The Type of Spot Quotes Used in Australia - Assignment Example

QUESTIONS: 1. Answer a. The U.S normally uses the direct quote method. b. In Europe, they also use the direct quote spot. c. Indirect quote is typically used in Australia. Please critically discuss why Australia uses the type of spot quotes that it does relative to two other countries? An Indirect quote reports foreign exchange rate as units of foreign currency expressed per unit of the domestic currency. Therefore, indirect quote relies on domestic currency as the base currency for making the quantity quotation. Hence, the value of the domestic currency is expressed in terms of the foreign one. The quotes are used to determine the value of the AUD by quantification. Conventionally, by using it as the base currency makes it easy to quantify its value for the exchange purposes with the currencies of other countries from Europe and U.S that use the direct quote spot. 2. Answer Australia use indirect quote spot Using the description provided in 1(c) above, we can deduce a formula as follows:- Indirect Quote=1/Direct Quote, Using the relationship, AUD=1/USD But 1/USD=0.801 This implies that 1 AUD is quantified as 0.801 USD As a result, 250,000 will be multiplied by the quantifying amount of 0.801 to obtain the USD =250000(0.801) Hence the answer is 200,250 USD 3. Answer: The 1.2772-87 is the range of the bidding and asking price. In this case, the figures show that the bid provided by the exchanger was 1.2772 USD/GBP. In relation to the GBP it is an indirect quote spot while as per USD it is a direct quote. It is worth to note that currency exchangers normally sell to the customers at the asking rate and buy from the customers at the bidding rate. a. Answer: Bearing in mind the bidding and asking rate and how they are applied, it implies that 1GBP=1.2772 USD Therefore, for customer who wants a GBP, he will be required to give 1.2772 USD. If 1.2772 USD=1 GBP 20,000 USD=? 20,000*1.2772=25,544 GBP To be converted back to USD, the bidding rate will be used for the conversion 1 GBP=1.2787 USD 25,544=? 25,544/1.2787=19,976.50 USD b. Answer: Suppose the USD is X If converted to GBP using the bid rate it will be X value divided by the bidding rate=X*1.2772 GBP. The X*1.2772 GBP should then be converted back to USD using the asking rate of 1.2787 Therefore, this will translate to (X*1.2772)/1.2787 Bearing in mind we anticipate 1750 USD, the amount needed is Expected amount = (X/1.2772)*1.2787=1750 1.0011744X=1750 X=1750/1.0011744 X=1747.95 Thus, the required amount is=1747.95 USD. NB: For the answers, the figures are rounded off. 4. Answer Foreign markets play an integral role in the society as they support the international business and transfer of money from one country to another and aid direct foreign investments (Jain, 2013). Bearing in mind that that foreign exchange is the practice for trading currencies, it makes it possible for people to use the currencies accepted in a given country by ensuring that there is fair valuation. Thus, it can be inferred that through the foreign exchange, the purchasing power of an individual or a business entity is transferred from one country to the other. This is made possible by use of different methods of international money transfer processes that are linked with financial instructions such as wire transfer, visa cards and or through western union. Therefore, a person can transfer money from the United States of America to Australia and the cash is received in Australian currency making it readily acceptable in the receiving country. Therefore, foreign exchange serves as an enabling market for the international transactions and can be pointed out as having increased integration and the globalization process. Besides, it is a business process in which the executors make profits. It is worth noting that the foreign exchange has different functions both for the participants and the society. One of the common functions as pointed out in the discussion is the transfer function. This function entails the conversion of the currency and ensuring that businesses can be carried out across the different countries. The conversion relies on the use of the different quote spots in the country. This implies that if the function lacked, the prospects of international trade will be affected and hence the economic growth across the globe will not be realized. For example, with increased global integration, economic growth has been some of the main mandates of governments. As a result, governments need to woo investors in their respective counties as a way to promote development. The investors are normally from different countries. For this to be possible, investors need to trade their currencies in order to acquire securities and foreign assets. The foreign exchange has also made it possible for existence of stock exchange markets in which investors buy and sell securities (Lander & Preece, 2014). Through the trade, the participants are able to make profits based on the volumes that have been moved. This makes it possible for the investors to benefit from buying and selling stocks. It has led to absolute dynamic of the financial markets. For example, it is due to the foreign exchange that there have been exponential expansions of stock exchange markets to adopt electronic transfer processes that have revolutionised the way investors can buy and sell their stocks. It is in this context that there have been digitization of money and the use of computer hardware and software applications in the trading of securities. Therefore, the foreign exchange allows the valuation and subsequent digitization of money that creates the way of using technology inn stock markets. The other function is that through foreign exchange, the participants are able to realize the hedging function. This implies that the risk associated with the volatility of market is minimized because traders and investors have the ability to monitor market and can do forward contracts which reduced the risk of loss of their currencies due to the variations in the market. However, this is limited to a given timeline and across the globe forward contracts are executed within 3 months (Lander & Preece, 2014). Noteworthy, the foreign exchange markets are based on valuations of worth of currencies. This works on the basis of demand and supply of the currency a factor that is normally influenced by many factors within a country. It is worth noting that the foreign exchanges are either carried out electronically or over the counter. Even though the foreign exchange has revolutionised the international business and paved way for growth, there are challenges of transparency about the trades. Due to the limited transparencies, the international foreign exchanges have led benchmark in which a single rate is used to fix a forex relatively to the other at given time. The fixes are critical to investors and the traders because the forex rates are required by international investors to value liabilities, assets and different kind of goods. A variation can lead to a big loss or gain hence, the foreign exchange ensures check and balances and curbs unhealthy fluctuations in the markets. 