a. Managing Exchange Rates: Achievement of Global Re-Balancing or Evidence of Global Co-Dependency
In this article, the author has very widely explained how the changes in the rates of the currency are affecting the development of the economy. It also stresses on the idea that the government should take requisite step in that area, by which the effect that the fluctuating prices have on the economy can be reduced. It helps in establishing the connection between the rates of dollars and the external accounts of the U.S economy and its policy management, on a macro level (Mann, C.L., 2016. 2004). If the value of dollar further depreciates then that will lead to a phenomenon that will be known as global rebalancing. It implies how the major two imbalances that are present in the world are reducing. The external imbalance is that which affects the economy on a macro level by affecting the overall export of the goods and the services, and the internal imbalance that is related to the overall saving and expenditure capacity of the individuals (Shanmugan, V.P. and Armah, P.W., 2017)
This article traces the path in the history where the changes in the rates of dollars have led to global rebalancing. As we go through the records, we notice that the current account of the economy is mostly related to the overall trade of goods and services, and the foreign income growth, in which the price of the dollar plays a good role. Therefore, we see how the rate of dollar is playing an important role in determining the total value of the goods and the services. The position of the dollar plays an important role in defining the income of the companies that are holding their major stocks in dollar (Buxbaum, H.L., 2016). Due to the effect of the global imbalance that is caused by the fluctuating rate of dollar, these companies are affected immensely. As import and export is affected, that causes an uproar in the U.S trade variables, the value of the investments of these companies is also affected. If we go through this article, we get to know how the prices in the different nations of the home-grown product are affected by the present rate of the foreign currency. Since these investment companies are having major investment in dollars, if the rate of dollar grows up, that reflects a strong dollar position in relation to the other currencies, the company will benefit. On the other hand, if the price of the dollar goes down, which reflects a weak dollar position, the company will suffer loss. That is where the companies resort to transaction hedging end risk exposure management that will help them reduce the overall loss in most of the scenarios (Moffett, M.H., Stonehill, A.I. and Eiteman, D.K., 2017)
Global co-dependency is a very wide known phenomenon, where most of the world trade is dependent on each other. Given the position of the foreign currency, the companies will suffer if there is a U.S trade deficit. Import and export is one of the major forms of business for these multinational companies. If there is a strong dollar position then the company will gain because in case of converting the same dollar in local currency, they will be able to buy more stuff. Hence, the position of the currency is very detrimental to the success of the investors who majorly hold stock in dollars. The world economy is highly related in today’s era, if there is a recession situation in one part of the world. Many other countries are also hampered because of the inter trade relation between the nations (Markopoulou, C.E., Skintzi, V.D. and Refenes, A.P.N., 2016). The companies that are having stocks in dollar will be able to cover themselves better in the international market given the position of the currency. It will be a very comfortable position for them to be. If We give a close look to the entire scenario, when the U.S was facing recession, and the value of dollar was diminishing. We saw that not even the companies that were based in U.S that were facing the wrath, due to the U.S trade deficits. Other companies that were having trade relations with such countries and those that were dealing in dollar were also largely affected. This shows the overall position of global co dependency and how in cases of imbalance not one but all are affected together. Being one of the strongest currencies in the world, and one that is preferred by many organisations around the world, to deal in international transactions. It is one of the most important currencies that often are responsible for regulating the flow of trade between nations. If the trade in U.S will be affected due to low position of the currency, it will end up affecting the trade in other parts of the world also. In the given article, we have verified various scenarios where if the dollar depreciates how it will affect the global economy. Each of the nations are independent on each other, hence it is a matter of great concern ( Shanmugan, V.P. and Armah, P.W., 2017)
In the long term if we see, this scenario will keep on persisting given the enormous amount of trade and development that is taking place worldwide, and that is affecting the global trade scenarios. The U.S trade deficit is a bye-gone phenomenon, with the passing away of the recession. However, most of that has only occurred on paper, and in the times to come, it is important for the economies of the world to be careful. It is important for the investors that deal in dollar, to be careful about their investment positions so that eventually they do not succumb to the hollowness of the economy. This article has helped in discussing the various scenarios that may persist and the investors should take their decisions based on the same(Bekkerman, A. and Tejeda, H.A., 2017).
