International Financial Management - Assignment Example

International Financial Management Name Institutional Affiliation International Financial Management Question 1 The agency theory implies the branch of financial economics, which addresses the conflict of interest that arises between the people of different interest, on the same group of assets. Most of these conflicts, as illustrated by Sun (2014), arises between the principal and the agents in a business, hence the name agency theory. The agency theory has an overall objective of resolving the conflict, which exists in the agency problem. That is, between the principals and the agents. Concerning the separation of ownership and control on the basis of Agency Theory, it implies the relationship that exists between the directors of a company, and the shareholders. In this case, the shareholders are the owners of the company, while the directors play the role of the controlling the company or the business. The shareholders handle the appointment of the directors. They also oversee their performance, by attending the annual general meetings. The directors are entrusted with the management of the company, and the shareholders are not supposed to interfere with the daily activities of the of the directors. Complex Issues Facing Multinational enterprises due to separation of power and control As illustrated by Sun (2014), the issue of separation of power and control in multinational business leads to the significant conflict of interest, between the shareholders and the directors. The major reason behind this conflict of interest arises when the directors act in a manner in which is against the best interest of the shareholders. For instance, the directors may not conduct the business in a manner that it will maximize the overall value of the company, which in turn boosts the value of the shareholders. Additionally, directors may undertake short term and high profitable investments while the shareholders prefer long-term investments. These bring the conflict of interest between the shareholders who are mostly based in the headquarters homework country, and the directors operating foreign branches. Another issue that may be arising due to this separation of power is the abuse of power by the directors. Since the Directors have all the powers in the management of the business, there is the high possibility of abuse of these powers. Therefore, the shareholders need to put the right mechanisms, to prevent this abuse of power. Further Potter, Allen, & Hemming (2013) suggested that in situations of labor and capital imperfections, directors may maximize their utility, at the expense of the shareholders. The reason is that directors, acting as agents of the company have the capacity and power to operate in their self interest, rather than to act in the best interest of the shareholders, their principles. To address these situations, the shareholders need to institute measures such as incurring the agency costs and management representations. Question 2 Foreign exchange market also referred to as the currency implies the decentralized market in which currencies are traded. Currency trade involves the exchange of the currency of one country with that of the other. The individuals or countries who participate in this market are referred to as the market participants (Nechita, 2015). They carry out the exchange of different countries, through the foreign exchange transactions. The participants in the market include the commercial companies, banks, hedge funds, central banks investors and forex brokers. As illustrated by Likhman (2014), the forex market is the world’s largest market. For the market to function effectively, each of these three stakeholders- the foreign exchange market, market participants, and foreign exchange transactions plays significant but different functions. The functions of these stakeholders are comprehensively analyzed below. Functions of the foreign exchange market There are three basic functions of the foreign exchange market. These are Transfer Function: It is the basic function of the for market, which involves facilitation of conversion of one currency to another. This conversion implies the transferring the purchasing power among different countries. There are several instruments, which are applied to this transfer, which includes credit instruments, foreign bills, and bank drafts. Credit function: Another function is facilitation of the international trade, through facilitation of the national and international credit. It is particularly applicable when the international payments are completed through foreign bills of exchange. Hedging Function: It is the third function of the forex market, which involving hedging against the forex risks. These risks result from the fluctuations of the foreign currency, in a free exchange market. The market provides hedging from liability, through forward exchange contracts. Functions of Foreign Exchange Market participants There are two categories of market participants. These are the wholesale market, also referred to as interbank market, and the retail or the clients market. The wholesale market trades in multiples of million dollars during the retail market trades in quite smaller amount. The interbank market plays a significant role in controlling the rate of exchange and the inflation rate. In addition, it plays the role of controlling the money supplied. The multinational companies play a significant role in carrying out the financial activities, seeking the exchange of the currencies, to exchange goods and services (Deviarti, Dewi & Sunaryo, 2014). The national central banks, who are the major players controls and sets limits for the interest rates, inflation rates, and currency supply. The Financial investment management firms, on their part, are involved in the large accounts management, such as pension funds and endowments. Brokers connect the small investors to the forex market. Functions of the market transactions The foreign exchange market transactions imply the agreement of exchange of one currency with another, at a specified date between the seller and the buyer. These transactions include the spot and forward transactions, and the sales and purchase transactions. These transactions facilitate the exchange of the foreign currency with another, at a spot rate. They also help to hedge for the future transactions of exchange of currency, between one currency and the other. Additionally, as noted by Guess (2013), they facilitate the business transactions for the forward foreign exchange, as well as the foreign currency option transactions. Question 3 The purchasing power parity (PPP), as illustrated by Agarwal (2009), is a theory which stipulates that if the purchasing power between countries is the same for two different countries, then