Module Name International Finance

Prepared by Sanif Sentosa Liong Medan, Indonesia

Module Facilitator Dr. Gerald Peries

15 October 2009

International Finance

Sanif Sentosa Liong

INTERNATIONAL FINANCE ASSIGNMENT Lotus Telecommunications is a multinational corporation that produces and distributes telecommunications technology. Although its corporate headquarters is located in Chicago, Illinois, Lotus usually must buy its raw materials in several different foreign countries, and several different foreign currencies. The matter is complicated even further by the fact that Lotus usually sells its products in other different foreign countries. One product in particular, the SY-20 radio transmitter draws its principal components Component X, Component Y, and Component Z from Germany, Mexico, and England, respectively. Specifically, Component X costs 84 euros, Component Y costs 650 Mexican pesos, and Component Z costs 105 British pounds. The largest market for the SY-20 is in Japan, where it sells for 38,000 Japanese yen. Naturally, Lotus is very concerned with economic conditions that could adversely affect dollar exchange rates. You will find the following table useful. Exchange rates of select major currencies, relative to the U.S. dollar Direct Indirect Quotations Quotations British pound Mexican peso Euro Japanese yen 1.6648 0.0952 1.1542 0.0085 0.6007 10.5080 0.8664 118.0400

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International Finance

Sanif Sentosa Liong

You are required to answer the following questions: a. How much, in dollars, does it cost for Lotus to produce the SY-20? What is the dollar sale price of the SY-20? SY-20 production cost: Comp. X: 84 Euros Comp. Y: 650 Pesos Comp. Z: 105 Pounds

Ans.

x 1.1542 x 0.0952 x 1.6648 Total

= = = =

US$ 96.9528 US$ 61.88 US$ 174.804 US$ 333.6368

Sales price: 38,000 yen x 0.0085 = US$ 323 b. Ans. What is the dollar profit or loss that Lotus makes on the sale of the SY-20? Selling price: $ 323, Production price: $ 333.6368 Loss: US$ 10.6368 If the U.S. dollar were to weaken by 10% against all foreign currencies, what would be the dollar profit or loss for the SY-20? 333.6368 + 10% x 333.6368 = Loss: US$ 44.00048 US$ 367.00048

c.

Ans.

d.

If the U.S. dollar were to weaken by 10% only against the Japanese yen and remained constant relative to all other foreign currencies, what would the dollar profit or loss for the SY-20? Selling price: 323 + 323 x 10% = US$ 355.3 Profit: 355.3 323 = US$ 32.3 Using appropriate examples discuss what you understand by Multinational Corporations and the reasons for their expansion into foreign countries. Multinational company is a company that operates in more than one countries, for example: The Coca-cola Company, Toshiba Corporation, Microsoft Inc., etc. The reasons for their expansion are: 1. Take advantages of the currency exchange rate differences. 2. Take advantages of the lower labor cost for production. 3. Market their products in high living cost countries for good price. 4. Broaden their market. 5. Seek for product differentiation opportunities.

Ans.

e.

Ans.

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International Finance

Sanif Sentosa Liong

f.

Discuss with appropriate examples any six major factors which distinguish multinational financial management from financial management as practiced by a purely domestic firm. o Currency differences Exchange rate difference is the most significant factor in the success of a company. Nowadays, almost all companies, whether domestic of multinational company, deal with more than one currencies, especially the local currency and USs Dollar. This is because USs Dollar is the most widely-recognized currency for the International market. For a domestic firm, dealing with currencies differences is quite simple. Any imported materials using foreign currency, just need to be converted into home currency, calculate the acquired price in home currency, and can be used directly for the production cost calculation. For example, a textile company, buying cloth materials from another country at US$ 10 per meter. Exchange rate to Indonesias Rupiah is 1:9000. Therefore, if the company sell the cloth for IDR 10.000 is still profitable. As for MNC, the case is quite complex, especially if it has multiple factories and sales office in different countries. When a currency weakened to USD for example, does not mean all other currencies will also weakened. Therefore, calculation of the conversion should be very precise and extra careful to prevent lost. o Economic and legal differences Every country has own unique economic and legal regulations, for example import tax for cars. Therefore, exporting cars to a country with high import car tax will cause the company not able to compete with the countrys local cars producers. One of the solutions is set up a factory and sales office in the target country to avoid the high import tax, provided the country regulations permitted that. As for legal matters, every country also has different legal systems. There are some countries without copyright regulations. Hence, software, music, and movie piracy are quite free and remain all the time in the country. For example, a music producer company should consider and has a very good copyright protection if it insisted to penetrate those countries market. o Language differences Language is also one of the main problems for an MNC. Any communication, whether written or not, should be in one agreed standard language, i.e. English. Before a domestic company can transformed into an MNC, it should plan very carefully and recruit those employees with English skills, spoken or written, to be able to communicate among employees around the world of the same company. Language differences are not only for communications matters, but also for product names. A product with a name in one country might not be appropriate in another country. Therefore, sometimes the product name should be changed slightly to be able to be accepted by the targeted countrys market.
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International Finance

Sanif Sentosa Liong

o Cultural differences Cultural differences might affect several aspects of a company. The first one is the characteristic of the employees. An MNC company operating in several countries with different cultures and social characteristics, might not be able to set fixed regulations. For example, a Myanmars company, where most of the men are wearing sarong in daily life, cant have the same regulation applied in its branch office in America. Second thing that affected by the cultural is the products. Product diversification are highly needed to suit and accepted by the local market, if a company would like to set up a branch in the country. o Government roles For example, the role of government in the U.S. is to create an environment that promotes free enterprise and competition. However, in many countries, the government takes a much more active role in business affairs, and even in some countries, an MNC must deal directly with the government to conduct business. o Political risk Nations exercise sovereign rights over their people and property. Thus, a government can seize the assets of a multinational corporation, or restrict the repatriation of earnings from the country, and the affected company has no recourse for recovery.

g.

What is exchange rate risk? And discuss any two ways that can be used to deal with this risk. Funds repatriated from foreign operations have to be converted into dollars, so foreign capital projects are subject to exchange rate risk. The volatility inherent in a floating exchange rate system increases the uncertainty of cash flows that must be translated from one currency into another. Companies can deal with exchange rate risk in the following ways: 1. They can influence the underlying source of the risk. Governments, for example, can reduce the rate of depreciation and the volatility of the exchange rate by keeping budget deficits small and inflation low. 2. They can hedge or diversify away the risk. Hedging exchange rate risks is possible in only a few developing countries. But most of the ultimate foreign shareholders of the project company - individuals with savings in mutual funds, pension plans, and life insurance - can diversify their savings, limiting their exposure to any one countrys exchange rate risk (as defined).

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