Management of foreign risk exposure is a very crucial factor in case of any multinational corporation. The companies that do trade across boundaries often face the vulnerabilities of foreign risk exposure. With the help of invoicing and hedging such foreign companies can protect themselves to such types of risks. There are various ways by which the companies can hedge these transaction risks, derivatives are mostly commonly used method by these multinational companies (Almgren, R. and Li, T.M., 2016). Derivatives are the type of security in which the price is derived based on one or more underlying asset. It is a contract between two parties, which is based on the price of one or more asset. Most of the underlying assets in derivatives are bonds, stocks, commodities, interest rates etc. Derivatives are mostly traded over the counter or in an exchange and can, help in hedging the transaction risks that the multinational companies face giving to the fluctuation of the currency rates. In that case, they resort to derivatives, where they enter into a contract to cover their foreign exchange transaction, so that they are not affected by the fluctuations of prices in the future (Bissias, G., Levine, B. and Kapadia, N., 2017)
Types of Derivatives
There are various types of instruments that help the company to huge more profit at a reduced level of risk. Each has their own share of advantages and disadvantages. These instruments are frequently traded in the market through recognised stock exchanges. Thus, the level of risk is low in investing such types of securities. Most of the commonly used types of derivatives instruments are –
- Forward Contracts – In case of forward contracts, if any company has certain foreign currency payable at a future date, then it can enter into a contract today that will specify the price at which they can buy the foreign currency that they will eventually need in future to pay off their dues. It will help in covering the uncertain value of the currency in the home currency of the company that it will receive on a specified date. Hence, by covering itself with a forward contract, the company will no longer be affected by the fluctuation of prices. It is one of the most commonly used cover, and is preferred by many small scale investors, however when it comes to multinational companies, since they deal in huge amount of investments, such methods are very less preferred(Bouchard, B. and Chassagneux, J.F., 2016).
- Future Contracts – They are like forward contracts, in some or other way. They are mostly exchange traded and have many specific characteristics as if they have particular contract size, date of maturity, initial collateral prices and are standardized. It is not always possible to get an offsetting position in case of future contracts, giving their limited amount of availability as they are available in only few types of sizes, currencies and particular maturity period. There are also advantages with dealing in future contracts, since they are traded on exchange, they are more liquid in position and in case the exposure timing mismatches with the contract timing , they can easily be offset(Conlon, T., Cotter, J. and Gençay, R., 2016).Since many options are available to the traders in case of any mismatch. In addition, the credit risks that are associated with such type of trading are also very low. Often the traders are requiring taking a margin on their overall position, in that case it becomes easy when they are dealing in future contracts (Blanco, I. and Wehrheim, D., 2017).
- Swap – Swaps are derivative contracts, in which there is exchange of financial instruments between two or more parties. In case of swaps, a cash flow is based on a principal amount that is decided by the two parties. For every cash flow, that compromises one leg of the swap, there is trading done between the two parties. There are various kind of swaps, the most common type of swaps are the interest rate swaps. They are not traded on exchange. The retail investors do not indulge in such kind of swaps. They are over the counter traded between the financial institutions and the business institutions. In case of currency swaps, there are two currencies involved, where the principal and interest of one currency are exchanged in another currency. Most of the exchange is done at the current prices of the market. The rates are mostly same at the time of the inception and maturity of the overall contract (Pernell, K., Jung, J. and Dobbin, F., 2017).
When it comes to multinational companies, these swaps are very helpful. It helps the companies to hedge against interest and currency exposure. It helps the companies to look after the debt conditions and it helps them to take the advantage of the current and the expected conditions of the future. In case of financial swaps, the currency and the interest are used as tools that will help them to lower the overall cost of the debt services. There is often risk involved with the other party not able to meet the financial obligations, but the overall benefits that the companies earn through these swaps is often more than cost involved. It helps the companies in taking advantage of the global market. It helps in bringing parities from different market conditions hence bringing in a competitive advantage to everyone who are involved in such kind of swaps (Blanco, I. and García, S., 2017). A better example to understand how these swap works, suppose there are two companies, one is located in England, and one is located in U.S. Company one that is located in U.S takes loan that is denominated in pounds, and the second company needs to take loan in dollars. Both these companies take advantage of the swap, to make sure that these companies have better rates in their respective capacities. By combing the advantages that they have in their particular markets, they can receive savings of the interest rate in their total loan and principal amount (Wan, K. and Kornhauser, A., 2017)
Options- Options are types of derivative contracts that do not put an obligation on the buyer to buy a particular currency at a specified date at a particular price. It creates aright but does not impose an obligation on the buyer. The right to sell option is known as “put option” and the right to buy option is called “call option “. The main difference between options and the other derivative instruments is that there is no linear payment profile present in an option contracts, the traders can choose non-linear payment methods. There are various advantages of dealing in options. The most common advantages are listed below (Allayannis, G., Allayannis, G., Allayannis, G. and Allayannis, G., 2017).
