rate     Customer Quantity SP SP ($) Revenue ($) Mean-Revenue Squared Mean SD Mean ($) SD ($) UK 12 ?57000 91006.2 1092074.4 765151.6057 5.85457E+11 $ 1.41/? $0.041/? 80370 2337 Japan 1 5 Y 8500000 85442 427210 100287.2057 10057523630 $0.00904/Y $0.00045/Y 76840 3825 Japan 2 3 Y9000000 90468 271404 -55518.79429 3082336519 $0.00904/Y $0.00045/Y 81360 4050 Canada 1 1 CAD 97000 92447.86 92447.86 -234474.9343 54978494808 $0.824/CAD $0.0342/CAD 79928 3317.4 Canada 2 3 CAD 100000 95338 286014 -40908.79429 1673529450 $0.824/CAD $0.0342/CAD 82400 3420 South Africa 2 R4 100000 9654.65 19309.3 -307613.4943 94626061867 $0.0211/R $0.000083/R 2110 8.3 USA 1 $100,000 100000 100000 -226922.7943 51493954566         Total Revenue     564356.71 2288459.56         403008 16957.7 Mean       326922.7943             Variance           1.14481E+11         SD           338350.8071         Probability           5.85252E-13         3 (b) Worldwide Orders         Exchange Rate     Customer Quantity SP SP ($) Revenue ($) Mean-Revenue Squared Mean SD Mean ($) SD ($) UK 12 ?57000 91006.2 1092074.4 765151.6057 5.85457E+11 $ 1.41/? $0.041/? 80370 2337 Japan 1 5 Y 8500000 85442 427210 100287.2057 10057523630 $0.00904/Y $0.00045/Y 76840 3825 Japan 2 3 Y9000000 90468 271404 -55518.79429 3082336519 $0.00904/Y $0.00045/Y 81360 4050 Canada 1 1 CAD 97000 92447.86 92447.86 -234474.9343 54978494808 $0.824/CAD $0.0342/CAD 79928 3317.4 Canada 2 3 CAD 100000 95338 286014 -40908.79429 1673529450 $0.824/CAD $0.0342/CAD 82400 3420 South Africa 2 R4 100000 9654.65 19309.3 -307613.4943 94626061867 $0.0211/R $0.000083/R 2110 8.3 USA 1 $100,000 100000 100000 -226922.7943 51493954566         Total Revenue     564356.71 2288459.56         403008 16957.7 Mean       326922.7943             Variance           1.14481E+11         SD           338350.8071         Probability           9.39973E-13         Question 4 The idea of HSBC paying a sum of $ 2150000 in return for the sales in domestic currency is a good idea for USASuperCars. The issue of globalization enables the company to internationally expand their production and sale activities (Cummings & Power, 1993).Therefore, the phenomenon is greatly affected by the presence of the foreign rate exposure which can affect the profitability of the company, market values, and net cash flow. When this capital market technique is applied USASuperCars, they will be able to protect themselves against the fluctuations of the of primary exchange rate that the company might expose itself to. The predictability of the higher fluctuations enables the company to apply this effective risk management technique (Copeland, 1989). Question 5 Considering a one year period, the fluctuations of the bilateral exchange rate is more significant to the company’s revenue returns than now. However, because the company exports its products, the exposure to the risk is more consistent to the competitive advantage when the domestic currency depreciates. Additionally, it is a good idea to seal the deal with HSBC because the changes in the conditions of economy and the demand of the market will affect the automotive market which USASuperCars operates (Dooley & Landau, 2005). Consequently, the fluctuation in the exchange rate of currency majorly in respect to the Japanese Yen, California, and Rand and the fluctuations of the interest rate make it proper for the company to deal with HSBC. The funding environment in the financial markets and the increasing competition in the service favor the deal. Other reasons in favor of the deal include the company’s ability to distribute and market their products effectively (Cameron, 2004). Also, their ability to realize the efficiency of production and the implementation of capital expenditure at the times planned and the levels by management. In the company, the sales manager is willing to seal the deal with HSBC, but the CEO is reluctant (Dornbusch, 1988). Therefore, the Sales Manager is more risk-averse than the sales manager. The sales manager has a decreasing marginal utility for revenue. With the decreasing marginal utility of revenue, the sales manager obtains more utility from the certain revenue than the same amount of revenue that is involved in the risk. Because the sales manager obtains more utility than certain sales than the risky income, follows that smaller amount of the revenue generates similar utility as the risky revenue (Ryan, 1982). This means that the sales manager is willing to accept the offer from HSBC to avoid risks. The difference in the revenue is called the risk premium and is the highest price that the sales manager would pay for costs such as the insurance policy that will eliminate the risk (Bradbury, 1983). The sales person prefers a low but a certain rate of return, like the bank account, over a higher rate of return on the equities. The sales manager made the choice by putting a lot of weight on the outcome considered to be worst. The sales manager is highly influenced by the economic environment of the industry (Floyd, 2010). Question 6 The banking nature is related to the control and the