International Financial Management - Forex Direct and Indirect Quotes - Literature review Example

International Financial Management Name Institutional Affiliation International Financial Management Question One Financial markets operate in unstable environments characterized by fluctuating currencies. Imperative of these currency markets is the uncertainty in foreign exchange rates which Frömmel and Luetje (2014) defines as the sensitivity of stock returns to the investor or investing firm. Moreover, the foreign exchange exposure is a function of both the exchange rate and the return of foreign assets. As such, it becomes vital to the trader, especially multinational companies to understand the patterns in currency markets particularly about quoting currencies. According to Frömmel and Luetje (2014) the movement of the foreign exchange market affects the firms’ value through a number of channels including. Here, these channels include the appreciation of the domestic currency which interprets to a loss of competitive value on both the international and domestic markets (Frömmel & Luetje, 2014). Again, with the appreciation, there is a parallel decrease in value of the foreign assets. Frömmel and Luetje (2014) explore the second channel of these impacts involving the foreign-denominated debt. The appreciation of the foreign currency leads to gains in enterprises holding the foreign-denominated debt. Here, the challenge of the aforementioned occurrences involves a currency mismatch between the domestic and the foreign currencies (Frömmel & Luetje, 2014). In light of these crucial consequences about a mismatch of currency between nations, it is necessary to understand currency quotes. Here, currency quotes develops a relation between currencies which also reflects the value of each relative to the other. As such, quoting currencies influences trade, foreign exchange and international monetary systems (Blenman & Wang, 2014). Imperative in currency quotes is the system of quoting used which directs the reading of a quote as well as identifies the relation of a currency pair. Based on Blenman & Wang (2014) there exist two currency quoting techniques including the direct and indirect method. In a direct quote, the currency pair follows the expression of the domestic currency per unit of the foreign currency. Contrary, indirect quote entails the foreign currency per unit of the domestic currency expression (Blenman & Wang, 2014). Reading the quotes in determining the exchange rate between currencies varies according to the type of quote. However, the principal involves distinguishing of the base and quoted currency. (Admiral Markets, n.d). The first symbol to the quote or the symbol left of the slash identifies the base or the counting currency whereas that to the right of the slash is counter currency (Admiral Markets, n.d). Imperative in the reading is the value or importance of the domestic currency relative to the foreign (Admiral Markets, n.d). As such, the US dollar forms the base currency to a majority of currency pairs following its being a major currency globally (Admiral Markets, n.d; Hassan & Mano, 2014). In this case, the United States uses a direct quote to other currencies of the world. According to Frömmel and Luetje (2014), exchange rate regimes in a significant number of nations introduce various base currencies. In the beginning, the US dollar dominated the currency market including its function as the base currency. However, these regimes on exchange rate saw the rise of the Euro as a major currency leading to the use of indirect quote in Europe (Frömmel & Luetje, 2014). Here, the euro forms the base currency relative to other currencies including the US dollar (Admiral Markets, n.d). Moreover, with the growing popularity of the Euro as a major in financial trading, it becomes a crucial currency in cross-currency rates (Frömmel & Luetje, 2014). In Australia, the currency in use is the Australian dollar. Here, the Australian dollar is one of the common wealth currencies which include the British pound and New Zealand dollar. Significant about these currencies in relation to currency exchange involves the indirect quote system they apply in the trade (Admiral Markets, n.d). In this case, the use of the indirect quote follows the need to limit exchange rate exposure of the nation which may introduce adverse effects about its market performance and profitability (Frömmel & Luetje, 2014). Similarly, Barroso and Santa-Clara (2015) affirms the negative impacts about the uncertainty in currency spots. Therefore, with an indirect quote, Australia is able to apply the carry trade strategy (Barroso & Santa-Clara 2015). Question Four Globalization and internationalization continue to influence an interrelation between the formal and informal sectors. Holmes Jr, Miller, Hitt and Salmador (2013) notes that the formal sectors in a nation influence the availability of long-term investment from Multinational Enterprises (MNE’s). Furthermore, these MNE attract Foreign Direct Investment (FDI) which impacts the social and economic sectors. Holmes Jr et al. (2013) explain these impacts