Move and Pick company uses Italian Euros for most of its transactions such as when purchasing locally available inputs such as coffee beans, baking flour, and other ingredients purchased in the local market. When making important decisions in a multinational corporation, currency forecasting model is important as it provides important decisions used when making decisions such as whether to hedge funds, reinvest in a foreign market or repatriate money back home and finally decisions on whether to obtain financing in foreign currency (Gabaix & Maggiori, 2014). The value of the Euro as compared to the US dollar has been fluctuating over the past two weeks. The exchange rate for EURO/USD has been fluctuating over the past two weeks. The value has been appreciating over, and the Euro exchanged for a dollar at a rate of 1.1383 as at Friday, April 1, 2016.
The currency experienced low volatility over the next seven days. The exchange rate at April 8th, 2016 was valued at 1.1379 indicating a slight decrease over the last seven days. The trend continues to rise to a high of 1.1407 on April 11th, 2016. However, the value of USD significantly dropped to 1.1264 and began to rise steadily (OANDA,2016). As at April 20th, 2016, the value has appreciated to 1.1301. The two weeks period low is 1.11623; the period average is 1.13074 and the period high is 1.14069.
The trend indicates that the US Dollar currency value will appreciate over the next few weeks. The purpose of forecasting is to assist Move and Pick Company to make important decisions on whether to hedge funds, make an assessment of whether to reinvest earnings in Italy or remit earnings back home. Finally, forex rates provide valuable information that can be used to make a decision on whether or not to obtain financing in foreign currency.
In our case, Move and Pick are in a long position and should protect themselves from downside risk through spot contracts and foreign currency option. Due to the increasing value of the home currency compared to the foreign currency, the company should repatriate some of the profit back home to take advantage of the appreciating value of the US Dollar (Battistini et al., 2014). Similarly, the company should also take advantage of the decreasing cost of capital and obtain financing in foreign currencies. These decisions are very important for Move and Pick Company as it will enable the company to take advantage of the exchange rates to gain values. Similarly, it will enable the company to take advantage of the decreasing cost of capital in a foreign country and obtain cheap capital.
Recognizing Exposure to Exchange Rate Risk
The foreign exchange market is extremely volatile, and the value of a currency keeps on changing from time to time. Therefore, it presents challenges to Move and Pick because the value of USD/EURO may change substantially from time to time. Move and Pick Company accepts Euros and US dollars for payment of goods and services purchased by its customers. At the same time, the company imports some of the raw materials from the home country. As such, the company is exposed to exchange rate risks because of volatility.
Exchange rates of US Dollar to Euro are unstable because the two countries operate in a floating exchange regime (Klein & Shambaugh, 2012). . The value of USD/EUR has been fluctuating from time to time. The monthly average exchange rate for a dollar to the euro was approximately 0.92 euro’s for a dollar in January. By the end of January, a dollar was charged for 0.86 euros and by November the value increased to 0.93 euros per dollar. This shows how unstable the exchange rate between USD/EUR.
According to OANDA (2016), the price movements of EUR/USD was less than 494pips. The standard deviation is 113 pips with an average movement of 296 pips and a median of 265 pips. The maximum 1-day loss that Move and Pick can expect if one expect no change in the peso is 697pips*10, which is 697 US Dollars.
Move and Pick Company is exposed to three types of risks because of the volatility of the exchange rate system. The company faces transaction exposure because of the effect that the exchange rate fluctuations have on the organization’s obligations to receive and make payment dominated by US Dollars in future (Piercy, 2014). For instance, making future payments for purchasing raw materials and when repatriating cash back to the home country.
Secondly, Move and Pick Company faces translation exposure due to effects of volatility on the organization’s consolidated statements. Particularly when the company makes a decision to open foreign subsidiaries in other countries.
Finally, volatility in exchange rate system may result in economic exposure because of the impact of changes in exchange rate systems on the general economic conditions. Exchange rate fluctuations may affect the company’s future cash flow, market value and competitive position (Cavusgil et al., 2014). It is Important to note that economic exposure affects a company whether or not it operates in the international market.
Establishing a Subsidiary in Foreign County
With the world becoming an oyster for anyone, Move & Pick can choose Italy to go into and open a subsidiary because it forms a potential market for its products due to its large consumer base. Both the United States and Italy share a common heritage; however, different their languages are. The culture of Italians includes enjoying coffee while on commuting or waiting for trains. EU as a trading zone is more feasible to foreign investment given their strong economic potential whereby Move & Pick can enjoy positive returns on investment and an ensured viability of the subsidiary.
Italy, as a potential market has a strong currency that is stable and the exchange rates with a US dollar, is relatively low given the net outflow of investments and profits back to the mother country. Domestic consumption is a key factor which inculcates families on holidays and commercial travelers and if possible, some of the subsidiary’s shares can be owned domestically. Political stability reduces the risks that can be encountered in the foreign market and thus, a subsidiary will reduce the costs associated with exporting the products given the distance (Wang et al., 2013). This will further help in minimizing losses encountered while exporting the products including late deliveries.
