MNC in Mexico
When a company reach a level where a significant portion of its revenues are gained from international operations, the company generally experience quite a notable change in the way it manages its internal and external operations. Internally, management is demanded to have a higher level of professionalism and display an even more efficient managerial operations; human resources must be better managed to deal with the expanding and more diverse workforce, etc. Externally, the company is demanded to have an international-level customer service quality, quicker and more dependable solutions to customers’ problems, wide partnership network and good relationship with authorities.
In this paper, I am discussing a portion of the challenges that must be faced by a multinational companies and how it will affect the company in its operations. In order to provide more practical discussions, I will use a Mexican MNC as an example of how these problems affects MNC’s in relation to its surrounding business environment.
II. Description of Product
The product I choose is banking services. We assume to have lots of branch offices and accounts for 20% asset of the Mexican Banking System. Our bank has extensive financial services commonly provided by private banks.
Moreover, we see a considerable increase in its banking industries, especially in the private credit sector. Nevertheless, because Mexican businessmen are inexperienced debtors, the personal credit sector soon brought the Mexican companies into another episode of financial crisis. This situation leads our company to experience merger and acquisition with other financial institution to strengthen our presence.
It must be noted that the merger with other companies lead to great opportunity to expand its business internationally. The integration allows the offering of a broad range of financial services in Mexico and worldwide. However, internationalization also poses many challenges including foreign exchange risks, country risks and many others.
III. Foreign Exchange Risks
Because of the increasing amount of international transactions, our bank was entering a new realm of business and organizational management. One of the increasing difficulties that it has to face is regarding the foreign currency risks. Having customers in 100 countries worldwide, our bank will have to increase the effectiveness of its hedging program. There are various hedging strategies available for helping our bank managers its foreign currency risks, they include pricing, settlement, leading and lagging, and forward contracts, netting and reinvoicing.
Each of these strategies requires considerable portion of concerns from managers because all of them contains complications that requires considerations. For instance, pricing is considered the fundamental strategies of controlling risks. Exchange risk could be eliminated if the company bills customers in the currency of the company. If the company can negotiate a price for receivable in its own currency, the company will have shifted the exchange risks to another party (‘Managing’, 1990).
IV. Dealing with Currency Exchange Risks
As mentioned, the most common mean to fight exchange risks is an effective hedging program. Within the hedging strategies, there are several common terms, like the spot market, forward market, futures market and options market. In this paper I am elaborating the terms and how they functions within corporate hedging strategy.
IV.1. Spot Market
Spot is the term that represents the most practical type of transaction in international business. In the spot market, people buy and sell (trade) goods and services instantly. In other words, transactions are made on a cash basis and goods are delivered immediately. Unlike other types of transaction, a contract in the spot market is effective immediately after it was signed. The spot market is called the physical market or the cash market because of the characteristics. Trading in the spot market is called a spot trade, a condition where all transactions are settled on the spot. A trade is considered a spot trade if the time limit of the deliver of goods is no more than one month (‘Spot Market’, 2007).
Managers generally use the spot market if they believed that the trade will not be exposed to considerable risks. Managers will generally use the spot market unless there are specific conditions that require them to use other markets instead. Managers prefer to use the spot market and not any other market because the spot market use spot rice, which is safer and more reliable to prices in any other markets.
IV.2. Forward / Futures Market
In a forward contract on the other hand, transactions are made today with all of the specifications, but the delivery or the actual exchange of product and payment is postponed until a certain date on the future. In a forward contract, we use forward price, which is a price used in the future payment of the products, regardless of what the spot price at the time might be. Most forward contracts do not have definable standards and they most of them are not traded on exchanges. Forward trading can be used with a variety of purposes. There are people who are using the financial tool to manage risks and there are people who are using the financial tool to gain profit from existing risks.
Forward contract is a more complicated terms of trade than spot trade. Nevertheless, they are used widely across the international markets to manage foreign currency risks. The forward market is useful when we believe that our products or the product we would like to buy is exposed to significant currency risks. Fluctuating condition of foreign currencies often generate dangerous uncertainties for certain businesses. Using the forward contract, managers shift the currency risks to another party for a fee. On other words, forward contract is a tool to purchase certainty by a price. An example of a forward contract is if a farmer agrees to sell his grain to a foreign buyer in three months time for a specified price today. Whatever happens to the price of grain and the value of the national currency, the farmer will still gain the agreed price for selling the agreed amount of grain (‘Forward Contract, 2007).
IV.3. Option Market
The option market is another tool of managing risks in international transaction. It is more complicated than both spot trading and forward contracts. Options contract is a contract to buy the right to buy a certain amount of goods sometime in the future for a named price. When the time comes, the buyer of the options contract can choose between exercising his right to buy the products or not exercising his buying rights. Either way, the buyer is obligated to pay a certain amount of fee in exchange of the right to choose. Like the forward contract, options contract can also be used with a variety of intention. Speculators can gain millions of dollars by buying and selling currencies or goods in the options market (‘What is’, 2007).