through an organizational institutionalism and institutional economics approach. Examining the approach, particularly on the organizational institutionalism segment; the society through its values and actions enhances the sustainability of social institutions. Consequently, these institutions function in the economic sector influencing investment behavior, market function and wealth generation (Holmes Jr et al. 2013). The most important formal institutions to any community include the political, regulatory and economic bodies. Focusing on the economic institutions, an example includes the foreign exchange bureau which directs the operation of businesses (Holmes Jr et al. 2013). Furthermore, it embodies the rules and standards shaping the values within the society along availing the society’s financial resources. Consequently, these values and resources at the society level support capital investment (Holmes Jr et al. 2013). Imperative on investment about a financial institution operating within a formal and informal sectors interaction is its function market exchange. Here, market exchange realize an economic activity that carriers a social element defined through the actors (Holmes Jr et al. 2013). These actors are the market participants who interact to facilitate a business transaction. According to Holmes Jr et al. (2013), formal institutions define the acceptable behavior among the participants. As such, they allow the society to develop particular expectations about the conduct of the transacting parties (Holmes Jr et al. 2013). With the expectations there is the development of equilibrium practices that guide and support the performance of the market exchanges (Cetina & Bruegger, 2002). As a result, the formal institution merges the social and economic sectors through creating an interdependent system. Knorr Cetina and Bruegger (2002) consider the global financial markets as significant field that extrapolates the relation between the foreign exchange and society. Foreign exchange develops through an interdealer form of transactions involving a number of formal institutions. Here, it is the space where this exchange occurs that identifies a particular culture with far-reaching effects to the community. Knorr Cetina and Bruegger (2002) explain that these cultures create global social systems implanted in economic transactions. In this global social system, the traders are the participants engaging in international currency markets interconnected through communication channels. Here, the aspects of communication and participants enrich the culture within the society (Knorr Cetina & Bruegger 2002). Furthermore, Knorr Cetina and Bruegger (2002) discuss the characteristics of foreign exchange market including economic behavior and trade. Here, these features define the relations of production in institutions along the consumption and distribution patterns. The concept of current markets includes an integration of theories that define the market. Specifically, the market if a form of exchange founded in a social paradigm (Cetina & Bruegger, 2002). With this theory, there is the understanding of a social-economic correspondence whereby the social behaviors directs the financial and economic transactions and maintain the socio-economic relationships (Cetina & Bruegger, 2002). As a result, there is reaching long-term outcomes such as economic growth and development. Furthermore, the individuals in the society gain opportunities to invest which in most cases involve a political participation by the government in generating capital investments (Holmes Jr et al. 2013). Question Five As global economy continues to influence emerging markets, enterprises become more invested in international trade (Pananond, 2015). Consequently, with international trade and investments, these firms transform into MNE. Therefore, it is imperative to identify the motives behind the transformation of the business of becoming or not becoming MNE. Pananond (2015) begins by noting that FDI and strategic assets attainment are the significant motives that influence companies to become MNE. Focusing on FDI, Pananond (2015) explain that it includes different categories focused on the needs of the trader and the trading commodity. Examples of this include the natural resource, efficiency, market and strategic asset seekers (Pananond, 2015). Here, FDI facilitate the exploiting of a firms position of advantage and establish competitive advantage. An example in this case is the Chinese private-owned enterprises where the practice of FDI has seen a progressive escalation of their annual revenue (Wei, Zheng, Liu & Lu, 2014). Economic developments in a nation interpret to the expansion of its local assets enhancing its extension to international markets (Pananond, 2015). However, the firms’ specific assets determine the motivation behind attainment of strategic assets. Examples of the specific property include proprietary resources, technology, brand name and managerial skills which altogether enhance the company position the global value chain (Pananond, 2015). As such, the seeking of strategic assets as a motivation to