5. Answer In the modern globalised world, many companies take strategic measures to establish their physical presence and operations in different countries other the country of origin. Various motivates inform the undertaking (Franco, Rentocchini, & Vittucci Marzetti, 2008). For instance, the companies may be looking for markets that are not saturated or just a move to expand their market share (Hansson & Hedin, 2007). In relation to the strategic motives for companies to become multinationals, there are different studies that have conducted since the early 1990s. For example, Dunning (1993) cited the taxonomy for foreign direct investment (FDI) by firms. Also, Dunning (2000) provided an OLI paradigm that provides a succinct explanation for reasons relating to ownership advantage and internalisation advantage that inform companies to become multinationals. In the taxonomy, Dunning included location advantage as key factor of consideration (Franco et al. 2008). It is based on the provisions by Dunning 1993 and 1997 that two key motives for becoming multinationals can be deduced. According to Franco et al. (2008) the two motives include: i) Resource seeking ii) Market seeking Concerning the resource seeking, the main aim of multinationals is the need to access resources that are not readily available at home or which are relatively cheap in the foreign market. Examples of the resources are the raw materials which may be naturally available in the target countries or are cheap. The second factor relating to resource seeking is the need for skilled labor that is of relatively lower cost compared to the home country. According to Yeaple (2003), the resource seeking can best be understood by the fact that foreign direct investment for any firm is aimed at maximizing profits. This is through the exploitation of the differences in processes across the different countries. In such cases, the multinational are regarded as undertaking vertical integration. Besides, multinationals are informed by the need to replicate their practices across countries through horizontal integration. The integrations can be complex in which companies take advantage of the complementarity in the different countries (Yeaple, 2003). This results to a form of dependence of the FDI in the countries by leveraging on policies and economic characteristics of the countries. The strategy is aimed at ensuring that there are complements hence giving the country a favorable survival and sustainable competitive advantage due to the availability of cheap resources. The value of the resources across the countries can vary based on the exchange rates. In relation to the second motive of seeking market, Franco, Rentocchini and Vittucci Marzetti (2008b) noted that the reason businesses invest in foreign countries is to benefit from greater market dimensions. This motive is based on the fact that the market is not only restricted to their customers but the multinationals can sometimes be following suppliers who have established production facilities in the specific countries. The seeking market becomes a pull factor for a business that wants to become multinational. The market seeking motive is also aimed at adapting goods to the needs of the locals or preferences in order to reduce the cost of serving market from distances. In essence it reduces wastages and leakages that are associated with losses and risks in a long supply chain. The market seeking motive is also used as a competitive strategy in which the physical presence discourages new set ups in the line of production. Also, for a firm to decide to be a multinational, it has to do preliminary analysis that establishes the costs of setting up a foreign company or just serving the market through exportation. The analysis entails considering the transport cost, cost incurred through tariffs, government policies and their influence on the mode of operation and the customer’s needs. This allows a firm to determine the cost differences and in case it is found that setting a plant through FDI is relatively cheaper in the receiving country, a company will opt to be a multinational. The market seeking and resource seeking are normally defined as horizontal and vertical FDI. In the two motives, the companies focus on profit maximization (Yeaple, 2003). Also, the two motives are based on internalization theory that postulates that companies decide to be multinationals in anticipation for net benefits. It is worth noting that most of the multinational companies originate from countries that have relatively stable currencies and move to developing countries. In doing so, they exploit the foreign market imperfections and they gain from the rates of the countries with the weak currencies. It can thus be deduced that it is important for firms to come up with measures that reduce the vulnerability of firm caused by variation in exchange rates; because this can affect the profit margins of a firm and the value of its assets (Papaioannou, 2006). Multinationals firms have strategies for monitoring their finances to manage the exchange rate. In order to cushion themselves from the variations that arise in the international foreign markets, firms engage in tactical hedging. This is in relation to short term payable and receivable transactions. The companies also have to consider risk measures that come with currency exchanges. For example, the do hedging like exposure of the balance sheet that can be affected by movements in exchange rate. This ensures that the income statement of a multinational is not affected (Papaioannou, 2006). Firms may also not become multinationals because they want to protect their strategic assets in the home country. This is informed by the fact there are inherent risks that come with FDI. Therefore, if a firm carries out investigations and finds that the possible hedging measures may risk value of its assets and profitability, it may opt out of being multinational. For example, as pointed out, companies normally move from the hard currency economies that are relatively stable to the countries of the weak countries. The targeted receiving countries may not be politically stable and their stability may affect the currency and value of assets. 