International Finance: Theory And Practice Essay.

Theory of Comparative Advantage and its Applicability in Current Contexts

1. What is the theory of comparative advantage? Is the theory applicable in the current contexts? Why or why not?

2. Discuss and compare the different corporate governance regimes. Why should MNEs be concerned with such differences?

3. Classify the following as a transaction reported in a sub-component of the current account, orthe capital and financial accounts of the countries involved:
• An Australian firmpurchases a web hosting service from a US firm.
• Singaporean parents pay for their son’s study at an Australian university.
• A German company buys an insurance policy from a US insurer.
• AnIndian firm pays the salary of its executive working for a subsidiary in Australia.
• An Australian firm buys 100% shares of a Malaysian company.

4. Discuss what you understand by the term ‘impossible trinity’.

5. An Australian company is planning to import a new machine and is making a choice between two international suppliers. A supplier in Japan has quoted ¥2,500,000 as the price of the machineand¥100,000 as the shipment cost. A supplier in Germany has quoted €20,000as the price of a similar machine and €350 as the shipment cost. The following exchange rate informationare available:
Exchange Rate between Australian Dollar and US Dollar: $0.77/A$
Exchange Rate between US Dollar and Japanese Yen: ¥107/$
Exchange Rate between Euro and US Dollar: $1.22/€
Which of these suppliers should the company choose? Assume that the choice is solely based on total Australian Dollar cash outlay required to cover the price of the machine and the shipping cost.

6. A German car now costs €50,000. The spot exchange rate is €0.67/A$. If the expected inflation rates in Australia and Germany are respectively 2.50% and 0%, what will be the Australian Dollarprice of that car 1 year from now:
i. If there is 100% exchange rate pass through?
ii. If there is 65% exchange rate pass through?

7. Discuss whether he should buy a PUT on S$ or CALL on S$, and what would be his net profit (in $)if the spot rate at the end of the 180 days is $0.92/S$.

8. Is purchasing power parity an accurate estimator of future exchange rates? Why or why not? Please explain.

9. On a particular date, the exchange rate between the Great Britain Pound (GBP) and the Australian Dollarand the exchange rate between the Australian Dollar and Euro were respectively £0.5221/A$ and A$1.60/€. On a later date, the exchange rates were respectively £0.5507/A$ and A$1.64/€. What were the percentage change in the values of the GBP and Euro against the Australian Dollar between these two dates? Were the changes devaluation or revaluation or appreciation or depreciation of these currencies? Assume that Australian Dollar is the home currency.

10. An Australian organization has a ¥40,000,000 account receivable from a Japanese customer in 3 months. The current Japanese yen (¥)/Australian Dollar (A$) spot exchange rate is ¥88.35/A$. The Australian organization expects that the spot rate in 3 months will be ¥95.45/A$. The 3-month forward exchange rate is ¥92.50/A$. The Australian Dollar (A$) 3-month borrowing rate is 8.00% per annum and the Australian Dollar (A$) 3-month investment rate is 5.00% per annum. The Japanese yen (¥) 3-month borrowing rate is 4.00% per annum and the Japanese yen (¥) 3-month investment rate is 2.00% per annum. The organization’s weighted average cost of capital is 10% per annum. The organization is considering three hedge positions: remaining unhedged, forward market hedge and money market hedge. Which of these hedge positions should the organization adopt?

Comparing Different Corporate Governance Regimes

The theory of comparative advantage relevantly indicates the ability of a producer to provide goods and services at lower opportunity cost in comparisons to other producers. In addition, the principle of comparative advantage relevantly indicates the positive attribute, where agents are willing to produce more and consume less of the goods, who have a comparative advantage in the economic reality. Furthermore, the comparative advantage can be identified as the overall progress obtained by industry such as technological progress, endowments, and economic model, who increases the opportunity cost of the company or producer.

In addition, David Ricardo developed the comparative advantage theory, where he explained the efficiency of workers of developing an edge for the industry in the country. The theory is effectively applicable in the current context, where the with the competitive hedge companies can minimise the opportunity cost of goods and services. This increases their competitive edge in the market and improves the level of profits that could be generated from operations. The companies with competitive advantages are able to improve the level of revenues, while reducing nay kind of extra expenses incurred from operations. In this context, Borio, Gambacorta & Hofmann (2017) stated that with the use of skilled labour organisations can reduce opportunity cost of production and maximise the profits from operations.

There are four corporate governance regimes such as Market-based, Family-based, Bank-based and Government Affiliated, which has adequate difference and comparison for the companies. The difference between the corporate regimes are depicted as follows.