The benefits of establishing a subsidiary in Italy are varied depending on the level of acceptance of the products in the foreign country. The main benefit is that much of the business aspects of the day in both companies can easily be shared through an automated system that connects the parent and subsidiary company. The company enjoys a joint financial system and a shared marketing program including the availability of cooperative administrative services (Wang et al., 2013). This helps in saving both resources and money including time spent in developing and putting them into place. The parent company owns the assets and have the authority to invest as much or as little as they want to the subsidiary depending on performance in Italy to help reduce the risk of financial loss.
There exist disadvantages with establishing a subsidiary in Italy by Move & Pick. Establishing the subsidiary is an expensive undertaking, but if a local company is acquired, it facilitates market entry (Wang et al., 2013). However, the company may overpay for the assets of the company in the existence of a bidding war.
Furthermore, most time is spent in establishing relationships with the foreign suppliers and customers. This can be alleviated through the acquisition of a local company with built-in networks to speed up the process. Another challenge is finding skilled employees to deal with the coffee business including cultural barriers which may alter integration of the subsidiary’s operations and the parent company. On the other hand, the parent company will bear all the risks of the subsidiary which may include a lawsuit aimed at the subsidiary leading to financial losses for the parent company.
Italy views DFI to be a key tool in solving economic problems such as unemployment, and it may further provide incentives to encourage the forms of DFI that it desires in the coffee and soft drink business thus the removal of barriers. The market resources including the regulations of Italy allows for foreign-owned companies to operate (Lee & Swenson, 2016). The tax breaks of the Italian government including discounted rents for land and buildings plus loans with low interests facilitates the acquisition of new branches. However, there exist restrictions from the government through the power to block mergers and a restriction of a foreign-owned majority plus red tapes and operational conditions.
The transfer of profits of a foreign subsidiary in Italy is ordinarily not subject to tax because such foreign subsidiaries are not considered to be Italian corporations even if such corporations are wholly owned (Wanget al., 2013). However, the payment of dividends from the subsidiary to the parent corporation may be subjected to withholding tax.
Price and Consumer Demand
Year 1 and 2: 50,000 units @ $80 per unit
Year 3: 75,000 units @ $84 per unit
Year 4: 100,000 units @ $84 per unit
Year 1 and 2: $40 per unit
Year 3: $ 48 per unit
Year 4: $ 55 per unit
Fixed Cost: $ 70,000 per year
Tax Laws: 20% of income tax
Remitted funds: 8% withholding tax on remitted funds
Exchange rates: Spot exchange rate of 1.1303 for Italian euros
Salvage value: $ 110,000
Required rate of return: 8%
The exchange rate fluctuations will impact on the Move and Pick subsidiary transaction because volatility will either lead to increase or decrease in revenue earned, the amount remitted to the parent company, and the value of corporate tax to be paid (Cullen & Parboteeah, 2013). On the same note, it will affect the cost of raw materials to be purchased either locally or imported from the home country.
Assessing Exposure to Country Risk
Multinational corporations are often exposed to a certain number of foreign exchange risks. Some of the main factors that can expose a multinational company to risks include:
Foreign exchange risks or transaction risks: this is risks that arise because of fluctuation in the value of investments as a result of changes in currency exchange rates (Khanna & Palepu, 2013). When the value of domestic currency appreciates as compared the foreign currency, the returns the company will earn will decrease after being exchanged back to domestic currency. Because of the volatile nature of the exchange rate, it is a bit challenging to protect against such kind of risks. However, Multinational Corporations often hedge their investment to avoid such risks.
Economic fluctuations: fluctuations in macroeconomic variables such as interest rates, monetary policies among other may also affect the profits of the company and thus cause what is termed as an economic risk (Foley & Manova, 2014). This is often risks as a result of concessions in economic control.
Changes in government policies regarding international trade; changes in government policies result in political risks. There are two primary types of political risks. That is Macro risk and Micro risks. Macro risks are political risks that arise because of adverse actions were taken by the government that may affect all multinational companies such as insurrection and expropriation. On the other hand, micro risks are adverse government actions that may only affect specific economic sector or business for example prejudicial actions against certain multinational firms, and corruption. The government might change its policies which may negatively affect Move and Pick Company. Some of the policy changes that may affect a company includes such things as increased trade barriers, an increase in tariffs and quotas that are aimed at protecting domestic companies at the expense of multinational companies. Such changes might also impact on Move and Pick company profits because it result in taxation of exports, and restricting the amount of revenues earned among others.
Italy country risk rating is B which implies that there are some political and economic risks and occasionally difficulty in the economic environment that can have an impact on corporate payment behavior (Globaledge.msu.edu., 2016). The corporate default probability is appreciable. The country is ranked six among the 37 developed countries having a nominal GDP of $1,819 billion. The country was faced with recession for three years, but the economy has grown by 0.7% by the end of 2015, and economic prospect indicate that the economy is expected to grow by 1.3% by the end of 2016.
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