I need a 100 word reply to each of the following 8 forum post (800 words total). They are from a finance class.
There are some risks involved with international transactions due to fluctuations of the foreign currency exchange rates. One way to mitigate those risks is through hedging.
Discuss the hedging options: forward contracts and option contracts.
What are the advantages and disadvantages of each alternative? Options allow companies the opportunity to profit from favorable exchange rate changes, currency options a flexible “optional “hedge against exchange exposure. The options hedge gives an organization the ability to limit loss risk while cradling the upside potential. Forwards only allow an organization to lock in an amount with no upside profit potential.
What are the costs of each alternative? Costs is the one big negative, basically the organization has to pay for the flexibility of being able to get upside possibility in the form of a premium; in contrast there is not an upfront cost when hedging with forwards.
When is one alternative preferred over the other? If an organization is content with just being assured of receiving a certain dollar amount and avoid foreign exchange uncertainties, I would advise just using a plain vanilla forward market hedge. If a firm is looking to capitalize on the foreign exchange market and has some reason to believe that the change could benefit i.e. offsetting the premium and added upside gain potential I would advise utilizing the options market hedge.
Eun, C.S. & Resnick, B.G. (2015). “International financial management” New York: McGraw-Hill/Irwin
International transactions can be heavily influenced by changes in exchange rates between two countries. In the mining equipment business we deal with manufacturing in Japan, Brazil, China, Germany, and several others. The machines’ costs generally go up a couple of points a year in pure labor and materials, but the wild card is always what is going on with the exchange rates when it comes to total costs. A $1M machine today can be $1.3M or $700K next year, depending on the exchange rate. MNCs use hedging to manage the risk of these large swings, especially when the delivery (and payment) date is several months in the future.
A forward market hedge is when the buyer places an order with a payable sometime in the future and then buys the forward exchange rate of that currency at the same time. “Generally speaking, the firm may sell (buy) its foreign currency receivables (payables) forward to eliminate its exchange risk exposure.” (Eun & Resnick 2015) The main advantage of a forward market hedge is that the buyer can plan for exact costs and mitigates an exchange rate negative fluctuation (where money would be lost to the exchange). The main disadvantage is that any positive exchange fluctuation would not be gained. Also – if the positive fluctuation is sustained for a long period of time, the buyer would likely have overpaid for the product and in essence lost money.
An options market hedge eliminates the disadvantage of the forward market hedge by allowing the buyer to exercise the foreign exchange if the market improves or declines. This type of hedge can be thought of as insurance for the buyer to protect them on both sides of market fluctuations so they can eliminate risk of loss due to the exchange rate as well as profit from a favorable change in the market. “Generally speaking, the firm may buy a foreign currency call (put) option to hedge its foreign currency payables (receivables).” (Eun & Resnick 2015) The advantage of this type of hedge is obvious, but there is a cost to buy the option, which is the main disadvantage.
The costs of forward hedging can be zero if money is kept even or made and can be very expensive if a positive market increase isn’t capitalized on. The costs of an options hedge is the transactional costs of buying the option. If a company has no expertise with the foreign exchange markets and wants to manage the risk of loss and make profits if the market gains, then the options alternative is likely preferable. Large MNCs that deal in massive international transactions likely have a department, subsidiary or partner that deals with hedging. This is the case with Apple, who makes large step-changes in their market performance due to its management of hedge funds. “An extremely well-timed currency hedging regimen saved Apple Inc. about 70 cents a share – or $4.1 billion – in its earnings during fiscal year 2015.” (Adinolfi, 2015).
Eun, C. S., & Resnick, B. G. (2015). International financial management (7th ed.). New York: McGraw-Hill Irwin. ISBN: 9780077861605
Adinolfi, J. (2015). Apple Saved $4.1 Billion in Hedging Against a Rising Dollar. Retrieved from: http://www.marketwatch.com/story/apple-saved-41-billion-hedging-against-a-rising-dollar-says-stifel-2015-12-14
It is generally not possible to completely eliminate both translation exposure and transaction exposure. In some cases, the elimination of one exposure will also eliminate the other. In other cases, the elimination of one exposure actually creates the other.
“Translation exposure might be viewed as the most important to manage because it does not have an immediate direct effect on operating cash flows, its control is relatively unimportant in comparison to transaction exposure, which involves potential real cash flow losses. Since it is, generally, not possible to eliminate both translation and transaction exposure, it is more logical to effectively manage transaction exposure, even at the expense of translation exposure”. Eun, C.S. & Resnick, B.G. (2015).
What are the advantages and disadvantages of the common methods for controlling translation exposure?
Balance Sheet Hedge: from my understanding this hedge attempts to control assets and liabilities of the same currency denomination in order to keep them even on the balance sheet. This is easy if the company is only using one currency but becomes more involved for the multinational that is buying and selling in different currencies.
Derivatives Hedge: this is speculation, when attempting to control translation exposure this way it simply involves speculating in regards to foreign exchange rates and very risky.
