Market-Making, Arbitrage, and Speculation - Assignment Example

Question and Answer Student’s Name: Institution Affiliation: Question and Answer Question 1. There are two types of quotes in the spot currency market, direct or indirect. Please respond to the following questions. (LO1&2, 6 marks) a. Which of these is typically used in United States? b. Which of these is typically used in Europe? c. Which of these is typically used in Australia? Various forms of quotes that are actively utilized in the international business community. The main types of quotes stated in the spot currency market are indirect or direct quotes. First, an indirect quotation considers the domestic currency as the base currency and the foreign money as the counter currency. On the other hand, the direct quote or price quotation is the reciprocal of the indirect quote. Ideally, currency quotations are essential in the foreign exchange markets since they express the amount and rate of exchange between the domestic and foreign currency. Most importantly, spot market is the commonly found in the MNEs environment. Moreover, the broader contexts of the international business management argue that foreign market exposure depends solely on the forward rates, cross rates, and spot rates (Peirson, Brown, Easton, & Howard, 2014). Additionally, direct quotes are commonly termed as the perspective of a British entity, while direct quotes are used in firms that use euro as their domestic currency. The literature of multinational corporate management relates to the optimal implementation of the corporate financial decisions that pertain to capital structure, dividend policy, investment, and working capital management (Peirson, Brown, Easton, & Howard, 2014). In other words, the applicability of any quotes is associated with the foreign exchange exposure, capital budgeting, political risks, and capital structure. However, different markets use dissimilar quotes depending on the other economic variables such as international policies. The following brief paragraphs examine the quotes used in U.S., Europe, and Australia. a. The United States of American uses the indirect quote in its international business management. For instance, the US dollar is used as the dominant current in the multinational foreign exchange markets. However, the American international trade has indicated the conventional use of direct quotes where the US dollar becomes the base currency, while other currencies such as Japanese yen, Indian rupee, and the Canadian dollar become the counter currency. b. Unlike the American foreign exchange market, the European MNEs use direct quotes. This means that the euro is used as the domestic currency or the base currency of determining the cost of the item being exchanged in the international market (Brown, 2017). Therefore, European MNEs typically uses the direct quote in the spot currency market despite the existence of numerous challenges. c. On the other hand, the Australian international market is presumed to handle its multinational trading through the spot currency direct quotation. However, this market underwent a rapid shift from indirect quote approach where it had experienced foremost operational challenges. Domestic and international investors in the Australian market welcomed the transition with remarkable changes in economic growth and improvement of the business environment (Diebold, 2015). However, the triangular arbitrage has been associated with this rapid shift of market quotations for the Australian dollar (Brown, 2017). Direct quotes have helped the international market stakeholders in evaluating the facts of market changes. However, there exist more complex issues and claims that Australia still uses both direct and indirect quotes in the spot currency market. This has been attributed to the rapid increase of spot rates in the MNEs and market competition. It is believed that pressures from the market mainframe and financial practices have led to the growth of a mutual market (Diebold, 2015). This has been linked to the fact that many nations tend to use direct quotes against the U.S dollar. In this case, Australia has a low exchange rate that has pressured the financial analyst and economists to impose the indirect quotation system (Moffett, Stonehill, & Eiteman, 2017). The magnitude of economic forces experienced in the Australian market is stronger than that of Europe and U.S. In addition, economists have argued that variations in the capital markets and foreign market exposure contribute primarily to the changes in the international business finance. Please critically discuss why Australia uses the type of spot quotes that it does relative to two other countries? The Australian international market dealers include banks and other capital players such as finance organizations that are licensed to sell and buy foreign currencies. For decades, the Reserve Bank of Australia had the licensing and management abilities until March 