management of risk. The section gives the general overview of risks that banks are subjected to. Apart from exchange rate, the banks are faced with market risks, interest rate risks, credit risk, liquidity risk, and broader systematic risk. Risk can be defined as the unpredictable contingencies that banks incur, which leads to uncertainty in the cash flow (Bonanno, 1989). Credit risk arises when the party that was contracted fails to obligate the discharge terms of the contract. The interest rate risk is a type of risk that is derived from the changes of market prices due to changes in interest rate (Raunig & Scheicher, 2008). The market risk, is a general term that describes the shift in market prices. The liquidity risk is a type of risk that the owner of the asset is unable to recover his asset’s full value when it is sold. Other type of risks that banks face includes the reputation risk, operational risk, and a fraud risk. A systematic risk is a risk that banks undergo during the contagious failure due to other forms of risk or shock (Best, 1998). Question 7 Assuming the offer pays the sure sum in 3 month time rather than in one year period, the difference in time would make a very big difference (Moosa, 2010). The company would prefer a three month payment while the bank would prefer one year payment. Banks tend to maximize their profits from the customer by getting relief from the interest payment. A three month period is best for the company because the fluctuations of the bilateral exchange rate are more significant to the company’s revenue returns than in three month time (Frankel, 1993). However, because the company exports its products, the exposure to the risk is more consistent to the competitive advantage when the domestic currency depreciates. Additionally, it is a good idea to seal the deal with HSBC because the changes in the conditions of economy and the demand of the market will affect the automotive market which USASuperCars operates. Consequently, the fluctuation in the exchange rate of currency majorly in respect to the Japanese Yen, California, and Rand and the fluctuations of the interest rate make it proper for the company to deal with HSBC (Frenkel, 1983). The funding environment in the financial markets and the increasing competition in the service favor the deal. Other reasons in favor of the deal include the company’s ability to distribute and market their products effectively. Also, their ability to realize the efficiency of production and the implementation of capital expenditure at the times planned and the levels by management (MacDonald, 1999). Question 8 Assuming that USASuperCars accepts the offers of HSBC, the level of revenue which is below $ 2,150,000 will be zero. This means that the bank will realize future profits. Therefore, the probability of the bank incurring loss that will never occur is 0. However, the certainty is calculated to be0.29, which on records as a lower likelihood. Question 9 The value at risk is a method of statistics used in measuring the financial risk degree in financial institution or in an investment portfolio like a bank. The bank’s risk managers use the method to control and quantify the risk level of the bank. Most banks set the threshold value for the amount of loss they can handle for the improbable financial assets returns. Consequently, it measures the confidence amount in handling various situations dealing with financial assets. A platform is very important for bank’s “Value at Risk”. It will result to better outcome in assessing the performance of banks. The expected revenue meaning when the financial institutions make a plan for the project it should plan for the future cash flow. Therefore, the bank needs to compute the expected value from various ways such as the foreign exchange rate, investment insurance, and personal finance. However, the section assumes that the banking institutions pay a lot of caution on rate of foreign exchange and tend to attract lot of currencies. Therefore, for the bank, the expected revenue that just earns the value of variance between the foreign exchange rate current value and its previous value. The expected profit and the bank’s value at risk were calculated to be 26,875.05 dollars and 47,877.87 dollars respectively. Question 10 Assuming the bank fails to convert some or all of the currencies within a year time, they can store the currencies as they observe the trends in foreign exchange rate. When the rate of exchange attains the highest level, they should convert all of the currencies. The banking facility should assume the greatest risk because the global economy influences the rate of foreign exchange. But the bank cannot predict the risk level and their exchange rate. The bank can also use the currencies by saving them in the local bank, and then earn interest from the bank. Consequently, they can use the currencies to develop and produce their reserves of the foreign exchange; this is because the greatest people want travel abroad. If the bank has control over the foreign exchange, investors will be attracted to