International Finance - Essay Example

Introduction In the study of international finance, the investigations usually underpin on the concept of international trade, and hence there is sharp focus on multinational enterprises (MNE). Withers (2011) states that multinational enterprises are simply enterprises that operate far beyond their indigenous borders. The common characteristics of multinational enterprises include huge capital outlay, which contribute to the massive investments usually made by the MNEs. MNEs also have wide market presence in form of retail stores in numerous countries or subsidiary companies in numerous countries, a big workforce, and huge sales volume because of the wide market presence, wide and highly decentralized organisational structure. Lastly, MNEs have cultural diversity within their organisational setting (Sercu, 2009). However, the creation of multinationals is usually driven by certain factors that attract such enterprises to a particular new market, these factors encourage expansion, and they highlight on untapped opportunities within a particular market that has good economic prospects. This present essay has two sections. The first section focuses on Japan as a foreign market that plays host to numerous American MNEs. Under this section, the essay will use General Electric, which is an American MNE operating in Japan as the case study to investigate why the company decided to venture into the Japanese market. Secondly, the first section will also highlight how General Electric suffered adversely because of the 2011 crisis in Japan that involved an earthquake, tsunami, and nuclear radiation. The second section of the paper will involve calculations on covered interest arbitrage in order to investigate the amount of profit achieved and the amount of loss achieved by a corporate foreign investor. The rationale for General Electric to be in Japan in the first place Carlson (1991) writes that General Electric Company is an American multinational enterprise which head offices are located in the state of Connecticut in the United States. Carlson (1991) states that the company was originally formed in 1892, and it has witnessed massive growth ever since its formation. The growth is evident by the wide market presence that the company enjoys and the diverse range of products that the company offers, which include consumer and industrial products, capital finance products, technological infrastructure products, and energy products. In Japan, General Electric has notable presence in the finance and technological sectors. It is of essence to note that General Electric usually enters or penetrate a market through the acquisition of an already existing business in the new market or through the formation of a merger with an already existing business. For instance, in Japan, General Electric ventured into the market by forming an alliance with a Japanese company called Hitachi, and as a result, Hitachi-GE Nuclear Energy Limited was formed in 2007. The joint company has its headquarters in Wilmington, the United States and it basically specializes in the provision of nuclear services and advanced reactors (Carlson, 1991). In the writings by Withers (2011), she stipulated on some of the reasons why a foreign company may decide to venture into a particular market. One of the reasons that could explain why General Electric ventured into the Japanese market, not only through the Hitachi-GE Nuclear Energy Limited but also through other subsidiaries, was because of the large Japanese population. The over one hundred and twenty million population provides a ready market for General Electric products and therefore, by establishing a subsidiary in Japan, General Electric was foreseeing an increase in their sales volume. Sercu (2009) also noted that MNEs might decide to venture into a particular market or country because of the availability of qualified and cheap workforce. Therefore, it is correct to assert that General Electric ventured into the Japanese market because of the readily available workers who are qualified equally to Americans and much cheaper. Consequently, by establishing their operations in Japan, General electric was set to benefit from reduced operational cost because of low salaries and wages expenses, which will positively affect its overall bottom line. Thirdly, Sercu (2009) noted that MNEs decide to venture into a specific country or market if there is massive source of raw materials that the MNEs can utilize in their production process. Furthermore, it is crucial to note that MNEs establish subsidiaries in markets where there is abundant source of raw material to save on cost of importing the raw material from these locations, which is more expensive than exporting finished products (Withers, 2011). In particular, Hitachi-GE Nuclear Energy Limited was established in Japan because of the readily available source of uranium, which is the key material for nuclear energy. Secondly, the company ventured into Japan because nuclear power plants within the country were getting older with time, and hence General Electric explored the opportunity of offering services that can extend the life of the nuclear power plants, increase their efficiency and output level. General Electric decided to venture into Japan also because of the infrastructures that the country have. They make cost of doing business lower as well as increase efficiency in the operations of a company. Sercu (2009) notes that Japan is endowed with abundant source of energy that also include nuclear energy. Secondly, the telecommunication infrastructure is well advanced, reliable and allows for cheap connectivity. In terms of the transport sector, Japan is revered for having more than two hundred and fifty high-speed trains that use modern railway networks that interconnect every region of the country. The country has 1.2 million kilometers of road, which makes every region within the country easily accessible. Lastly, there are over one hundred airports within Japan, which indicates how well the country is interconnected and how easy it is to move from one region to another. In addition, General Electric decides to venture into Japan