2002 when the Australian Securities and Investment Commission (ASIC) took over (Peirson, Brown, Easton, & Howard, 2014). On the other hand, the foreign-exchange brokers are intermediary companies between the market participants (Brown, 2017). This market has an exchange rate that is applicable for forward exchange contracts and spot transactions. Therefore, direct or indirect quotations control the Australian market. Question 2. Suppose the quote in Australia is USD 0.801. How much would AUD 250,000 cost in USD? Please provide a formula and all workings. The quote in Australia is USD 0.801, therefore a formula relating Australian dollar to US dollar is as follows: 1 AUD = 0.801USD Where AUD - represents Australian dollar USD – represents US dollar Thus AUD 250,000 cost in USD is calculated as follow; 1 USD = 0.801 AUD 250,000 USD ? 0.801 * 250,000/1 = AUD 200,250 Question 3. If the GBP quote is USD 1.2772-87 answer the following questions and please provide formulae and show all workings. If GBP is USD 1.2772-87 then the formula is as shown below 1 GBP = 1.2772-87 USD a) aIf you converted $20,000 to GBP and then back to USD, what would be its value in USD? Converting $20,000 to GBP 1 USD = 1.277287 GBP 20,000 USD ? 20,000 * 1.277287/1 = GBP 25,545.74 Converting GBP 25,545.74 to USD 1 USD = 1.2772-87 GBP ? 25,545.74 25,545.74 * 1/ 1.277287 = USD 20,000 b) If you are able to buy pounds at the bid rate and sell them at the ask rate, how many USD would you need to earn $1,750 on a round-trip transaction (buying GPD for USD and then selling the GPD for USD)? Pounds bid rate is equivalent to 1 USD = 1.277287 GBP ? 1 GBP 1 * 1/1.277287 = 0.7829094 USD Therefore; 1,750 USD will be equivalent to 1,750 * 1.277287/1 = 2,235.25 GBP Pound ask rate is equivalent to Converting 2,235 GBP to USD the rate used is the ask rate which is 1.227287 thus 1USD = 1.277287 USD 2,235.25 ? 2,235 * 1.277287/1 = 2,854.74 USD Therefore to earn $ 1,750 one would require 2,854.74 USD Question 4 Critically discuss in your own words, the functions and contribution to society of the foreign exchange market, market participants and transactions. The wellness of the global economy depends on the economic, political, and social policies that aim to study the different market variables and determinants (Musteen, Datta, & Butts, 2014). It is presumed that the international financial management holds the key answer to the drawbacks experienced in the market and economic realms. Specifically, the study of economics and business development are some of the major topics that influence the stability of financial management (Peirson, Brown, Easton, & Howard, 2014). Ideally, the arguments behind economic policing and financial firmness highlight several concepts and notions related to the international business management (Diebold, 2015). Therefore, there exist several theories and models through which multinational relations and corporate contexts are examined. It is argued that financial management in an international organization requires conceptual and practical evaluations of the financial management practices. However, the existence of these practices in the international business has influenced the mainstream society especially the market participants who depend on the decisions relating to the market wellness and products (Moffett, Stonehill, & Eiteman, 2017). Moreover, every foreign market idea aims at improving the business performance and optimize the nation’s potential to participate in the global communities (Musteen, Datta, & Butts, 2014). Therefore, one of the key functions of the foreign market literature is to ensure that the market participants and the society can collaborate and develop strong relations while minimizing the unnecessary costs. Nevertheless, MNEs in the international market exposure involves subsidiary types of foreign exposure namely transaction exposure, translation exposure, and economic exposure. Translation exposure refers to the risk that the firm’s liabilities, assets, income, or equities will face because of changes in the exchange rate. It is also known as accounting exposure since it deals with variables of business finance. Alternatively, transaction exposure refers to the risk experienced by firms participating in the international trade. This risk emerges from a change in exchange rate after the organization has already been involved into financial obligations (Brooks, Cuthbertson, & Mayes, 2017). Lastly, operating exposure is associated with the effects of unpredicted currency variations on the business’s future cash flow. This foreign exchange exposure is also known as an economic exposure since it has a significant impact on the firm’s market value (Diebold, 2015). The environment of the international economic management involves numerous stakeholders who participate in the current market competition (Peirson, Brown, Easton, & Howard, 2014). In many cases, analysing the academic literature of multinational business