- Cost Efficiency – One of the best benefits of dealing in options is that it is very cost effective to the trader. The investors can get hold of an option position that will be exactly similar to its position of stock, but that will be at a reduced price. Hence, there will be huge savings. Though the overall method of investing in options is a bit complex, with having a sound knowledge of the market condition, to understand when to invest in the stock options and when to not, it becomes difficult to deal in the same. However, the strategy that is looks so efficient in real life is equally efficient when it comes to practicality and real life scenarios (Bolton, P., Santos, T. and Scheinkman, J.A., 2016).
- Less amount of risk – There is less risk involved, in buying the options, then totally owning the securities. The prices of the stocks are fluctuating repeatedly, in that case if one is having option contracts, they can decide their long and short position accordingly. If the person is holding equities, it becomes difficult, as there are many financial commitments that are involved with equities. There are more dependable and very much safe then other types of stocks. Options are thus considered a better option of hedging then other type of derivative instruments(Bessler, W., Leonhardt, A. and Wolff, D., 2016).
- More returns – If a trader deals in stock then the total amount of profit that it will be earn will be much less than what it can earn by dealing in options, as it has better positions and also the overall risk is low. The companies can earn a higher return by dealing in options and that too at a reduced level of risk (Sass, J. and Schäl, M., 2017).
- More strategic Investments – In case of options the companies has plenty of investing opportunities. They are one of the most flexible investing instruments that are present in the market. The various methods by which options helps in creating multiple investment opportunities is known as synthesis. These synthetic positions help the investors to deal in variety of stock options depending on their choices and the level of risk and return opportunity is different for different user. It allows the investors to fully utilise the uncertainty of the market movements in their favour. With so many advantages that are associated with dealing in options they are the most traded financial instrument in today’s time. In today’s time, there is a lot of online access to such type of option instruments, at low brokerage costs, that offers mostly high returns, so many companies, and retail investors are switching to these kinds of alternatives to improve their overall position in the financial markets (Xingyun, P.E.N.G., 2015).
Hence, from the above discussion, we see that these multinational companies have many advantages of dealing in such kind of derivatives, and mostly it has helped in changing the scenario of the present market conditions. It has also helped in improving the overall investment opportunities to many new companies and retailers (Meyer, R., 2017).But it has its share of disadvantages too; the main drawbacks that are associated with dealing in such instruments are –
Advantage often works two ways, if in any case the investor is not able to make the right decision, then chances are there that he might end up losing large amount of money. Introduction of derivatives have also led to huge speculations in the market and that is one of the major drawbacks of such kind of investments (Mun, K.C., 2016).With the continuous rise and fall in currency prices, the market is getting affected. It is also very complex, and often-expert recommendations are needed to decide the right kind of investment and that limits its usefulness, making it difficult to be used. In addition, if we observe closely, sometimes the overall cost incurred in huge then that of dealing in normal stocks, because the bid ask spread is being assimilated with each change in currency price. In addition, the life span is an important considerate and in as the expiration date approaches the instrument tends to become useless. These are few areas in which the use of derivatives has been critiqued by the investors (Feder, N.M., 2017).
There is no doubt in the fact that dealing in such securities and such instruments have opened new doors for the investors. It gives them better and new methods of covering their transaction exposure and reducing the overall risk that they are exposed too, because of the changing currency prices. The main question that one investor’s needs to focus on are selecting the best type of instrument that will be beneficial as per his requirements. There are so many derivative instruments from forward cover to future cover, to options and swaps, selecting the one that is suited to your requirements and that will eventually help in earning the highest return at a reduced risk is a task, and also is very crucial for the success of your portfolio. It is also important to apply the right technique of hedging for long term sustainability and high returns. Overall these instruments are more or less very helpful for the growth and development of the multinational companies. If we ignore the hustle that is involved in choosing the right kind of instrument, it is more or less profitable, with reduced level of risks involved(Karmakar, A.K. and Mukherjee, S., 2017).
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