enter MNE follows the need to overcome competitive weakness by a firm relative to domestic and international market power (Zheng, Wei, Zhang & Yang, 2016). Examples in this case includes the British, American and European firms dominance in international markets following their exploiting their specific property to gain strategic assets in the global market (Guillén & García-Canal, 2009). Although motives for businesses to become MNE exist, there is also a parallel negative motivation in discouraging this initiative. In particular, the motive in not becoming an MNE involves the merger and acquisition of the smaller firms by the larger firms (Zheng et al. 2016). Here, these mergers and acquisition for the smaller firms function to overcome their competitive disadvantage contrary to leveraging the present specific assets seen in large and advanced companies. Again, there is the challenge of institutional differences between the domestic and merging or acquiring company, cultural variations and a significant number of liabilities towards the practice (Zheng et al. 2016). An example is the case in China where these differences in the international market fail to equalize the strength of participants engaging the merger and acquisition strategies. Question Six Purchasing power parity (PPP) allows an extensive cross-country comparison about the exchange rate, inequity and poverty levels (Majumder, Ray & Santra, 2015). Its use follows the difference and instability of market exchange rates engineered by the difference in currency value. Moreover, the market exchange rate fails to present the actual purchasing power of a given currency resulting in differences in currency value (Majumder et al. 2015). Consequently, the application of PPP technique covers the difference by adjusting the market exchange rates such that two trading currencies become identical if expressed through a common currency (Majumder et al. 2015; Arize, Malindretos & Ghosh, 2015). PPP rates account for both the tradable and non-tradable goods and services which out performs market exchange rates that focus on tradable items (Majumder et al. 2015). As such, it provides a comprehensive system of comparing living standards in different countries. In this case, it assists authorities in developing countries to present an accurate measure of their economies (Majumder et al. 2015). Similarly, Arize et al. (2015) argues that its performance enhance its validity to policy makers and market participants engaging in financial transactions. This occurs following its setting equilibrium about the exchange rates between currencies (Arize et al. 2015; Majumder et al. 2015). In PPP, there exist different versions of the term including an absolute and relative form. Concerning the absolute PPP, Arize et al. (2015) explains that it defines an equalization of purchasing power of different currencies about a given basket of goods. The equilibrium included in this version follows the assumption that the perfect commodity price difference is a mechanism that equalizes the purchasing power of different currency for a said group of goods (Arize et al. 2015). Comparatively, in relative PPP provides a relation on the exchange rate and the difference in goods prices in both the domestic and international markets. Here, relative PPP explain that the difference in price changes in both the aforementioned markets including the disparity in inflation rates becomes equated to the appreciation or depression of the exchange rate (Arize et al. 2015). Furthermore, Majumder et al. (2015) discusses absolute PPP as that which approximates the equilibrium rate of exchange while the relative PPP involving a system that determines the necessary adjustments in exchange rates through examining the change in relative price. As such, absolute PPP relates to static Penn effects with the relative PPP corresponds to dynamic Penn effect (Majumder et al. 2015). At this point, it is important to question the usefulness of the PPP mechanism in exchange markets. In particular, the Big Mac Index contributes to this subject as one of the existing system that tests the relevance of PPP (Atal, 2014). Examining the model, it considers the long-term projections of PPP where the exchange rate of currencies about a basket of good will cost the same when postulated on a common currency. Research by Atal (2014) focuses on affordability of a common good involving a McDonald burger to populations in the countries of Brazil, US, China and Russia. Here, the affordability of the commodity focuses on the real-income disparity in the aforementioned countries. From the results, Atal (2014) although the price of the good varies in these regions, a PPP projection fails to provide an equilibrium as evident by the different affordability performances. In this case, PPP proves not useful in reaching currency exchange equilibrium across nations which explains that the currency value in the market continues to affect the exchange rates about goods and services. References Admiral. Markets. (n.d). Forex direct quote vs. Forex indirect quote. 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