6. Answer The valuation of currency influences the manner in which multinationals manage their finances. According to Haidar (2011), the theory of purchasing power parity (PPP) states, “Nation’s price levels should be equal when expressed in a common currency” (p.1). The stipulation is a pointer of the fact that real exchange rate is an adjustment of the national process levels and thus any variation in PPP is a pointer of deviations. It is on this basis that currencies can be evaluated and under-valuations or over-valuations in relation to the real exchange rate can be established. In essence, the theory provides for one price for a particular good in different regions. The implication is the value for same good in one region should replicate in other regions if the currency of the exchange market value is precisely priced. For example, the value of a given model of Toyota car in Japan should be relatively the same in the U.S and Britain. However this is not always the case. The Absolute Purchasing Power Parity is based on the ideology of one price. Therefore, the real price of goods is supposed to remain the same in different countries. This should be maintained unless there is depreciation in the currency of one country and hence the price of the good will not be competitive in the international market because the prices will revert be the same (Lafrance, & Schembri, 2002). On the other hand, the Relative Purchasing Power Parity takes into consideration the inflation rates between countries. For example, if inflation rate in Australia is higher than in the U.K, the price of the same good in the two countries will be different, with Australian price being higher than that of the U.K. The implication is that the Australian currency will depreciate compared to the U.K’s. However, bearing in mind the stipulation of PPP theory, the differences in the currency depreciation should be equal to the inflation rates in the countries. Therefore, the difference between the absolute and the relative PPP is due to the inflation. These inflations can be due to political and economic issues in a location. The variation in prices due to relative PPP is typically unsustainable. However, it creates arbitrage opportunities that make makes traders to move goods from the area of low process to those of high prices. However, the competitive arbitrage helps to force the same goods to trade at same price across countries due to competition and mechanisms of supply and demand (Lafrance, & Schembri, 2002).The implication is that in the different countries, if the exchange rates satisfy PPP, countries’ competitive position will not be affected. However, in the case there are fluctuations in the currency by deviations that are not within the PPP, the countries’ competitive position will be affected either positively or negatively depending on the nature of the changes. For an appreciation, the competitive advantage will decrease while for a depreciation, the advantage will strengthen. Usefulness of PPP in Practice PPP is useful as it can be used to predict exchange based on the price of goods across the different markets. It provides a hint on operations of foreign exchange market (Lafrance & Schembri, 2002). This is critical in establishing a relatively long term prediction of the exchange rate. However, it is important to note on short-term basis, it cannot be used to forecast the rates of foreign exchanges. This is due to the fact that in the international markets, the commodity arbitrates takes a lot of time. References Dunning, J. (1993). Multinational Enterprises and the Global Economy. Harlow: Addison-Wesley. Dunning, J. (2000). The eclectic paradigm as an envelope for economic and business theories of mne activity. International Business Review, 9(1), pp. 163–190. Franco, C., Rentocchini, F., & Vittucci Marzetti, G. (2008). Why do firms invest abroad? An analysis of the motives underlying Foreign Direct Investments. Retrieved from http://www.etsg.org/ETSG2008/Papers/Franco.pdf Franco, C., Rentocchini, F., & Vittucci Marzetti, G. V. (2008). Motives Underlying Foreign Direct Investments: A Primer. In 5th International Conference on Innovation and Management (pp. 2329-2345). Hansson, A., & Hedin, K. (2007). Motives for internationalization: Small companies in Swedish incubators and science parks. Retrieved from https://scholar.google.com/scholar?um=1&ie=UTF-8&lr&q=related:bhRQZTZhbrNnoM:scholar.google.com/ Haidar, J. I. (2011). Currency valuation and purchasing power parity. World Economics, 12(3), 1-12. Jain, A. (2013). Forex Risk Management: Ways for Succeeding in Turbulent Economic Times. International journal of Emerging Research in Management & Technology, 1(1), 26-30. Lafrance, R. & Schembri, L. (2002). Purchasing-Power Parity: Definition, Measurement, and Interpretation. Bank of Canada Review, 1-7. Lander, K., & Preece, R. (2014, April 6). Finance briefing: Foreign exchange market and why it matters. Financial Times. Retrieved from https://www.ft.com/content/a3b9e74c-ba6f-11e3-aeb0-00144feabdc0 Papaioannou, M. (2006). Exchange Rate Risk Measurement and Management: Issues and Approaches for Firms.International Monetary Fund. Yeaple, S. R. (2003). The complex integration strategies of multinationals and cross country dependencies in the structure of foreign direct investment. Journal of International Economics, 60(2), 293-314. Read More