International Finance Strategies and Competitive

Question: Discuss about the International Finance for Strategies and Competitive. Answer: Introduction: In the given case, Pomo Ltd expects to receive payment of S$800000.00 in one-year time. The one-year forward rate is $0.76. The forward contract hedge is calculated by multiplying the forward rates with the currency receivable. Calculation of Forward Contract hedge Particulars Amount Payment receivable (Singapore $) $ 800,000.00 Forward Rate $ 0.76 Forward contract hedge $ 608,000.00 Table 1: Forward Contract hedge (Source: Created by Author) Money market Hedge The money market hedge is a three-step process. The first step is that the company will take a loan from a bank in Singapore at the interest rate of 7% per annum. The maximum amount of loan that the US Company can borrow from a bank in Singapore is S$747664. The calculations are given below: Calculation of Maximum loan amount (Singapore dollar) Particulars Amount Payment receivable $ 800,000.00 Interest rate 7% Maximum Loan Amount $ 747,664 Table 2: Maximum loan Amount (Source: created by Author) The second step is to convert the loan amount from Singapore currency to American currency at the spot rate of $0.74. The loan amount comes to $553271. The calculation is given below: Calculation showing conversion of loan to US dollar Particulars Amount Loan Amount $ 747,664 Spot Rate $ 0.74 Loan Amount in US dollar $ 553,271 Table 3: Conversion of Loan (Source: Created by Author) The third step is to deposit the amount in bank for earning interest at the rate of 9%. If the amount is remained invested in American bank for one year, the total amount received is $603605.00. Calculation of Amount Receivable at the end of one year Particulars Amount Deposited Amount $ 553,271 Interest rate 9% Interest Amount $ 49,794 Total Amount received $ 603,065 Table 4: Amount received (Source: created by Author) The customer in Singapore settles the loan amount at the end of one-year period. The total cash inflow from the money market hedge is $603065.00. The exercise price of put option is US$0.77 and the premium payable for put option is $0.04. The put option hedge is $584000.00. The calculation is give below: Calculation of Put Option Hedge Particulars Amount Payment receivable (Singapore amount) $ 800,000.00 Exercise price $ 0.77 Option premium $ 0.04 Net receivable (US) $ 0.73 Amount receivable (US) $ 584,000.00 Table 5: Put option hedge (Source: Created by Author) In foreign currency, transaction there is a risk of foreign exchange fluctuation that might cause loss. In such a situation, the company has two options either to undertake hedging or not to hedge the position (Bartram et al., 2013). If the company does not hedge its position then it will have to receive payment based on the future spot. The statement showing probability and the amount that is receivable to the company with no hedge position is given below: Amount receivable in no hedge position Probability Future Spot Rate Amount Receivable (Singapore) Amount Receivable (America) 20% 0.75 $ 800,000.00 $ 600,000.00 30% 0.77 $ 800,000.00 $ 616,000.00 50% 0.81 $ 800,000.00 $ 648,000.00 Table 6: Amount receivable no hedge position (Source: Created by Author) The above table shows that there is huge fluctuation in receivable. In order to reduce the risk it is important to hedge the position. The optimal hedge is that which reduces the loss. The best hedging strategy is selected based on the cash flow received. The cash inflow in forward contract hedge is $608000.00, in money market hedge, the cash inflow is $603065.00 and in put option hedge, the cash inflow is $584000.00. As the inflow of cash in the forward contract hedge is maximum so this hedging strategy should be selected. Profit/ (Notional loss) on Hedge Particular Probability 20% Probability 50% Probability 30% Forward Contract Hedge $ 608,000.00 $ 608000 $ 608000 Amount Receivable (America) $ 600,000.00 $ 616,000.00 $ 648,000.00 Profit/(Notional loss) $ 8,000.00 $ (8,000.00) $ (40,000.00) Table 7: Profit/ (Notional loss) on Hedge (Source: Created by Author) The table shows that the there is a 20% probability that hedging will save the company $80000.00. There is a 50% probability that the amount received is $608000.00 so there is a notional loss of $8000.00. There is a 30% probability that the amount received is $648000.00 so there is a notional loss of $40000.00 if the company opts for hedging. The Multi National Companies as Pomo Limited does hedging in order to reduce or limit the losses arising from international transactions involving foreign exchange. The Multinational Corporations has operations in different countries but the currency of different countries does not move in the same trend at the same time. In order to mitigate this risk the MNC usually applies hedging strategies (Dong et al., 2014). The hedging strategies are used as an operational or financial risk management strategy. The success of hedging strategies can be assessed after determining the effect it has on the objective of mitigating risk and increasing the value of the shareholders (Kroencke et al., 2014). In the hypothesis developed by Modigliani and Miller in 1958, it was established that financial policies of the company does not have any impact on the value of the company. The theory also found that if the financial market is efficient then the hedging activity does not increase the value of the company. On the other hand, if some the hypotheses are relaxed then it is possible to show that the hedging increases the value of the firm. The companies risk management has developed many theories and one of them is optimal hedging theories (Stulz, 2013). The over hedging is a term used if a position is hedged to such an extent that it ceases to be profitable. On the basis of the above discussion it can be seen that as per the Modigliani and Miller Theorem hedging does not influence the value of the firm further and the over hedging defeats the very purpose of entering into the transaction. Therefore, it can be concluded that over hedging can negatively influence the financial position of the company so it should be avoided (Mancini et al., 2013). Reference Bartram, S. M., Burns, N., Helwege, J. (2013). 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