organization involves the flexibility of the applied financial management policies in the Multinational Enterprises (MNEs). However, the recent changes in the corporate environment have seen certain themes and models capture and dominate the global markets (Brooks, Cuthbertson, & Mayes, 2017). It is important to note that international economics help in the monitoring of the increased volatility in the financial and real asset prices that concern resource development and market growth. Every multinational enterprise operating across nations is subject to the international financial management theories and practices, which help mitigate the actual economic risks such as market instability (Ozturk, Joiner, & Cavusgil, 2015). MNEs must determine the appropriate control mechanisms and appraisals of the current financial risk management practices (Diebold, 2015). Further, the global business studies aim to provide a concise description of the international market segmentation, product differentiation, and financial market integration, especially in the capital market. The influence of globalization on the business community has been the driving force of the widespread changes in the MNEs. Consequently, the intervention of the global business through MNEs has benefitted the market with cheaper and affordable products (Musteen, Datta, & Butts, 2014). This stiff competition has led to more product differentiations thereby increasing the innovative abilities. On the other hand, consumers have been able to enjoy market and commodity flexibility since diversified products provide better products in the market. Moreover, foreign markets have prevented market dominance and torture of small enterprises. In this case, the ability of international foreign markets to lower the inflation rate in many nations has prevented the societal from facing the high costs of living. Additionally, another function of foreign markets is to attract Foreign Direct Investment (FDI) in the developing nations. This has been a significant contribution to the infrastructural upgrading and protection of the capital markets. Nations without foreign market regulation have a high risk of economic deterioration. Moreover, countries without strategic financial measures such as market regulations have seen societies demand for affordable cost of living. Further, transactions conducted in the international market are monitored thereby minimizing the rate of frauds. Indeed, market control is a paramount task in the economic wellbeing since it directly and indirectly improve the societal welfare. Finally, foreign markets protect the production of domestic firms that are unable to sell their products abroad. Moreover, it helps to reform the companies that may be bested by the international brands. Question 5 List and explain in detail two strategic motives why firms become multinationals and provide one motive why firms may not become multinationals and give an example of each motive The decision of a firm to transform to a multinational enterprise is associated with various relational factors and practices. In business literature, the argumentative notion of creating a multinational firm has persisted mainly because many institutions are willing to reach greater goals. To this end, a firm must meet a couple of requirements before deciding whether to become MNE including size, objectives, management, production, industry, and location. To begin with, firms in technology, automobile, and fashion industries have high opportunities of becoming MNEs. Additionally, MNEs requires the company to accommodate certain management theories and financial management practices (Kruesi, Kim, & Hemmington, 2017). In this case, regional managers are responsible for making strategic decisions that can fit in the enterprise without difficulties. The international business literature point two tactical motives that can make firms become multinationals, and one reason to why a potential firm may fail to become MNE. A firm may only become MNE if its goals, vision, and mission are set from an international perspective. Moreover, its products must reach the foreign markets such that the company operates under international business requirements. This only happens if the company is not planning to engage in political, economic, and social malpractices. In addition, an organization may become MNE if it generates authentic and reliable products that will improve the welfare of the people (Peirson, Brown, Easton, & Howard, 2014). Furthermore, companies involved in non-profit making activities can also become MNEs. These strategic motives act as the incentives of converting a company to a multinational enterprise. In addition, technological advancements and globalization have been essential aspects or purposes that can transform a firm to a multinational corporation. These scenarios have been viewed as powerful and developmental moves behind the creation of MNEs. Nevertheless, the conception