Eun, C.S. & Resnick, B.G. (2015). “International financial management” New York: McGraw-Hill/Irwin
Translation exposure is described as the risk a company has in relation to the value of their assets, equities and liabilities as a result of the change in exchange rates. A chance in exchange rates will impact the value of the liabilities, equity and assets. This type of exposure is also known as accounting exposure and has medium to long term impact on the value of a business as it directly impacts the overall value of the business.
Transaction exposure is described as a cash risk that investors assume when they enter into a forward FX contract. These investors or firms have done their best to forecast the future exchange rate, but because of changing market conditions, their forecast could be incorrect and cause them to lose money in the transaction. A small error in forecasting could have a significant impact on their ROI. The impact of translation exposure has short to medium term impact and affects the cash on hand a company may have.
While it is both are important to consider, Transaction exposure poses a greater risk and is important to manage more aggressively than translation exposure.
There are methods of controlling each type of risk, but firms have to be careful to balance the risk in each category as one could adversely affect the other. Some common methods for controlling the risk are to focus on and manage transaction exposure more aggressively as it can have a significant impact on the cash flow of a business. Another method is to employ a balance sheet hedge that would, in essence equalize the risk between exposed assets and exposed liabilities in a common currency and create a zero sum net exposure. When this method is used, the change in exchange rates of a given currency would affect the value of the assets and offset the change in the firm’s liabilities.
Transaction and translation exposure are important elements that can affect the overall value and cash flow of a business. Both need to be managed aggressively, but particular attention needs to be paid when considering transaction exposure.
Contrast the structure and function of investment banks, mutual funds, hedge funds, pension funds and insurance companies. Support your discussion with examples from scholarly sources other than the course text, such as reputable news organizations, recognized trade groups, government sources, and the Ashford Online Library. Sources such as Investopedia and Wikipedia will not be accepted.
The one thing that brings all of this institution together is that they deal with the investment of money with the into to watch money grow. Even with an insurance company money is allocated with an understand of if something goes wrong one would always be cover for a small flat rate in case a major payout is needed. By first glance the one thing that all of this funds have together is that every institution separately pools everybody money in order to make investment. An investment bank is meant to help people and business gather the funds and grow their business or personal stances. When it comes to hedge fund there are private equity investment company that pools money for individual and companies, in comparison to mutual funds, “Now for the simple explanation: Mutual funds can be considered baskets of investments. Each basket holds dozens or hundreds of security types, such as stocks or bonds. Therefore, when an investor buys a mutual fund, they are buying a basket of investment securities. However, it is also important to understand that the investor does not actually own the underlying securities–the holdings–but rather a representation of those securities; investors own shares of the mutual fund, not shares of the holdings.” ( Thune, K. (2015, February 26). When it comes to pension they are constructed in a completely different manner. Pension funds are typically set up to secure ones’ retirement. It too is a pool of investment, which is set up through an employer in order to add equity to ones’ position at the company. The primary structure of an insurance company is to insurance people liability toward potential lost due to risk.
Thune, K. (2015, February 26). A Simple Explanation of Mutual Funds. Retrieved May 11, 2016, from http://mutualfunds.about.com/od/mutualfundbasics/a/What-Is-A-Mutual-Fund.htm
Investment banks are structured around securities, among other things, such as involvement in mergers and acquisitions. “An Investment Bank raises capital (money, in the form of debt and equity) for companies and advises them on financing and merger alternatives” (Duke University, 2011, p. 1). They are centered around helping companies with securities with advice and their issues. They will assist companies on making decisions regarding what type of securities to issue to raise funding for projects. If a company wants to open a new factory or a new line of products but needs capital to do so, it would go to an investment bank for advice on what type of capital to raise. The investment bank would also help find investors in the securities issued. In addition, if a company were looking to acquire another company an investment bank would aid them in finding the company and help with financing it as well.
A mutual fund is structured to provide an investor with a diversified portfolio of assets. It is a program that is professionally managed and funded by shareholders. Assets in a mutual fund can include bonds, stocks, money market securities, etc. “[I]nvestors seek out either the best manager for their funds, or an incentive contract to obtain the best possible performance” (Mamaysky & Spiegel, 2002, p. 3). These financial intermediaries allow investors to buy a portion of assets without individually purchasing each one, reducing their risk through diversification of the assets provided. There are several types of mutual funds including open-end funds, closed-end funds, ETFs, no-load funds, and money market mutual funds. (I will not delineate their differences here in the interest of keeping this post from being even longer.) Forbes.com provides an interesting article regarding the biggest mutual funds here: http://www.forbes.com/sites/billharris/2012/08/08/the-10-biggest-mutual-funds-are-they-really-worth-your-money/#758dfb914acf.
Hedge funds are like mutual funds but they are general have fewer investors that are institutions or individuals that are well off and accredited. They are legally limited partnerships, unregistered investment companies not regulated by the SEC. In addition, hedge funds may use investments such as options, swaps, futures, and short selling, use leverage, and have limited liquidity (Chriss, 1998).
