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Running head INTERNATIONAL FINANCE
INTERNATIONAL FINANCE
Ahmed Majed AL-Hrazin
200800293
Bader Marzouk AL-Balawi
200900163
Dr. Mohammad A. Magableh
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INTERNATIONAL FINANCE
International Finance
Introduction
Up-tech Technologies is a multinational computer and mobile phone developing
company. Up-tech Technologies has branches in over five countries in five continents. Up-tech
Technologies headquarters is in Amrock New York City in the United States of America. The
company was established in 2002 with the aim of providing innovative technologies for daily
and professional use. Up-tech Technologies has a global market capitalization of 35% of the
computers supplies. Through is brand of computers and mobile phones known as Up-tech, the
company reaches over 30% of the domestic computer users and 15% of companies using
computers. The main market for Up-tech Technologies products are the personal users of
computers and mobile phones and organizations that require special computing equipment.
Up-tech Technologies’ main products Up-tech computers and Up-tech mobile phones are
recognized as the preferred brands in the United States of America, China, South Africa, Canada,
Australia, United Kingdom, and Germany. The brands are known for their superior design in
aesthetic feel and functionality. Up-tech computers are known to be high performance computers
with the ability to perform advanced computing operations. The brands are known to be small
and slim offering unmatched portability attributes in the market. Up-tech mobile phones emerge
as high performance mobile phones that operate as smart phones. The devices have a long
battery life and quality music and pictures. The mobile phones are also known to have multiple
functionality including the ability to perform as Wi-Fi hot spot devices and are equipped with
modern technologies such as compatibility with android and open source platforms.
Up-tech Technologies Company intends to roll out the distribution of Up-tech computers
and Up-tech mobile phones in South Korea. South Korea has emerged as a formidable economic
country in Asia after the Korean War. The country, which hosts more than 50 million nationals,
has seen the rise of urbanization and the continuous acceptance of the western culture and
modern trends. South Korea has also emerged as an Asian technological hub. The South Korean
currency is the won. 1 United Stated dollar equals an average of 1,154 Korean won. The
exchange rate varies over time. South Korea has had a robust foreign trade and economic input
with respect to the export and import. The fact that South Korea is a member of Organization for
Economic Cooperation and Development that coordinates economic policies makes it a viable
market and stable partner with regard to policies and legal issues.
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The commerce of Up-tech computers and Up-tech mobile phones faces challenges
resulting from the fluctuation of the South Korean currency exchange rate against the dollar.
Being that Up-tech technologies has its headquarters and production plant in the United states
while the market will be in South Korea, the exchange rate has the potential of altering revenue
stream and profit margin of the company. The production process, which is the object of the cost
of production, is carried out in the United States. Continuous change in the exchange rate of the
currencies of these two countries poses a risk to the financial projections of the multinational.
This study assesses the effect of the variation in exchange rate in the financials of Up-tech
technologies from the export of its goods to South Korea.
Country Factors That Affect the Demand for the Product
South Korea is the ninth largest exporter of good and services in the world. The country
is also the fourth largest economy in Asia. Most of South Korea revenue comes from its exports
to other countries. Although the country has vast amount of manufacturing activities, the lack of
natural resources and sources for basic goods has put South Korea into a predominant importer
position. The balancing of the capital flow based on short term debts and foreign investment has
pose challenges to the country. South Korea is in a precarious situation in maintaining the
domestic economy that relies primarily in the foreign trade and the international economy
(Svensson, 2000). The country has instituted several foreign exchange controls that are aimed at
managing this situation. These controls primarily instituted to manage the fluctuation of the
currency will affect the export of mobile phones and computers to South Korea by Up-Tech
technologies.
South Korea has in the past instituted currency controls with the aim of curbing the shifts
in capital flows. The country had faced challenges that are linked to its short-term foreign debts
because of its nature as a major exporter. The actions are purposed to stabilize the currency. The
restrictions include the control of slap limits on the exchange banks and other financial
institutions. The restrictions are aimed at controlling currency forwards, cross currency swaps
and non-deliverable currency forwards. The rules infer that currency forwards and derivatives
will be at 50% of their equity capital with the foreign branches of the banks having a cap of
250% of the equity to account for their lower capital (Svensson, 2000). South Korea intends to
control the capital flow through these rules.
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In addition to these laws, there are other regulations that have been imposed on the
exchanges. Other controls such as transaction taxes and transaction limits exist in the economy.
South Korea has employed caps to allow the volumes of foreign currencies to be sold or
purchased of various assets. The country sets transaction taxes such as the Tobin tax and imposes
minimum stay requirements. Other regulations that will affects the operation of Up-Tech
technologies in South Korea include the required mandatory approval of the exchange and the
limits on the amount of money allowed to be removed from South Korea in facilitating its
operation.
