International Finance Essay

4512 words - 19 pages

MFI 442 International Finance-Individual Assignments II
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MFI 442 International Finance-Individual Assignments II
Over the years, global businesses are increasing rapidly because most countries are attractive and have lucrative policies that attract foreign direct investments (FDIs). Foreign direct investments are simply business entities operated by a corporation in one country (the home country) but with subsidiaries in the foreign markets (the host countries) (Agarwal, 2009).A perfect example for FDIs is Multinational Corporations (MNCs) which have their parent company located in their home country but with subsidiaries in foreign markets. In most cases, FDIs ...view middle of the document...

A futures contract is a form of a standardized forward contract where the participants agree to sell or buy the underlying asset. This contract involves specifying a future date and a price to conduct the transaction via a specified exchange. Hedgers trade futures contracts on exchanges which set standardized terms of quantity, quality, date, price quotation and the place of delivery if in case of commodities (Drabek, 2013). The cost of hedging will be none if futures hedge is unbiased protectors.
B).Forward Hedge- to lock in the future exchange, this technique uses forward contracts. A forward contract pushes the date of transaction of the asset to a future date. The participants of forward contracts reduce uncertainty significantly by immediately agreeing to a fixed exchange rate (Shapiro, 2006).Forward contracts are negotiated for enormous significant transactions. The decision to hedge or not to is made by comparing the unknown result of currency remaining unhedged and the known effect of hedging. Hedging is done while considering the firm’s magnitude of risk aversion. The real cost of hedging incorporates expenses incurred when hedging has been done (Sader, 2000). When using probability distribution to identify the cost of hedging, hedging is an appropriate measure to undertake when the computed results are negative.
C).Money Market Hedge- this hedge involves transactions that take a market position to cover future receivables or payables position (Rugman, 2001). In case of a payables position, the method involves borrowing funds in the form of home currency and converting these to foreign currency immediately. The proceeds are then invested in foreign currency to enable payment of creditors when interest maturity arrives (Mariano, 2011). In case of a receivables position, the idea is converse. This method will involve borrowing funds in the form of foreign currency and converting these immediately to home currency. The proceeds will then be invested in local money to enable payment by the debtors when the interest of these funds reaches maturity. It is significant to know that when there are no transaction costs and interest rate parity is active, the results of the money market hedge are similar to those of a forward hedge (Madura, 2003).
D).Currency Options Hedge- this hedging technique uses currency options, these are either put or call options to hedge exchange rate exposure (Nder & Sexton, 2011). A call option gives the holder of the asset the right to buy it. A put option awards the owner of the property the right to sell it at an agreeable strike price (Wells & Wint, 2000). Options insulate firms from extreme changes in the exchange rate because it is not a must to exercise options. This technique is also vital in helping MNCs to hedge contingencies arising from exchange rate risk (Toporowski, 2000).
It is important to note that, a multinational corporation decision to use any of these hedging techniques is...

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