Pension funds are financial intermediaries that take employee contributions and employer matching contributions and invest them in assets such as stocks and bonds in order to raise money for employee retirement. These assets are then provides to employees upon their retirement. Two types of pension plans exist, defined benefit and defined contribution plans. Defined benefit plans will provide a specified amount upon retirement and a defined contribution will not guarantee a certain amount of benefit but it will set an amount that will be contributed by employers.
Insurance companies are structured as financial intermediaries as well. These type of intermediaries protect policyholders from risk associated with various types of possible occurrences. A policyholder will sign a contract and provide payments, or premiums, to the insurance company for coverage against the particular risk, such as a house fire, automobile accident, or loss of life. The insurance company then uses these premiums and invests them to make a profit. The proceeds are used to pay claims made by policyholders when events they were insured for occur. Examples of insurance companies would include those providing insurance, such as Progressive or State Farm. Many insurance companies provide various types of insurance including automobile, home, life, etc.
Chriss, N. (1998). Introduction to Hedge Funds. Retrieved from http://www.math.nyu.edu/faculty/chriss/neil/lecture12/hedgefunds.htm
Duke University (2011). What is an Investment Bank? Retrieved from http://econ.duke.edu/uploads/media_items/investment-banking-demystified.original.pdf
Mamaysky, H. & Spiegel, M. (2002). A Theory of Mutual Funds: Optimal Fund Objectives and Industry Organization. Retrieved from http://som.yale.edu/~spiegel/mf/mf.pdf
From the reading in Chapter 13 explain the reasons for the structure and function of the Federal Reserve System. What special problems does a central bank have to solve? Should Congress and the president be given greater authority over the Federal Reserve System?
The way that the Federal Reserve is set up is that it’s the central bank of American but it is not a federal institution, which means no one regulates this institution. Another key element to the structure of the federal reserve system is that since it the central bank where majority banks come to borrow money, and it borrows at an interest rate, one will always be in debt to this institution. This interest rate is considered to be the discount rate. The primary function of the FED is to create money and control the interest rate. As it was discussing in the require multimedia there was several different banks at one point in time with multiple values for each bill. The addition of the one central bank gave American the insure and reinsurance that their money is protect. Also the FED also start to back everybody money with a FDIC approval seal. One special problem that the FED can seem to get a handle on is the stabilize the economy for a long period of time. Let I mention early the Fed is task with controlling the money supply which is inflation and they set the interest rate in attempt to stabilize a national economy. They are in charge of regulating or economy. “The Reserve Banks serve banks, the U.S. Treasury, and, indirectly, the public. A Reserve Bank is often called a “banker’s bank,” storing currency and coin, and processing checks and electronic payments. Reserve Banks also supervise commercial banks in their regions. As the bank for the U.S. government, Reserve Banks handle the Treasury’s payments, sell government securities and assist with the Treasury’s cash management and investment activities. Reserve Banks conduct research on regional, national and international economic issues. Research plays a critical role in bringing broad economic perspectives to the national policymaking arena and supports Reserve Bank presidents who all attend meetings of the Federal Open Market Committee (FOMC).”(www.federalreserveeducation.org ). I don’t believe that the President or the Congress need greater authority over the Federal Reserve System, Congress can hardly handle the responsibility they already have. But I don’t believe that the FEDs should be allow to continue to work exclusively in the dark in comparison to any other institution. Like every person, business or government organization, everybody understand that “we the people” should be reinsure that this institution and its actions are in regulation order to serve the people. The President or Congress need this responsibility but it should be address by some regulator agency not independent from the United Stated Government.
The Structure and Functions of the Federal Reserve System. (n.d.). Retrieved May 11, 2016, from https://www.federalreserveeducation.org/about-the-fed/structure-and-functions
The Federal Reserve System seeks to stabilize the economy and is the central bank of the U.S. It serves as a lender to banks. It was originally designed with the purpose to control the amount of currency and the volume of loans that were given. It is structured into 12 districts in the U.S. each with their own reserve bank within the district. “The 12 Federal Reserve Banks carry out duties related to the Fed’s roles in the payments system, control of the money supply, and financial regulation” (Hubbard, 2013, p. 392). They determine the discount rate that banks pay on loans and the amounts that they can borrow.
The Board of Governors is the governing board of the Federal Reserve System. It has seven members and they are appointed by the president and confirmed by the Senate. “The Board of Governors administers monetary policy to influence the nations’ money supply and interest rates through open market operations, reserve requirements, and discount lending” (Hubbard, 2013, p. 392). The board has influence over economic policy decision and is also in charge of some of the financial regulations. The Federal Open Market committee runs the open market operations of the Fed, setting the federal funds rate target.
The central bank has several special problems that need to be solved, such as methods to control inflation. Special problems to be solved in recent years include financial crises, such as the recent one in 2007 – 2009.
In order to separate the Fed from politics, the president and congress should not be given greater authority over its operations. I agree with the reasoning that politicians have short-term goals and monetary policy should reflect long-term goals that will affect the economy for years to come. Politicians’ agendas usually will only include what will satisfy their constituents currently and do not consider their long-term effects.
Hubbard, R. (2013). Money, Banking, and the Financial System (2nd ed.). New York, N.Y.: Pearson. ISBN: 9780132994910
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