through other subsidiaries such as Hitachi-GE Nuclear Energy Limited because of the country’s robust economy, which is ranked third Worldwide in terms of gross domestic product after the United States and China (Withers, 2011). Moreover, Japan embraces the market economy, which is more liberal, and even its political system embraces democracy unlike that of China, thus encouraging MNEs such as General Electric to set-up shop in the country because of the democratic space and political safety (Sercu, 2009). Lastly, General Electric was motivated to venture into Japan in order to benefit from the country’s well-advanced scientific and technological sector, of which according to Withers (2011), Japan is the leading country in terms of scientific research in the field of biomedicine, machinery, and technology. Impact of Japan’s 2011 crisis on General Electric According to Architectural Institute of Japan (2012), in 2011 Japan witnessed one of the worst ever natural disaster in the World’s history, the natural disaster was later to be known as the 2011 Tohoku earthquake and tsunami. Birmingham and McNeill (2012) stated that it was the worst ever earthquake to hit Japan and among the top five most powerful earthquake in the World’s history. The Tohoku earthquake had a magnitude of 9.03 (Mw) and it originated from under the sea at the coast of Japan. The earthquake ignited powerful tsunami waves that led to further distraction in the surrounding region and additional loss of lives and injuries. Architectural Institute of Japan (2012) states that the actual effect of the 2011 Tohoku earthquake and tsunami was more than fifteen thousand lost lives, over six thousand injuries and more than two thousand people missing. In addition, more than one hundred and twenty thousand building totally collapsed, more than two hundred and fifty thousand half-collapsed and nearly seven hundred thousand buildings were partially damaged. Infrastructures were also affected as roads and railway lines were extensively damaged. Perhaps, the most detrimental effect of the Tohoku earthquake and tsunami on General Electric was the nuclear accidents that occurred on the reactors at the Fukushima Daiichi Nuclear Power Plant. General electric was blamed for these accidents since it was the company that designed the reactors, worse was that the design of the reactors was brought into question as early as 1972 when they were initially designed. This blame leveled against General Electric meant that it was partly responsible for the damage, loss of lives and injuries attributed to the nuclear power plant accidents. Consequently, the blame was a major blow to the business operations of General Electric in Japan as its public relation as well as reputation with the Japanese people was badly damaged. These subsequently affected the business of General Electric in the Japanese market, as it will be highly unlikely if the company is able to get a tender in the future to design nuclear reactors. However, it is beneficial to note that despite the negative impact of the crisis in 2011, the company is continuing with its operations in Japan and notably its subsidiary Hitachi-GE Nuclear Energy Limited, which is currently sourcing for technological development project to deal with accidents of nuclear power reactors. Conclusion This essay has identified that for a foreign company to decide to venture into another local market or country, the local market has to be endowed with various factors that make it a conducive business environment. Such an environment is most likely to favour the business operations of the foreign company, give it an opportunity to growth further, and increase it profitability level. It is evident that Japan had numerous strategic advantages for the business of General Electric and this is why even after the 2011 crisis the company is continuing with its operations in Japan. Second Section 2.0 Covered interest arbitrage This second section conducts covered interest arbitrage to investigate the amount of profit achieved and the amount of loss achieved using the following market information; USD interest rate: 2.0% AUD interest rate: 6.0% AUD/USD spot rate: AUD0.9700 per USD 6 month forward rate: AUD0.9900 per USD The corporate foreign investor will first exchange the 10 million Australian dollars to United States dollars at the spot rate. This is calculated as follows: 10 million AUD*0.97 = $9,700,000 USD The second step is for the corporate foreign investor to invest the $9,700,000 US dollars interest rate, which is 2%. This is calculated as follows; $9,700,000*2% = 194,000 as the interest, hence the total sum will be: $9,700,000+$194,000 = $9,894,000 The third step, which the corporate foreign investor will undertake is to convert the sum back to Australian dollars in order to be able to repay back the loan. This is calculated as follows: $9,894,000*0.99 = 9,795,060 Australian dollar Through this covered interest arbitrage scenario using the pyramid method the corporate foreign investor will achieve a loss of: 10,000,000 – 9,795,060 = 204,940 Australian dollars However, the corporate foreign investor will achieve a profit if he or she decides to invest in the local market, which offers an interest rate of 6%: 10,000,000*6% = 600,000 Australian dollar Therefore, if the corporate foreign investor invests the money in the local Australian market, he or she will earn an extra 600,000 Australian dollars, which can offset the bank loan interest loan and bank charges, leaving the investor with a substantial profit. References Architectural Institute of Japan (2012). Preliminary Reconnaissance Report of the 2011 Tohoku-Chiho Taiheiyo-Oki Earthquake. New York, U.S: Springer. Birmingham, L. and McNeill, D. (2012). Strong in the Rain: Surviving Japans Earthquake, Tsunami and Fukushima Nuclear Disaster. New York, U.S: Palgrave Macmillan. Carlson, W. (1991). Innovation as a Social Process: Elihu Thomson and the Rise of General Electric, 1870–1900. Cambridge: Cambridge University Press Sercu, P. (2009). International Finance: Theory into Practice. New Jersey, U.S: Princeton University Press Withers, H. (2011). International Finance. Carolina, U.S; Nabu Press Read More