Regimes	Difference
Market based	The characteristics of the regime relevantly indicates the efficient market and dispersed ownership of the regime
Family based	This regime mainly combines both family ownership and minority shareholders
Bank based	The bank-based regimes are controlled by governments and have lack of transparency
Government affiliated	There are state ownership enterprises, where there is lack of transparency

The major comparison between the overall regimes is the rule of corporate governance, which needs to be followed by the companies operating in the region. In addition, the laws and situations in the regimes could be conducted for improving the level of returns that could be generated from operations. In addition, the regimes are a function of financial market developments, with a degree of separation of owners and managers. In addition, the regimes also have disclosure and transparency condition with a historical development of legal system.

MNCs needs to be concerned regarding the difference in corporate governance regimes, as it will affect their operational capability. In addition, the subsidiary in that region will have to follow the rules and regulations of that country, while the actual mother company will have different set of rules and corporate governance regimes. This increases the difficulty for the company for effectively conducting its operations in all its companies situated in different regimes (Frieden, 2015).

Classification of Transactions in a Sub-component of Current Account or Capital and Financial Accounts

An Australian firm purchases a web hosting service from a US firm: Debt to the Australian firm current account, while credit to the US firm current account.

Singaporean parents pay for their son’s study at an Australian university: Debit to the Singaporean parents in the current account, while credit to the Australian university current account.

A German company buys an insurance policy from a US insurer: Debit to the German company financial account, while credit to the US insurer balance of payment.

An Indian firm pays the salary of its executive working for a subsidiary in Australia: Debit to the current account of Indian firm, while credit to the executive working in subsidiary Australian subsidiary.

An Australian firm buys 100% shares of a Malaysian company: Debt to the Australian financial account, while credit to the financial account of the Malaysian company.

The impossible trinity is considered one of the unholy trinity, which is not possible by the government to comply with all the three symptoms. The counties that have broken the rules set by the impossible trinity has faced financial crisis, where the country faced cash stagnation and investment problems. In addition, the impossible trinity relevantly indicates that the government cannot implement a fixed foreign exchange rate, free capital movement and an independent monetary policy at the same time, as it will directly have a negative impact on its fiscal position. Moreover, it is also understood that impossible trinity hypothesis is not possible theoretically and in real world practices, where the countries ignoring the negative impact of impossible trinity has failed (Moffett, Stonehill & Eiteman, 2014).

In addition, the impossible trinity is considered to be one of the dilemmas, which cannot be followed by governments in improving their economic growth. From the experience of government, it could be identified that any two of impossible trinity could be conducted for improving economic growth of the country. The violation of impossible trinity measure was conducted by the Asian countries during the Asian crisis, which involved Singapore, Thailand, Hong Kong, Malaysia, South Korea, Indonesia, and Philippines. Moreover, the violation of impossible trinity has affected the Debt to GDP ratio of the country, which substantially rose from 100% to 167%. This relevantly indicates that ignoring the impossible trinity factors would lead to cash crunch and liquidity problems for the government.

Therefore, from the evaluation of impossible trinity factors it could be identified that the government and central banks needs to follow the measure of impossible trinity and should not violate the factors. However, any violation of The Impossible Trinity would result in economic crisis which was previously seen by the Asian countries (Avdjiev, McCauley & Shin, 2016).

Understanding the 'Impossible Trinity' in International Finance

Supplier in Japan	Value
Machine	¥ 2,500,000.00
shipment cost	¥    100,000.00
Total cost	¥     2,600,000.00
Price in AUD	AUD     31,557.23
AUD/USD	0.77
USD/AUD	1.30
USD/Japan Yen	107.00
Japan Yen/USD	0.01
Japan Yen/AUD	0.01

Supplier in Germany	Value
Machine	€     20,000.00
shipment cost	€          350.00
Total cost	€          20,350.00
Price in AUD	AUD   32,242.86
AUD/USD	0.77
Euro/USD	$                    1.22
Euro/AUD	AUD              1.58

From the overall evaluation of the above calculations, the actual cost of the machine on from German and Japan supplies could be identified. From the overall evaluation it could be identified that buying the machine from Japanese supplier will be fruitful for the Australia company, as the total cost of the machine will be AUD 31,557.23, where the company will obtain savings of AUD 867.65.

Particulars	Germany	Australia
Pass Through	100%
spot exchange rate	€ 0.67
German car Price	€ 50,000.00	AUD 74,626.87
Inflation rate	0%	2.50%
One-year price	€ 0.65
Price of the car after 1 year 100% pass through	AUD 76,492.54

Particulars	Germany	Australia
Pass Through	65%
spot exchange rate	€ 0.67
German car Price	€ 50,000.00	AUD 74,626.87
Inflation rate	0%	2.50%
One-year price	€ 0.66
Price of the car after 1 year 65% pass through	AUD 75,839.55

Particulars	Value
Current spot rate	$    0.76000
Spot price in 1 year	$    0.92000
Strike price (Call Option)	$    0.86000
Premium (Call Option)	$    0.00017
Total price	$    0.86017
Profit	$    0.05983

From the overall evaluation it could be identified that using the call option will be better for the forex trader, as increment in price is anticipated. Therefore, using the call option could allow the forex trader to maximise the profits from investment. In addition, the net profit that will be generated from trade is $ 0.05983.

