Decision Making Process Of Multinational Corporations Finance Essay - Free Essay Example

International financial management refers to the decision making process of Multinational corporations by aligning the stockholders right with the top managers. The multinational corporation are the global entities, should be properly managed and they must utilize the opportunities available to them. The major decision the firms have to cope up with is the volatile currencies and economic conditions of different countries and how to minimize the risk. As a student of finance we know where risk lies so as the opportunity. Currency rates primarily fluctuate because of constant changes in economic condition, political insatiability and changes in supply and demand conditions of foreign currency. The economic reason is due to the changes monetary policy, inflation rate and balance of payment. The political reason refers to the changes in government and the regime and the state policy of taxation, the other reason good is due to the restriction in a particular currency. The MNC has to make fundamental decision regard the currency fluctuations, these decision are forecasting the payables, receivables in foreign currency, the modes of financing in foreign currency, duration of finances, and investment decision in foreign currency. Investing in foreign countries and financing in the foreign currency have a definite impact on the revenues if the MNCs. The Multinational Corporation has to make certain decision to take advantage of foreign trades with facing minimal risk and high returns. Forecasting techniques: The multinational corporations use different forecasting techniques to take advantage of exchange rates, Technical forecasting Technical forecasting is the traditional way of forecasting the changes in the exchange rate of a currency; the exchange rates are predicted from the historical data. It only forecast near future rates it would not be reliable for long term finance. Fundamental forecasting; Fundamental forecasting is based on the macro economic variables and its relations to the exchange rates; the spot rate is affected by the different variables of economic. Increase in the inflation rate will affect in increase in general level of price which causes depreciation the currency, which certainly affects the foreign trade. The MNC has to forecast the changes in the condition of economic in both domestic and foreign country (Inflation). Variables like level of income, monetary policy, and the future rates must be forecasted correctly. Although the fundamental forecasting techniques has its limitations, such as inflation rate cannot be derived for a single period of time , and the regression analysis gives a set of different variables. Market based forecasting The market based forecasting is usually based on the spot and forward rate. Correct forecast of future spot certainly, an appreciation certainly benefits the MNCs earning the speculation of spot rates appreciation and depreciation and the correct measurement of forward rates will result in profits for MNCs. Mixed forecasting The combinations of different forecasting techniques certainly result in better prediction of the exchange rate. In mixed forecasting techniques different weights are assigned to the models and techniques with most weight is the most reliable. The weighting techniques of MNCs differ from each other. Foreign exchange risk and its Mitigation Foreign Exposure The foreign exposure is the measurement of a firms, profits, market value and cash flows changes due to the changes in the exchange rates. The cash flow and the market value of any MNC are the key elements of measuring the success of a firms success and failure. Foreign exchange is further sub divided, and these are Transaction Exposure Transaction exposure is the measure of changes in outstanding obligations which are before the changes in the exchange rate and its settlement must be after the exchange rate changes Operating exposure or Economic exposure The change in the exchange rates result in change of present value of future cash inflows is called operating exposure or economic exposure. The changes are due to unexpected changes in the exchange rate. Translation Exposure or accounting exposure The changes in the owners equity are due to translating the financial statement of foreign subsidiaries into consolidated financial statements for reporting in a single reporting currency. Tax Exposure The tax outcomes of foreign exchange risk differ by country; where as the losses of subsidiaries are deductable from consolidated income. Simply foreign losses are set off in domestic countries. Currency Hedging and its Advantages: Currency hedging is a technique to avail the opportunities presented by the fluctuations of exchange rate , by minimizing the risk Hedging works as protector of assets of an owner such as the future cash inflows from loss, however the appreciation of currency rate may not increase in capital gain of an asset hedged against. Multinational corporations mostly hedged their present value of future cash out flow, its vital for a firm to realize its standard deviation of its future net cash flows, so they can hedge the risk of currency. Immense growth in the international business and the globalization of worlds economy where as created many opportunities in trading among the nations has also faced an uncertainty in the exchange rate of foreign countries these uncertainty leads to fluctuating profits of the business. For effective growth the multinational corporations hedge the foreign exchange rate and interest rate for the better financial position of firm. Hedging provides many benefits to the firm, these advantages are discussed below. Hedging and short term techniques: There are different techniques used to cope up with the transaction exposure, these techniques are as below Future Hedge Future hedges are moistly used deal with the transaction exposure. Multinational firms that are involved in future contracts are entitled to receive an amount in a future date, the firm purchases a currency future contract and locks the amount in home currency the amount needed to make the payment, on the other hand the future contracts are also used for selling contracts, the corporations are entitled to sell a specified amount in a prescribed amount in a future date and time, the payment in which currency must be mentioned. The contracts are mostly made against the future receivables; the corporations lock the foreign exchange rate against the home currency. The spot rate is fixed and the payments and receivables are made according to it Forward hedge: The forward contracts are similar to the future contacts in some extent, the multinational corporations fixe the future exchange rate in order to get benefit from large transactions. The forward contracts are negotiations among the commercial bank and the multinational cop rotation for a specified currency , exchange rate and date to purchase the currency in future, forward hedge are done for a specified period against the know result through exchange rate speculations. The decision of hedging is based on the firms caliber of risk tolerance, firms with conservative approach may want to protect its share holders and hedge the exchange rate of foreign currency, the firms with aggressive approach may not hedge the forward contract in order to maximize their profits. Although hedging involves a cost, this cost is the cost of opportunity lost against the currency appreciation. Money market hedge Its a hedging technique against the future payables and receivables, the firms are more concern above the firms cash flows, if the firms have excessive cash it should in invest in short term deposit in foreign currency. The firm must maintain a reserve account in foreign currency to meet its short term obligations, it may use market hedge against its all payables. Where as in the case of receivable the firm borrows in the foreign currency and converts it into home currency in order to pay off the loan. Currency option hedge All the other three types of hedging have there limitations when the currency of the payables depreciate and currency of receivable appreciates over the hedge period , there are different techniques used in currency hedging these could be call options against the payables and the put options against the receivables Advantages of hedging: The main advantages of hedging are that it protects the investors in forex market, by reducing the chances of losses and creates opportunities in investing in foreign market. Its a good mechanism of minimizing the risk by using futures and options it benefits investors involved in long term trading. Its also used to fix the realized profits. Its a safeguard against the Market risk the firms survive against the period of recession The hedging of investment whether it be short term and long term investment protects the firm against the increase in prices of commodity, inflation, specially changes in exchange rate, and the interest rate. It protects the volatility of portfolio of investment by minimizing the risk and adjusting the currency fluctuation. Option trading opportunities maximizes the return of the Multinational corporation Successful hedging also protects the multinational corporations business risk such as operational risk, due to the nature of business. Successful hedging also protects Multinational Corporation from the financial risk, such as increase in the interest rate. Successful hedging also protects the firms being bankrupt Default risk is minimized Future contracts are traded in advance it gives the managers extra time to benefit from the decision. https://www.finweb.com/investing/currency-hedging-benefits-and-disadvantages.html https://blog.nobletrading.com/2009/03/advantages-and-disadvantages-of-hedging.html https://agecon.uwyo.edu/riskmgt/marketrisk/HedgingVsCashContract.pdf