the exchange rate between these two countries is in equilibrium. It implies that the price level ratio of the two countries fixed basket of goods and services is equal to their exchange rate. In case one of these countries experiences an increase in its price levels – the country experiences inflation, then the exchange rate of that particular country should depreciate, to remain in the purchasing power parity. The PPP is based on the ground of the law of one price. If there is no transportation and other transaction costs, the prices of a similar commodity when expressed in the same country will be the same, in two different countries. Carp (2015) illustrated that the theory assumes that the exporters and importers transactions are motivated by the differences in prices across countries. Additionally, the purchasing power parity one nation’s current account transactions have a significant effect on the exchange rate value in the foreign exchange market. In this theory, Adams-Kane, Jia & Lim (2015) suggests that there are two caveats in this theory. The first one is that there may be significant transaction costs and other trade barriers. The second is that in both countries, there ought to be competitive markets, for the goods and services. Thirdly, this theory is only applicable to the goods that can be traded. Goods that are immobile, such as the houses are not considered. Absolute PPP and Relative PPP There are two majors versions of purchasing power parity, as used by the economists. These are the absolute purchasing power parity and the relative purchasing power parity. Absolute purchasing power parity implies the price level equalization, across different countries. Relative purchasing power parity on another hand implies the price level exchange rates- the inflation rates. In this case, relative PPP implies that the currency appreciation rate is equal to inflation rate difference, between home and foreign countries. Additionally, there are many differences which exist between the absolute PPP and the relative PPP. These differences are discussed below. Differences between absolute and relative PPP The absolute purchasing power parity is similar to the Law of One Price. The Law of One Price concept means that, in different countries, the prices of similar goods should be the same, if they are expressed in the same currency. For instance, with consideration to a dollar/British pound exchange rate, the absolute purchasing power parity could be expressed as follows: The relative purchasing power parity indicates the inflation rate differences, between different countries. It relates to the changes in the expected inflation rates between two countries to their exchange rate changes. Therefore, it examines the price level relative changes between two different countries, and holds that in case of changes in these prices, the exchange rate will change, so as to equalize the differentials in the inflation. Question 4 1. OzzBank Cost of equity implies the required rate of return of the shareholders on the equity investments. Cost of Equity = Risk Free Rate + Beta Coefficient × (Market Rate of Return − Risk Free Rate) ra = rf + Ba (rm-rf) Beta Coefficient = = β =  Covariance of Market Return with Stock Return Variance of Market Return , =  Therefore Cost of Equity = 2.5 % + 1.2 (10.0 – 2.5) = 11.5% Cost of Debt = 6.5% Weighted Average Cost of Capital (WACC) WACC implies the minimum rate of return that should be accepted by the Happy Days (HDs), in order to compensate its investors. Where: Re = cost of equity Rd = cost of debt E = market value of the firm’s equity D = market value of the firm’s debt V = E + D E/V = percentage of financing that is equity D/V = percentage of financing that is debt Tc = corporate tax rate WACC = 58.0% * 11.5% + 42.0% * 6.5%* (1- 0.3) = 8.58% AustBank Cost of Equity = Risk Free Rate + Beta Coefficient × (Market Rate of Return − Risk Free Rate) ra = rf + Ba (rm-rf) Beta Coefficient = = β =  Covariance of Market Return with Stock Return Variance of Market Return , =  Therefore Cost of Equity = 2.5 % + 1.2 (13.0 – 2.5) = 15.1% Cost of debt = 6.8% Weighted Average Cost of Capital (WACC) Where: Re = cost of equity Rd = cost of debt E = market value of the firm’s equity D = market value of the firm’s debt V = E + D E/V = percentage of financing that is equity D/V = percentage of financing that is debt Tc = corporate tax rate WACC = 62.0% * 15.1% + 38.0% * 6.8%* (1- 0.3) = 11.17% Question 6 Interbank triangle arbitrage a) To find whether an opportunity exists, we calculate the cross exchange rate. Cross exchange rate = value of US dollars per pound sterling/ value of US dollars per euro = 0.67782/ 0.77495 = 0.874697 Since there is a difference between the actual exchange rate and the cross exchange rate, there is an opportunity for the triangular arbitrage in this market. The reason is that the sterling pond is underpriced than it should actually be in the market. b) If john takes the advantage of the existing profit opportunity, he would realize profit from his US$1 million. He should first of all convert his dollars into the sterling poun, then convert the pounds to euro and then euro in to the US dollars. It is shown in the calculations below. Convert dollars to pound 1000,000 * 0.77495= 774,950 Convert 774,950 Euros to pounds = 774,950*0.89283 = 691897 pounds Convert 691897 pounds to Dollars = 691897/ 0.67782 = 1020768 dollars Therefore, the profit gained by John from the above triangular arbitrage = 1020768 – 1000,000 = 20768 dollars. 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International Monetary and Financial Negotiations in Times of Crises: The G20 Pittsburgh Summit 2009. International Negotiation, 19(1), 154-188. doi:10.1163/15718069-12341273 Deviarti, H., Dewi, K., & Sunaryo. (2014). Review the Knowledge of Indonesian Management Accountant in International Financial Reporting Standard (IFRS) Compare with Malaysian. Procedia - Social And Behavioral Sciences, 109(2nd World Conference on Business, Economics and Management), 1164-1167. doi:10.1016/j.sbspro.2013.12.60 Likhman, V. A. (2014). MODERN ASPECTS OF INTERNATIONAL FINANCIAL MANAGEMENT. In The World Of Scientific Discoveries / V Mire Nauchnykh Otkrytiy, 57(9.1), 514. doi:10.12731/wsd-2014-9.1-12 Nechita, E. (2015). Managementul rezultatului şi calitatea raportării financiare: O analiza comparativă pre-post aplicare IFRS pentru societățile cotate la Bursa de Valori Bucureşti. (Romanian). Audit Financiar, 13(122), 10-84. Potter, B., Allen, R., & Hemming, R. (2013). The International Handbook of Public Financial Management. New York: Palgrave Macmillan. Sun, K. (2014). THE RELATIONSHIP BETWEEN CAPITAL ALLOCATION EFFICIENCY AND FINANCIAL REPORTING QUALITY: INTERNATIONAL VIDENCE. International Journal Of Business, Accounting, & Finance, 8(2), 1-11. Read More