The difference between options and forward contract is the fact that forward contract obligates buyers to perform the agreed trade when the time of the deal has arrived, while options buyer can choose whether to pursue the deal or cancel it. An option trading is performed when buyers can choose between buying or not buying the merchandise. On the other hand, there are also people who use the options contract to get the best price of the traded merchandise.
V. Factors Affecting Foreign Currencies
The value of a currency is important because it influences cross-border trade activities involving that particular currency. It is a common knowledge that the value of a currency changes with time and various other factors affecting the value. There are many analysis attempting to identify these factors and how they come in to play in determining the value of a currency. However, there is no single study or a single concept that has the ability to correctly predict the movement of a currency. In this chapter however, I will try to identify some factors that influences the movement of an exchange rate.
Within the fiat money system, we are relying on the market mechanism to shape the value of our currencies. This is better known as the floating exchange rate. In other words, the value of a currency is affected by the supply and demand for that particular currency in international market. In simple illustration, if the demand of currency A exceeds the supply, then the value of currency A will go up. On the contrary, if the supply of currency A exceeds the demands of currency A, then the value of currency A will diminish (‘Factors Influencing’, 2007).
Beside this basic mechanism of the fiat money system, there are other factors that come in to play, like interest rate. If interest rate in country A is higher compare to other countries, then international investors would prefer to invest in country A to other countries. As a result, there will be more demand of currency A. Given the condition where the supply of currency A is constant, the increasing demand of currency A will increase the value of currency A. In short, given any other influential factors constant, increasing interest rates will generally increase the value of currency also. On the other hand, if the interest rate in country A is lower than other nations, than investors would be less likely to invest in country A and resulted a decrease in demand. In the end this will lead to a decrease in the value of currency A. In short, lower interest rates generally refer to decreased currency values also (‘Factors Influencing’, 2007).
Inflation can also influence the movement of currencies in most countries. Perceived as a sign of unhealthy economic development, the higher the inflation rate gets, the less likely investors would invest in that particular economy. This is true because investors would think that the real value of the national currency will be eroded by the high inflation. On the other hand, lower inflation level generates the thought that the value of the currency will not be eroded by inflation, and therefore increases investor’s interest to the economy. In the end, this leads to higher demand of national currency and increase of currency value (‘Factors Influencing’, 2007).
Often, the value of national currency is also influenced by national balance of trade. Given other factors constant, if the price of a country’s exports is higher than its imports, the country will earn more for its exports compare to what the country spends through its imports. This generates the image that the country is economically strong which will invite international investors toward the country. This will lead to more demand of national currency and increased value of currency (‘Factors Influencing’, 2007).
VI. Changing Currency Policies
A multinational is exposed to currency risks when its transactions are paid using the national currencies of its international customers. In a financial report the currency risks are apparent in the receivable account where the multinational company must translate the receivables into national currency. However, if a currency fluctuation occurs before the payment of the receivable, then the amount of receivable will also change according to the national currency of customers. This poses as a significant risk that could lead to overstatement or understatement of the receivables.
On the other hand, if the company change its currency policies and requires that all transactions are denominated using the national currency of the company, then such a risk would not exist. In a case where exchange rate changes between the national currency and the currency of customers, then customers would be the parties that would be exposed to such changes and not the company who receive the payments. This means the company is able to reduce foreign currency exposure risks and transfer currency risks to its customers. However, in cases where significant changes is expected in exchange rate between the home country and customers’ country, customers generally asked for an agreement where the two companies will share the risks from the exchange rate exposure.
VII. Raising Capital for MNC
There are many ways to raise capital in managing the operations of a multinational company. Nevertheless, every method has its own advantages and risks. Analysts generally divide the source of capital into two, internal sources and external sources. Internal sources mean that company is using retained earnings or selling corporate assets or securities to generate the funding it needs in its operations. External sources mean that the company performs a financial deal with one or more external party to generate the need funding. External funding is the financial instrument that is more often discussed to internal funding because it represents significant influence toward corporate growth or survival.
There are two types of external funding instruments, debt instrument or equity instrument. Equity instrument requires management of a company to consolidate with investors in large decisions of the company. In other words, investors are given a portion of right to interfere in managing the company. Compare to debt instrument, equity instrument is considered more financially friendly. This is due to the non-existence of a fixed and timely payment required.
Debt instrument on the other hand, generates more financial burden because management would have to pay annual interests and there will be a time limit where all the borrowed funds must be paid. On the other hand, this type of funding instrument is also popular because it involves no agreement that debtors would interfere in corporate operations. Most multinational prefer debts instrument before they have no other choice but to engage in a partnership for equity financing opportunities.
VIII. Identifying Country Risks
Besides the risks in international markets, the company must also faced country-level risks, which is the risks that are generated by the economic, social and political conditions of the country we are investing in. Deteriorating economic conditions and political and social unrests could have adverse effect on the company’s business within a particular country. Country risks also include nationalization or expropriation of assets, exchange controls and currency depreciation or devaluation. Country risks that have been mentioned above have significant effect on bank’s international activities. Therefore, MNC’s like Our bank should take into account all the risk assessment considerations regarding all exposures to external issues (‘Country Risk’ 2001).
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