South Korea has identified the importance of the adjustment of the financial sector and
policies that affirm the capital control measures. Low inflation and stable inflation are internal
factors that are essential in balancing the value of the currency. Foreign trade lengthens the
horizon of the South Korean economy (Roubini, 2000). In as much as the foreign trade
facilitated by the currency exchange plays this role with respect to inflation control, the need for
evaluation and management of short-term debt and capital flow is central. Equilibrium between
the foreign trade and the need for capital flow management implies on South Korea to establish
need based policies and control. South Korea finds it important for the stability of the won.
However, issues such as political and environmental factors have managed to intrigue volatility
incurring risks.
Foreign Exchange Market
The won is a freely floating currency. South Korea trade with the international
community does not allow the country to manage the floating of the currency. Management of
the currency would result to the creation of an artificial economic environment for trade between
the partnering country and South Korea. The floating rates automatically adjust in response to
the economic environment. This facilitates South Korea to dampen the impact of shocks and
foreign business cycle (Goldfajn, and Werlang, 2000). Considering the extent of trade through
which the country conducts with the international community, it is essential that the possibility
of having balance payment crises be pre-empted. The Asian currency crisis discouraged most of
the Asian countries including South Korea from keeping a managed exchange rate.
The graph below illustrates the performance of the won against the dollar for the year
beginning October 2011 to October 2012.
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The trend of the graph illustrates a fluctuating currency. The value of the won against a
dollar oscillates between 1180 and 1080 won for every dollar. A variation of up to 100 won is
exhibited from the trend. The general trend of the performance of the won shows an increasing
value of the won since 2011 to late 2012.
The graph below illustrates the trend of the performance of the won against the dollar for
the past three months (quarter)
The data shows the performance of the won against the dollar for the months of August,
September, and October with part of November included for the year 2012. The statistical line
illustrates a general increase in value of the won over the dollar for the period of analysis. The
won exchanged against the dollar at a rate of between 1139 won and 1080 won for a dollar for
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the period analyzed. The won fluctuated significantly within the quarter showing an unstable
exchange rate. This poses high risk emerging from the high levels of uncertainty.
The table below illustrates the annual average value of the won against the dollar for the
period between 2000 and 2012.
The general trend of the won over the period of analysis indicates a strengthening
currency against the dollar. It is important to note the variation from the general trend between
the years 2008 and 2010. The weakening of the won is imminent. It is during this period that
there was a global financial crisis. From the event, it is inferable that South Korea heavily relies
on international trade.
The table below shows the forecast of the currency up to April 2013
Month
Date
Forecast Value
0
Oct 2012
1
50%
80%
accuracy
accuracy
1,107.4
0
0
Nov 2012
1,109
14
31
2
Dec 2012
1,122
18
41
3
Jan 2013
1,140
21
47
4
Feb 2013
1,161
23
52
5
Mar 2013
1,142
25
57
6
Apr 2013
1,126
27
61
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The forecast value depicts an improving currency. The won is projected to gain over the
dollar. However, the trend will fluctuate as the currency gains and losses. The forecast are based
on the indicated errors.
Exchange Market Derivatives
Foreign exchange exposes multinationals to three main types of exposures, which are
transaction exposure, economic exposure, and translation exposure. Transactional exposure
occurs when contractual cash flows of the company are subjected to uncertainty. The
unanticipated changes emerging from the foreign currency exchange poses risk to the companies
involved in foreign trade. The companies may not realize the domestic value of the money.
Translational exposure defines the extent to which reporting of the financial is affected by the
variation in the value of currencies international. The position of multinationals in relation to the
competitors is affected by the exposure (Labuszewski, 2012). Economic exposure reflects to a
firm exposure based on the operations. The exposure defines the degree at which the market
value of a company is influenced by the unpredicted exchange fluctuations.
The South Korean market through the analysis has shown that it is efficient. Like other
efficient markets characterized by purchasing power parity, interest rate parity and the
international fisher effect, there is need for hedging against foreign exchange risk. Up-Tech
Technologies like other multinational companies intends to employing hedging strategies to
reduce the risks associated with the exchange rate. The transaction exposure of Up-Tech
Technologies will be managed using foreign exchange derivatives such as forward contracts,
futures contracts, option, and swaps. Up-Tech Technologies also considers operational
techniques such as currency invoicing, leading, and lagging of the receipts and payment and
other measures such as exposure netting (Roubini, 2000). The realization that South Korean
currency the won has registered historical fluctuations necessitates the adoption of the strategies
to hedge the company from the posed risk.
Currency swap describes a foreign exchange agreement between two parties that are in a
mutual understanding to do business but operate in different currency jurisdictions (Svensson,
2000). The agreement involves accepting to exchange aspects such as principle and interest of a
loan for the equivalent of one currency on the net present value of another currency. This
agreement requires a comparative advantage between the two involved parties (Fischer, 2001).
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This process will facilitate secure cheap debt and hedge against the exchange rate fluctuations.
Being that the United States dollar is a world recognized standard of measurement, Up-Tech
Technologies has the advantage of easily finding a company in South Korea that requires loan in
United States dollars.