The purchasing power parity is not an accurate estimator of future exchange rates, as it is a theoretical measure, which is not possible in the real-world process. The purchasing power parity only focuses on the exchange rate value, which aims in bringing parity towards products sold between different nations. The currency exchange rate directly plays a vital role in nullifying the purchasing power parity theory, as the demand for currency increases the purchasing power conferred position of the currency relatively decline. In addition, the purchasing power parity is also not able to comprehend the export and transportation charges that is incurred by the importing country and is charged to the product. Therefore, it could be assumed that the purchasing power parity is not able to estimate the actual future exchange rates of country due to the lack of incorporating different factors affecting the prices of a particular product (Titman, Keown & Martin, 2017).

The other reason that could be identified for the negative impact of purchasing power parity is the use of derivatives, which allows the organization to minimize the negative impact from rising currency value. Due to the presence of complicated financial instruments the purchasing power parity is not able to subdue the actual theoretical value of a particular currency. the presence of continuous hedging measure used by companies to reduce there is from volatile currency market is directly affecting the accurateness of the purchasing power parity theory. In the modern world the inflation rate does not accurately affect the currency value of a country was different factors such as interest rates, demand, and supply of the currency in the currency market is used to determine the actual value of a particular currency. Hence, the purchasing power parity is not able to accurately define the actual currency rate of a country due to the lack of accommodating different external factors in evaluating the currency value (Chinn & Kucko, 2015).

Choosing Between International Suppliers

Currency Value	1st day	2nd day	Percentage change
Pound to AUD	£ 0.52	£ 0.55	5.48%
AUD to Euro	AUD 1.60	AUD 1.64	2.50%

From the overall evaluation it could be identified that appreciation of AUD can be seen against pound by 5.48%. In addition, the devaluation of AUD was seen from the dates, where the currency value declined against Euro by 2.50%. Hence, from the valuation it could be identified that AUD currency mainly appreciated against Euro, where with 1 AUD was providing a higher amount of Pound Sterling in the currency exchange. Furthermore, AUD declined the decline in Euro value is seen, where with 1 Euro additional AUD is being paid during the currency exchange.

Forward rate Hedge	Value
Forward exchange rate	¥ 92.50
Value in AUD	AUD   432,432.43
Expected spot rate	¥ 95.45
Value in AUD	AUD   419,067.57
Profit from currency exchange	AUD     13,364.86
PV value	AUD     12,149.87

No Hedge	Value
Expected spot rate	¥                  95.45
Value in AUD	AUD   419,067.57
spot exchange rate	¥                  88.35
Value in AUD	AUD   452,744.77
Loss in currency exchange	AUD   (33,677.19)
PV Value	AUD   (30,615.63)

Money Market Hedge	Value
Australia
3-month borrowing rate	8%
3-month investment rate	5%
Japan
3-month borrowing rate	4%
3-month investment rate	2%
WACC	10%
Borrowing in Japan	¥ 38,461,538.46
Convert	AUD 435,331.50
Value in 1 year	AUD 457,098.08
Expected spot rate	¥ 95.45
Expected exchange value	AUD 419,067.57
Profit from hedge	AUD 38,030.51
PV Value	AUD 34,573.19

From the overall evaluation of three different measures of hedging, the money market hedge is identified to be the most viable option to the Australian based company. With the implementation of money market n hedge the company can obtain an overall profit of AUD 38,030.51 from the transaction. The overall hedging measure such as forwards rate hedging only provides a profit of AUD 13,364.86, which is relevantly lower than the money market hedge that is calculated in the above table. In addition, the overall no hedge policy is mainly increasing the losses for the Australian company, where the currency conversion directly reduces the payment value for the company. Hence, the use of money market hedge is much more beneficial for the Australian based company, which might nullify the loses that will incur from currency transaction (Bech, Gambacorta & Kharroubi, 2014).

Reference and Bibliography:

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Bech, M. L., Gambacorta, L., & Kharroubi, E. (2014). Monetary policy in a downturn: are financial crises special?. International Finance, 17(1), 99-119.

Borio, C., Gambacorta, L., & Hofmann, B. (2017). The influence of monetary policy on bank profitability. International Finance, 20(1), 48-63.

Cheung, Y. W., Chinn, M., & Nong, X. (2017). Estimating currency misalignment using the Penn effect: It is not as simple as it looks. International Finance, 20(3), 222-242.

Chinn, M., & Kucko, K. (2015). The predictive power of the yield curve across countries and time. International Finance, 18(2), 129-156.

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