of organizational growth in the comfortable business environment has highlighted the major risks and benefits of financial globalization (Bodie, 2013). On the other hand, some factors and motives such as industrialization and modernizations have participated in the expansion of company from a national company to transnational corporations. Other business practices that may lead to the creation to MNE include approved mergers and acquisitions. Nevertheless, there are particular reasons to why a firm may fail to become a MNE. Scholarly sources provide a cohesive outlook of the business variables and practices that can lead to such hindrances. Even though many nations provide critical financial reports and future expectations, becoming a transnational company is an argumentative discussion that requires scrutiny and analysis of its market conduct. For instance, a company that manufactures unlawful or disapproved products may have its MNE request declined. This reduction aims at protecting the social, economic, and political wellness by ensuring that the products in the market are credible for human consumption (Diebold, 2015). In this case, the global capital values in the growing corporation may have major differences with the financial globalization. Similarly, the economics conferences assert that it may be problematic to convert a company that is oriented on a single financial market. Foreign expansion and growth of a firm require remarkable investments in the resource and capital markets. In this case, small and medium firms with a minimum capital base are discouraged not to become MNEs. On the other hand, weak financial systems have market-based economic risks, shortage of funds, and small production abilities. Therefore, firms in such fragile financial environments have inabilities to cope with MNE activities such as massive economic systems. Therefore, the nature of a financial system is viewed as the strategic motive that can prevent a company from becoming an international enterprise. The cross-nation contrasts and individual monetary policies indicate that not all businesses have the potential to handle international economic pressures despite having a positive relation to the degree of economic development and magnitude of financial system variations (McKinnon & Ohno, 2016). It is advisable for every business to withstand and embrace the benefits of the finance-growth relationship. Robert Lucas (1988) argued that economists relate the economic power of a nation lies in its financial factors that influence economic growth. Lucas insisted that market instabilities and unstable foreign markets might prevent corporate development and optimization of a financial system. Nevertheless, other reasons that prevent a national firm to become MNE are the challenges faced in the currency markets. For instance, hedging and foreign exchange risks are known to lower the participation rate of many firms in the capital markets (Brown, 2017). Notably, the efficiency of financing decisions favor better allocation of resources thereby boosting the economic growth. Question 6 Critically discuss in your own words the theory of Purchasing Power Parity (PPP), noting the difference between absolute purchasing power parity, relative purchasing power parity. As part of your discussion state whether PPP is useful in practice and why, drawing on your understanding of the Big Mac Index The economic literature involves macroeconomic and microeconomic studies that examine the product and consumer markets. Arguably, these two categories are interdependent since they aim at lowering the cost of living, creating a stable Balance of Payment (BoP), control the capital budgeting, and optimizing the production capacities (Brooks, Cuthbertson, & Mayes, 2017). Moreover, the consumer market is the most complicated economic aspects since it includes utility functions, budget lines, and customers’ preferential curves. In many cases, several theories and models have been imposed to foresee the strategic decision making in the foreign exchange market (Kruesi, Kim, & Hemmington, 2017). Among them is the theory of Purchasing Power Parity (PPP), which states that the exchange rates between domestic and foreign currencies are in equilibrium if the purchasing power is similar in the two respective nation (Taylor, 2013). In addition, PPP in the advanced macroeconomics involves nominal GDP in monetary value and real GDP that is adjusted using relative PPP (Taylor, 2013). This adjustment seeks to convert nominal GDP into a simplified comparison between states with different currencies. Therefore, PPP in GDP provides a collective outlook of the foreign markets. Moreover, PPP theory originates from the law of one price that is used to understand the economic meaning of basket of goods being traded between two currencies. The PPP finds the exchange rate of a product in between currency 1 and currency 2. In other words, it makes a comparison of prices across nations