Forward exchange rate involves Up-Tech Technologies agreeing with a bank to exchange
the currency for future transaction in the projected future exchange rate when it will enter in
contract to operate in South Korea. In this case, the risk of fluctuation is reduced because of the
preempted value of the currency at the time it will be effectively required. The spot exchange
rate and the difference in the interest rates between South Korea and the United States of
America influence the parity relationship between Up-Tech Technologies and the other involved
party. Through this arrangement, an economic equilibrium in the foreign exchange market is
conceived for the elimination of the arbitrage opportunities (Labuszewski, 2012). Through the
technique, the future spot rate is determined.
The other derivative is the foreign exchange option. The foreign exchange option or the
FX Option is an instrument that is usually employed by multinationals to reduce the exchange
rate risks. The strategy involves the owner in this case Up-Tech Technologies having the right
but not the obligation to exchange the money denomination in one currency to another currency
based on a rate that was earlier agreed on a date. In this case, Up-Tech Technologies would have
the right but not the obligation to change the United States of America dollars into South Korean
won based on an agreed fixed rate. The market for FX option has the advantage of being the
deepest, largest and the most liquid. The trading in this market is mostly over the counter but
under high regulations.
FX option hedging is primarily used in the event uncertain future cash flow in a foreign
currency is expected. Certain cash flows are hedged using forward. Up-Tech technology is
expecting to receive a cash flow of U.S. $ 10 million from its business in South Korea after 30
days if the current spot rate does not change. Being that the exchange rate is expected to
depreciate; an FX option is the appropriate hedging strategy to be employed. In the event UpTech Technology does not hedge the expected cash flow, on the 30th day of payment, the
company will receive less than US$10 million because of the depreciation. By using FX options,
the expected cash flow will be fixed at its current exchange rate securing the cash flow from
depreciation. Up-Tech Technology expected to pay for supplies in foreign currency equivalent to
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U.S. $ 2 million from its business that foreign country after 30 days. However, the foreign
exchange rate is expected to appreciate. To hedge these funds forwarding the exchange is
advised. Through this strategy, the payment of the supplies will be made at the same amount of
U.S. $ 2 million at an increased value won value than the current value. The spot rate is
0.0009221.
The table above shows the futures option for the South Korean won against the united
stated dollar
futures/ options
Discount
Dec 2012
0.0009221
0.00000010
Jan 2013
0.0009210
-0.00000100
Feb 2013
0.0009195
-0.00000250
Mar 2013
0.0009183
-0.00000370
Apr 2013
0.0009171
-0.00000490
May 2013
0.0009159
-0.00000610
Jun 2013
0.0009146
-0.00000740
Jul 2013
0.0009136
-0.00000840
Aug 2013
0.0009125
-0.00000950
Month
price
The equation Futures = Spot Rate x 1 + [Rterm x (d/360)] is used to derive the discount
rate of the won against the dollar as illustrated in the table above (Labuszewski, 2012).
Summary and conclusion
South Korea is a robust target market for Up-Tech technology investment. An analysis of
the fiscal environment of the country indicates that South Korea has the potential to grow UpTech technology products and enhance the expansion. South Korea involvement in the
international trade is encouraging for foreign investment. The correlation between the South
Korea currency and the global economy indicate an economy that is consistent with the market
trend. Moreover, the population of Seoul and other parts main cities is continuously growing.
However, the venture needs to assess other risks specifically foreign exchange risk.
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The impact associated with risk is established to be high. There is need for the situation
to be managed through hedging. The appropriate hedging strategy and the derivative that works
well for the situation is determined by the nature of the foreign exchange and the projected
charge in the rate. Up-Tech technology should consider these factors as it proceeds to mitigate
the available risks. The assessment recommends that Up-Tech technology company to proceed
with investment in South Korea. However, there is need for management of exchange rate risks
emerging from the possible fluctuation of the exchange rates. The report recommends
appropriate hedging strategies for specified economic situations depending on projected
depreciation or appreciation of the United States Dollar against the South Korean won.
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Reference
Fischer, S., (2001) Exchange Rate Regimes: Is the Bipolar View Correct? Journal of Economic
Perspectives, 15 (2) pp. 3–24.
Goldfajn, I., and Werlang, S. (2000) The Pass-Through from Depreciation to Inflation: A Panel
Study, Working Paper No. 423, Department of Economics, PUC-Rio.
Labuszewski , J.W. (2012) Managing Currency Risks
with Futures, CME group
[online]accessed form http://www.cmegroup.com/trading/fx/files/FX-261_FX-ManagingCurrency-Risks-with-Futures.pdf on 30 Nov. 12
Roubini,
N.,
(2000)
website
on
global
macroeconomics
[online]
accessed
from
http://www.stern.nyu.edu/globalmacro/ on 30 Nov. 12
Svensson, L., (2000) Open-Economy Inflation Targeting, Journal of International Economics,
50, 155–183.