Marine Finance and Insurance - Essay Example

Marine Finance and Insurance At present times, doing business has become more complex than before with the advent of globalization and the internet. The world has become one huge marketplace where businesses established in different countries all compete in the same fight. Companies in almost all industries have ended up having transactions with parties located beyond the borders of their respective countries. The marine industry is among those affected by these trends. The companies therein presently source their equipment and tools from offshore suppliers that offer better quality or more competitive prices. Similarly, they also have come to cater to companies from other countries in the course of their business. Through it all, marine industry players have become subject to foreign exchange risks. They have engaged in deals that would involve gains or losses resulting from the fluctuations in the exchange rates of foreign currencies used. Thus, foreign exchange risk should be acknowledged in the marine industry as a reality that all companies should be prepared for. If managed well, foreign exchange fluctuations can even present opportunities for companies to earn more. Huge capital investments for boats or similar fixed assets purchased from a foreign supplier can turn out to be big mistakes for marine companies that transacted them in a currency whose equivalent conversion to the native currency takes a nosedive right the next day or even weeks after the purchase date. The same is true with having collected revenues in currencies whose values abruptly plummets. Indeed, such cases are not to be underestimated or overlooked. They can lead to material, negative impact on the profitability and financial soundness of any marine company. As a matter of fact, the dread of ending up as casualties of abrupt foreign exchange fluctuation has led businessmen and investors across all industries to adopt different mechanisms to mitigate such risk. Fear and risk-aversion naturally come with things that are unpredictable, uncontrollable or unfamiliar. Risk, then, is a subject that ought to be explored and studied. If risks will be capably viewed in the right perspective by decision-makers, then strategic opportunities for growth and development will not go wasted or deliberately missed out due to attempts to avoid them. Winning companies do not avoid having to face risks; they embrace risk-taking and then learn from it. It is important to create in the company a culture that welcomes risk-taking as part and parcel of excelling in the business world. This culture would breed company leaders who are not afraid to commit mistakes and to openly learn from it (Welch, 2005). The only way to win and to succeed is to take risks and to make the right decisions in the process – making the wrong is part of the price of getting to this level. It is best to approach risk – like foreign exchange risk – with full knowledge of the potential gains or losses that it can bring in. This way, the idea of it ceases to be vague. Translating risk in concrete terms like specific amounts lessens one’s exposure to it; simply knowing about it somehow makes one a lot better off in dealing with it (Brigham & Houston, 1998, p.753). A marine company would have to include foreign exchange risk as a consideration that, like all other inputs of the trade, merits evaluation. Risk analysis as well involves dissecting and examining the components of risk to understand its nature and to conclusively determine how to best handle it. A good risk analysis would be one that is based on data that can be verified. Any conclusion would turn out to be unreliable and useless if it was based on wrong premises. It is equally necessary for marine companies to decide how it should handle foreign exchange risk. Company management teams should be well aware of the existing risk management tools available, such as futures and options. These tools enable investors, borrowers or lenders of funds in various currencies to protect themselves against the risks of changing prices, interest charges, or conversion rates. (Brigham & Houston, 1998, p.753) These tools have become financial products – derivatives – put together for the purpose of neutralizing risks (Knowledge@Wharton, 2006). A futures contract provides for the future exchange of a particular asset at a specified delivery date in exchange for a specified payment at the time of delivery. On the other hand, an options contract grants the owner the right, but not the obligation, to make a future transaction in an underlying commodity or security at a fixed price and within a predetermined time in the future. (Kolb, 2000) Both futures and options involve transactions that are yet to be undertaken in the future. Risk is dependent on the prevailing factors surrounding each transaction. Each case is a unique combination of different levels of risk. Choosing to invest in futures in preference of options presents both advantages and disadvantages. For one, there is the generally acknowledged positive relationship between the currency futures price and the conversion rate expected to prevail for any currency duo. Investing in futures at their prevailing prices on any given day, therefore, would give one a clue of the general projections of the market as to be fluctuations of the currency values in the coming days (Kolb, 2000, p. 27). Investing in currency futures for hedging purposes, meanwhile, gives one legitimate