invest in the projects thus earning a lot of revenue for the bank. Graphs The graphs below show the weekly and monthly exchange rate for the 4 currencies in relation Dollars. The exchange rate of EURO/USD fluctuated over the period. The general linear model is preferred, although the fluctuation in recent months caries. It is difficult in analyzing the future trends using a double step method. Additionally, a linear framework is better in terms of Y/USD because the general line is flat. The RAND/USD uses a general linear model because the rate of exchange is fluctuating during the period. Therefore, it is a good idea to carry out the long term investment. There is little difference in the CAD/USD conversion between the 2 step method and the general linear model. Using the model of linear regression, the trend forecasting was done for similar length of the period analyzed but forecasted for the 32 months and 136 weekly periods. The forecasting was done by coming up with an equation that obtained the intercept and the slope, where forecasting was computed. Where m is the slope b is the intercept. Forecasting is a risky parameter for making decisions in a business. From the graphs it is noted that the lowest fluctuating over period is Y and CAD. The forecast of Y and CAD are the most reliable. The relationship between USD and EURO fluctuates in a slower manner when comparing monthly numbers. This means that the currencies are highly volatile over a short period of time, therefore a higher financial risk. USASupercars should focus on doing business with Japan to reduce the exchange rate volatility and future risks. Therefore, the decision on the type of currencies to use depends on the nature of risk of the decision maker. The economic surrounding should be monitored closely together with the political issues. The function of residual is to find how good the regression equation is data fitting. The residuals are gotten from the distance between the regression model and the actual data point. From the charts it is noted that none of the models is 100% fit. This is due to uncertain position of the forecasted future values. Reference Best, P. (1998). Implementing value at risk. Chichester, England: Wiley. Bonanno, M. W. (1989). Risks. New York: St. Martin's Press. Bradbury, M. (1983). Rates of exchange. New York: Knopf: Cameron, S. (2004). Risks. Waterville, ME: Wheeler: Copeland, L. S. (1989). Exchange rates and international finance. Wokingham, England: Addison-Wesley. Cummings, B., & Power, J. (1993). Risks. New York, NY: Pinnacle Books. Dooley, M. P., & Landau, D. F. (2005). Interest rates, exchange rates and international adjustment. Cambridge, Mass.: National Bureau of Economic Research. Dornbusch, R. (1988). Exchange rates and inflation. Cambridge, Mass.: MIT Press. Floyd, J. E. (2010). Interest rates, exchange rates and world monetary policy. Berlin: Springer. Frankel, J. A. (1993). On exchange rates. Cambridge, Mass.: MIT Press. Frenkel, J. A. (1983). Exchange rates and international macroeconomics. Chicago: University of Chicago Press. MacDonald, R. (1999). Equilibrium exchange rates. Boston: Kluwer Academic. Moosa, I. A. (2010). The theory and empirics of exchange rates. Singapore: World Scientific. Raunig, B., & Scheicher, M. (2008). A value at risk analysis of credit default swaps. Frankfurt, M.: Europ. Central Bank. Ryan, K. (1982). Risks. New York: Dell. Sarno, L., & Taylor, M. P. (2002). The economics of exchange rates. Cambridge, U.K.: Cambridge University Press. Appendix 1: Questions 1) Find the distribution and report the mean and the standard deviation of the uncertain revenue in $ 2a) what is the probability that this revenue will exceed $ 2,250,000? b) What is the probability that this revenue will exceed $ 2,500,000? 3a) what are the probability that this revenue will be less than $ 2,150,000? b)  What is the probability that this revenue will be less than $ 2,000,000? 4) HSBC offers to pay a sure sum of $2,150,000 in return for the revenue in local currencies. What do you think, is this a good offer for USASuperCars or not? 5)  In USASuperCars, the Sales manager is willing to accept HSBC’s offer, but the CEO is not. Who is more risk-averse? 6)  What other risks the bank is taking apart from the uncertainty in the exchange rates? 7)  If the offer is to pay the sure sum in three months’ time rather than in twelve months’ time, would that make any difference? When would the bank and when the company would prefer the payment to be made, and why? 8)  USASuperCars has accepted HSBC’s offer. Now consider the bank’s risk, assuming the bank will convert all currencies into US dollars at the prevailing exchange rates. What is the probability that the bank will incur a loss? 9)  The bank defines its Value-at-Risk as the loss that occurs at the 5th percentile of the uncertain revenue (5% left tail of the distribution). What is the bank’s Value-at-Risk and what is the banks expected profit? 10) What other options does the bank has if they decide not to convert all /some of the currencies in twelve months’ time? Read More