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International expansion-business - Essay Example

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The purpose of this paper is to prepare an analysis as to the short term and long term prospects of the currency of Mexico (The Peso) relative to the American dollar. The format that this paper will utilize is to first highlight what the risks of currency fluctuations would have…
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International Expansion-Business The purpose of this paper is to prepare an analysis as to the short term and long term prospects of the currency ofMexico (The Peso) relative to the American dollar. The format that this paper will utilize is to first highlight what the risks of currency fluctuations would have on an American enterprise entering Mexico, followed by a brief history of the history of the Mexican peso then an analysis will be conducted as to the prospects of this currency in the near to late future.
As it is the case that Natural Detergent, Inc is interested in expanding into the Mexican market, one must make consideration for investing in new facilities in Mexico.
There are two types of currency risk associated with investing in Mexico which are transaction risk and translation risk. In the case of transaction it is the case that if Natural Detergent inc, were to engage in a contract with a Mexican supplier than the company runs the risk that arises out of a time delay from the moment they sign the contract and the moment they execute the contract. In this regard if the Mexican peso were to rapidly appreciate against the American dollar than it would theoretically cost more money to settle the contract. In regards to a translation risk this is the risk associated with Natural Detergents inc. keeping some measure of wealth (Property, plant, equipment, cash reserves etc.) and if the value of this measure dominated by a foreign currency that was to rapidly appreciate against the American dollar than Natural Detergent inc. would recognize a loss. One could conclude that before any expansion project were to move forward than a firm understanding of the Mexican peso and its historical exchange rate to the American dollar would be of utmost importance to potential investors.
Historically speaking, Mexico has had a lot of commercial ties with the United States and the economy of Mexico was strongly affected by the strength (Or weakness) of the American economy. For these reasons according to Iowa State University Department of Economics (2010) Mexico had indeed pegged the Peso to the United States Dollar. What this translates to is that the country had determined what the exchange rate ought to be (typically between 9 and 13 peso’s per dollar) and this became the official exchange rate. During these times there was effectively very little risk to engaging in commerce with Mexico because the exchange rate was always known, and any changes that would be made to the exchange rate would not typically be too drastic. However it is the case that the inflation rates of the two countries varied vastly and as such the decision to ‘float the currency’ was made. This sets the stage for how the peso now floats against the dollar.
According to data compiled at Currate.com (2010) the value of the Mexican Peso has fluctuated between approximately 10-15.5 pesos to U.S.$1 over the last five years (See graph below)
However it would appear that the exchange rate seems to be relatively stable from 2005 until late 2009 before the rate shifted drastically. It has been argued by Jannsen (2009) it is likely that this massive fluctuation is owing to the initial impact of the U.S. credit crisis on the Mexican economy but it begs the question what effect would other crisis’s have on the Mexican Economy. After the decision to float the currency in 1994 the country also recognized a drastic fluctuation of the currency relative the U.S. dollar but one favorable distinction could be made which is that the country received a bailout from the Clinton administration to provide a fund to provide loans and credits to Mexico (US DOJ, 1995). As such one could conclude that Mexico has close alliances with other Latin American countries, America and Canada and is likely to have relatively easy access to credit which in the long term is likely to stabilize the currency. One could conclude that any wild fluctuations that the country encounters should only be temporary. What does the future hold for the Mexican peso? According to the Financial Forecast Center (2010), the peso is expected to appreciate from 12.8 pesos to U.S.$1, to 13.3 pesos to U.S.$1 by September 2010. However the long term forecast for the currency is difficult to predict.
However even with this risk there are certain strategies that could be employed to reduce currency exchange risk such as engaging in forward contracts, or conducting all business in American dollars.
References
Currate (2010) Exchange Rate for Mexican Peso Relative to the U.S. Dollar 2005-2010. [online] Available at http://currate.com/historical-exchange-rates.php Accessed on March 15th 2010.
Financial Forecast Center (2010) Mexican New Peso to US Dollar Currency Exchange Forecast. [online] Available at http://forecasts.org/peso.htm Accessed on March 15th 2010.
Iowa State University Department of Economics (2010) Balance of Payments. [online] Available at http://econ2.econ.iastate.edu/classes/econ355/choi/bal.htm Accessed on March 15th 2010.
Jannsen, N. (2009) National and International business Cycle Effects of Housing Crises. Kiel Working Paper. [online] Available at http://www.docstoc.com/docs/27913105/National-and-International-Business-Cycle-Effect-of-Housing-Crises Accessed on March 15th 2010.
United States Department of Justice (1995) Use of the Exchange Stabilization Fund to Provide Loans and Credits to Mexico. [online] Available at http://www.justice.gov/olc/esf2.htm Accessed on March 15th 2010. Read More
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