claims to gains involving values that would have pertained to actual losses from the main transaction. In terms of gains when one has made the right projection on the future direction of a currency, futures yield much higher returns compared to options. The values of futures also are less volatile compared to those of options. The latter are the instruments that tend to be in steep upward or downward slopes throughout the trading hours or days, depending on the prevalent situation in any given currency market. Futures, however, do not offer the same flexibility that options have. A futures contract by itself is equivalent to an irrevocable promise to buy or sell currencies at the specified contract prices. This presents a disadvantage since, needless to say, it requires higher amounts of investments to buy packaged currencies and not just rights thereto. On the other hand, choosing options likewise presents advantages and disadvantages. Given the flexibility that options afford their holders in buying or selling currencies at stated prices, these holders can either exercise the rights attached to their options or they can just let such options expire. Holders of options decide to exercise their rights or not; the decision is basically hinged on the actual value of the currency on the exercise date. Options, thus, entitle investing entities to a financial leverage that may or may not be used. One disadvantage of investing in options as compared to choosing to forego the risk-mitigation that they afford is the considerable costs of purchasing them. The premium costs and the commission charges that go with them make options, on the whole, relatively expensive. There are furthermore added risks in purchasing options – it subsequently makes it imperative for investors to be ever on watch. They would have to be well-informed on the constantly changing variables of the foreign exchange markets. Running for cover from excessive foreign exchange risks by investing in currency derivative instruments such as futures and options has been classified as a conservative, risk-averse decision by companies. Derivatives serve to cushion the company from the crippling effects of significant foreign exchange losses. More than the profits that can be potentially earned, mitigated losses are the usual intended objects of decisions to go for futures or options. In the light of the foreign exchange risks that the marine industry is exposed to, companies with complementary services – like Boatdealers.ca and HIFX Canada Inc. – have forged partnerships for providing marine industry players with updated information on the Foreign Exchange markets. The services made available to marine companies to help them tackle foreign exchange risks include giving access to conversion rates that are higher than what banks give, executing buy and sell orders during trading hours, providing well-researched, independent information that should lead to well-informed decisions of clients, and constantly monitoring currency markets and other markets that affect them. (Evans, 2009, Boatdealers.ca website) The proliferation of companies offering services such as these give credence to the fact that the marine industry is, indeed, concerned about foreign exchange risk. On the other hand, some companies offer trainings designed to impart knowledge and insights on the business environment of the different countries across the globe and how studying them can create an undeniable edge for marine companies (Enterprise Florida website). Some transactions in the marine industry take over a year to be completed and payments are required throughout the term, like the building of big boats. With initial deposits required and portions of the total prices collected in different currencies and from varied clients after each phase of the construction, there would have to be ways for a shipbuilding company to go protect itself from financial damages that might result from having to receive payment, every now and then, in foreign exchange units. At the end of it, it is a matter of matching risks with returns. When returns are well worth taking the risks involved, then the risks become things that the company would have to be prepared to face. Part of the incremental income, though, would go to the cost of mitigating foreign exchange risks. This is the safer choice to make; it would be sad for any company executive to live to tell about having led his company to bankruptcy by refusing to incur costs that go with hedging via derivatives. Even if the costs of the derivative tools cannot be easily shrugged off – commission charges, among others, can be expensive – and even if it is easy to assume that all will turn out fine in the foreign exchange markets, the benefit that they can give is well worth the fees, no matter how unreasonably significant. References Evans, B. (2009). Currency Exchange Services. Boatdealers.ca. Retrieved August 12, 2009 from http://www.boatdealers.ca/currency-exchange.aspx. Kolb, R. (2000). Futures, Options & Swaps. Malden, MA: Blackwell Publishers, Inc. Finance and Investment. (2006). The Role of Derivatives in Corporate Finances: Are Firms Betting the Ranch? Retrieved August 12, 2009 from the Knowledge@Wharton database. Enterprise Florida. (2009). International Business Training Workshops for the Marine Industry. Retrieved August 12, 2009 from http://www.eflorida.com/uploadedFiles/Events/ MarineTraining_7-22.pdf. Welch, J. (2005). Winning. New York: HarperCollins. Read More