Financial report on spot rates, arbitrage and international profits (2009)

Résumé du document

This report explains which currency is expected to appreciate and by what annual percentage and, according to Purchasing Power Parity, which country should have higher inflation. The assignment describes the accounts of balance of Payments and how this balance can help determine exchange rates. We also try to explain the difference between Transaction Exposure and Operating Exposure and the different methods that multinational firms use to bring back their profits from foreign countries. Extract: "According to Purchasing Power Parity, which country should have higher inflation? According to the Purchasing Power Parity, when there is more inflation in a country, its currency will go down. In our case, we want the Euro to go down in order to have parity. For example, if we assume that the exchange rate is $1/Euro and that US inflation is 2% and Europe inflation is 0%, we know that the $ is depreciated by 2%, which make an exchange rate of $1.02/Euro. In our case, the $ is expected to appreciate, so to have the Purchasing Power Parity, Europe should have higher inflation than the United States in one year."

Extraits

[...] McDonalds Malaysia will pay a higher price to McDonalds America for the food they need, and by this way, McDonalds USA will bring back a part of the profits from Malaysia. So by charging their subsidiaries in cost of goods sold, companies can bring back their profits from any foreign country. But they have to be careful to not charge too much, because it can become illegal. The second method can be in the operating expenses, both administrative and general. [...]

[...] Explain the difference between Transaction Exposure and Operating Exposure. Describe the four techniques discussed in class to reduce Operating Exposure. Finally briefly discuss Translation Exposure and how it differs from Transaction and Operation Exposure INTERNATIONAL PROFITS 9 Calculate the return to an American investor Calculate the return to a French investor who invests Calculate is return after converting all his money back into euro Describe the different methods that multinational firms use to bring back their profits from foreign countries. [...]

[...] We have the following exchange rate: Deutsche Bank: 1.15 HSBC: $ 1.25 Société Générale: $ 1.30 We start with $ and we make the following exchange: $ / $ 1.25 = (HSBC) 1.15 = (Deutsche Bank) $ 1.30 = $ (Société Générale) So at the end, we have $ In order to know the profit, we make the following calculation: Profit = $ - $ = $ We make a profit of $ Explain the differences between speculation and arbitrage In order to explain what the main differences between speculation and arbitrage are, and why arbitrage is often considered beneficial for society while speculation is sometimes not, we have to explain what arbitrage is and what speculation is exactly. First of all, arbitrage is generally the practice of buying and selling equivalent goods or currencies in different market to take advantage of a price difference. It means that it is the action of making some profit selling and buying things in different markets without taking any risk or making any investment as an arbitrage opportunity. Arbitrage is taking profit from momentary differences between different places from a market. Generally, arbitrage is involving many operations of buying and selling. [...]

[...] So the balance of payment can help to determine the exchange rate of two currencies (two countries). If one of the two countries has too many deficit in its global balance of payment, or if a country is not in good economic health with too many debt or trade balance deficit for example, its currency will be affected and will be depreciated. On another hand, a country with a strong and equilibrated balance of payment will have a stronger currency toward a country which doesn't have a balance of payment as strong. [...]

[...] Of course, it can bring much more profit than arbitrage, but it can also make very important looses. That is why arbitrage is often considered more beneficial for society than speculation: it is a way to make profits for society without the risk of losing money Exposures Calculate if you should go unhedged or use a forward market hedge We expect to receive in 6 months and we have the following information: Spot rate: 1.10 6 months forward rate: 1.05 interest rate: p.a interest rate: p.a If we believe that in 6 months, spot rate will be 1.15 we study these two possibilities: Go unhedged: 1.15 = Forward market hedge: 1.05 = With the forward market hedge, we will receive more = so if we believe that in 6 months, spot rate will be 1.15 we should go using forward market hedge. [...]