while examining the trends in the foreign market rates. If the domestic product price increases due to factors such as inflation, that nation’s exchange rate must devalue to maintain the PPP (Taylor, 2013). It is presumed that in the absence transaction costs and transportation expenditures, competitive markets equalize the prices of an identical basket of goods being traded between nations when their prices are converted to the same currency. However, PPP is divided into two broad categories; relative purchasing power parity, and the absolute purchasing power parity (Majumder, Ray, & Santra, 2015). The absolute PPP is the equalization of prices across nations, and it is the beginner's guide to PPP theory (Ozturk, Joiner, & Cavusgil, 2015). It states that a consumption bundle or a basket of goods in the United States should retail the same in Canada if the exchange rate is taken into account. On the other hand, relative PPP is the dynamic description of the absolute PPP theory (Moffett, Stonehill, & Eiteman, 2017). Therefore, relative PPP is a theory that foretells the relationship between the movements in exchange rates and inflation rates of two currencies over a specified time. This concept has seen the derivation of new international financial practices of analysing the forex markets (Brooks, Cuthbertson, & Mayes, 2017). As such, the international monetary systems and forex markets have demonstrated the ultimate significance of involving PPP approaches in defining the currency exchange (Majumder, Ray, & Santra, 2015). Nevertheless, these aspects have shown the broader picture of spot market strategies such as hedging and risk analysis (McKinnon & Ohno, 2016). These have formed the foundation of a comprehensive evaluation of the business market strategies and decision-making. However, the above fundamental differences between these two forms of PPP prove that large disparities in the product prices between the nations are unsustainable since they create arbitrage opportunities for moving goods across borders (Brooks, Cuthbertson, & Mayes, 2017). Consequently, the significance of the purchasing power parity is understood from the perspective of Gross Domestic Product (GDP) per capita. In this case, PPP is used to contrast the substantial differences between the economic productivity of nations (McKinnon & Ohno, 2016). It accounts for dependent and independent variables such as inflation and relative costs. In addition, PPP help economists calculate the possible foreign market trends while evaluating the PPP exchange rate (Taylor, 2013). This is determined by the Big Mac Index that is conducted by The Economist to measure the PPP or the impression of undervaluation or overvaluation of currency across nations using the Big Mac price as the benchmark (Majumder, Ray, & Santra, 2015). Moreover, Big Mac index proposes that variations in the exchange rates among currencies affect the cost that customers pay for a Big Mac in an individual nation replacing the consumption bundle. Therefore, Big Mac Index is useful in calculating and understanding the differences in foreign market currencies and the significance of PPP in the international market. Moreover, the indices depicted help evaluate the possible changes in the exchange rate in case of domestic currency appreciation or depreciation. References Bodie, Z. (2013). Investments. McGraw-Hill. Brown, B. (2017). The forward market in foreign exchange: a study in market-making, arbitrage, and speculation. Routledge. Brooks, S., Cuthbertson, K., & Mayes, D. G. (2017). The exchange rate environment. Routledge. Diebold, F. X. (2015). Forecasting in economics, business, finance and beyond. University of Pennsylvania, USA. Kruesi, M., Kim, P. B., & Hemmington, N. (2017). Evaluating foreign market entry mode theories from a hotel industry perspective. International Journal of Hospitality Management, 62, 88-100. Majumder, A., Ray, R., & Santra, S. (2015). Preferences, purchasing power parity, and inequality: analytical framework, propositions, and empirical evidence. McKinnon, R. I., & Ohno, K. (2016). 7 Purchasing power parity as a monetary. The Future of the International Monetary System: Change, Coordination of Instability?: Change, Coordination of Instability?, 42. Musteen, M., Datta, D. K., & Butts, M. M. (2014). Do international networks and foreign market knowledge facilitate SME internationalization? Evidence from the Czech Republic. Entrepreneurship Theory and Practice, 38(4), 749-774. Moffett, M. H., Stonehill, A. I., & Eiteman, D. K. (2017). Fundamentals of multinational finance. Pearson. Ozturk, A., Joiner, E., & Cavusgil, S. T. (2015). Delineating foreign market potential: A tool for international market selection. Thunderbird International Business Review, 57(2), 119-141. Peirson, G., Brown, R., Easton, S., & Howard, P. (2014). Business finance. McGraw-Hill Education Australia. Taylor, M. P. (2013). Purchasing power parity and real exchange rates. Routledge. Read More