Part-4: The Global Monetary System

Discussion Questions:

1.      Read Management Focus on Volkswagen (p. 317) and answer the following questions:

(a)Why do you think management at Volkswagen decided to hedge only 30% of their foreign currency exposure in 2003? What would have happened if they had hedged 70% of their exposure?

Volkswagen already had lost a huge amount of profit in 2003, around 50% from the record levels attained in 2002. Among the several causes of having loses, a sharp rise in the value of Euro or decrease in the value of dollars was the major. At the same time, the company hedged just a 30% for a foreign currency i.e. US dollar by estimating that the value of dollars is going to rise in 2003 as well so that management of Volkswagen decided to hedge just 30 percent of its foreign exchange exposure. In addition to that, management thought that there would be no risk if things went as they estimated.

If they had hedged 70% of their exposure in 2003, they would have fewer amounts of losses. In other words, Volkswagen’s operating profit would not be reduced by some $ 1.5 billion. This happened due the fact that the company thought the euro would decline in value relative to the dollar. The company hoped that by saving the cost of the commission involved in selling a currency forward, it would increase its profit margin.  But unfortunately the strategy, of course, backfired on the company.

(b) Why do you think the value of the US dollar declined against that of the euro in 2003?

                                           

The euro had recorded a volatile trading history against the U.S. dollar at the beginning of 1999, 1 January when 12 members of the European Union became the currency unit. In early 1999, the exchange rate stood at 1 pound=1.17 dollar, but by October 2000, it had sharply declined to 1 pound=0.83 dollar. As a result, its rise has been attributed to record U.S. foreign trade deficits and pessimism about the future value of the dollar. Thus, I think the main reason of declining the value of the US dollar against the euro in 2003 was that they had united and involved in the European Union as a currency unit.

(c) Apart from hedging through the foreign exchange market, what else can Volkswagen do to reduce its exposure to future declines in the US dollar against the euro?

Apart from hedging through the foreign exchange market, Volkswagen could use derivative securities as a tool for minimizing their risks. For this, it could use a forward contract that gives the holder the right to exchange one currency for another at some point in the future. In addition to that, it could use currency swaps in which the simultaneous purchase and sale of a given amount of foreign exchange for two different values dates is done (Hill, 2011).

References

Hill, C. W. (2011). International Business: Competing In the Global Marketplace. New York: McGraw- Hill .

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2. Do you think the standard IMF policy prescriptions of tight monetary policy and reduced government spending are always appropriate for emerging nations experiencing a currency crisis? How might the IMF change its approach? What would the implications be for international business?

The standard IMF policy prescriptions of tight monetary policy and government regulation are very important forces for managing a currency crisis. And of course they are very successful in many developed countries. However, some critics argue that the tight macroeconomic policies imposed by the IMF in the recent Asian crisis are not appropriate to countries that are suffering not from excessive government spending and inflation, but from a private-sector debt crisis with inflationary undertones.  Anti-inflationary monetary policies and reductions in government spending usually result in a sharp contraction of demand, at least in the short run.  In the longer term, the policies can promote economic growth and expansion of demand, which creates opportunities for international business.

IMF has changed its approach by focusing on lending money to countries in financial crisis. It basically includes three major crises such as currency crisis, banking crisis, and foreign debt crisis. For example, the IMF was making loans to 68 countries by 2010 all of which require tight macroeconomic and monetary policy. However, some critics think that the “one-size-fits-all” approach to macroeconomic policy is inappropriate for many countries.  In addition to that, the IMF is exacerbating moral hazard. In this way, IMF has become too powerful for an institution without any real mechanism for accountability. In recent years, the IMF has begun to alter its policies and be more flexible.

It seems that it could be very implacable for international business. Ideally, international managers need to understand how the international monetary system affects business activities. It deals with currency management in which how government intervention can influence exchange rates. Another application is that it helps to operate business strategy where it should be understood with how exchange rate shifts can have a major impact on the competitive advantage of businesses. Last but not the least; it can be used for dealing with corporate-government relations where how businesses can influence government policy towards the international monetary system.

References

Hill, C. W. (2011). International Business: Competing In the Global Marketplace. New York: McGraw- Hill .

3. Why has the global capital market grown so rapidly in recent decades? Do you think this growth will continue through the next decade?

As globalization increases in the world, the global capital markets are also growing at an alarming rate. Many giant companies are growing in the global marketplace for the production and selling of goods and services. When giant companies emerge then they need a huge amount of capital to operate nationally and globally so they must be able to raise capital they need. Another reason for growing this is that technological advancement and deregulation of government that are making an ease for doing capital markets globally. For these reasons, global market has grown so rapidly and it seems that this growth will continue through the next decade too.

It can be seen that in 1990, for instance, the stock of cross-border loans was just $3,600 billion.  By 2006, this number had increased to $17, 875 billion.  Likewise, outstanding international bonds soared from $3,515 billion in 1997 to $17,571 billion in 2006.  A similar pattern exists with international equities offerings.  There are basically two reasons for continuity this growth for next decades. First, the need of huge capital for the companies is growing as operation increases in many parts of the world. Another reason is that advances in information technology and deregulation by government. For instance, when multinational company McDonald needs some amount of money to expand its operation then it goes for issuing share or bond in the global market in which foreign investors come and buy the shares or bonds so that it can raise its capital through use of information technology and government support.  Hence, having said this, I strongly agree that the growth of global capital market will continue all over the world for the next decades rapidly.

Reference

Hill, C. W. (2011). International Business: Competing In the Global Marketplace. New York: McGraw- Hill .

Lesson 5 Assignment: Case Study

                                              “Industrial and Commercial Bank of China”

               The industrial and Commercial Bank of China (ICBC) offered the world’s largest Initial Public Offering (IPO) in order to raise some $21 billion as of October 2006. It beat Japan’s 1998 IPO of NTT DoCoMo by a huge margin to earn a place in the record books. At the same time, Chinese enterprises were started expanding into the foreign markets as Chinese sought to give China’s industry leaders global identity. Since 2000, Chinese companies were able to raise more than $100 billion from the equity markets that surpassed the total amount raised by companies in the world’s second largest economy, Japan.

                 In order to raise such amount of money, Chinese companies have been looking the international investors and at that time ICBC also listed its IPO shares on the Hong Kong exchange and Shanghai Stock exchange. By offering its share in Honk Kong it would adhere to the strict laws and government standard that could attract the potential investors who were quite interested to invest in the Chinese economy. ICBC has a great number of bank networks, probably more than 18,000 as it claims 150 million personal accounts and 2.5 million corporate customers. Some $350 billion and $80 billion orders were attracted from Hong Kong and Shanghai stock exchange respectively. Due to an enormous success, ICBC raised its share price and reaped around $2 billion more than initially planned.

Advantages and Disadvantages of issuing equity in markets outside of China

The necessary to issue equity in markets outside of China:

There are some significant reasons for issuing the equity in the foreign markets. If any company issues its shares to its potential investors then the company is going to raise its capital for further development or activities. In the case of ICBC, it felt that it was necessary to issue equity in markets outside of China to raise their capital, to list their IPO shares on the Hong Kong exchange and Shanghai stock exchange (Hill, 2011). The reason of listing such shares was that ICBC wanted to ensure the strict reporting and governance standards to their foreign investors by sending a message. In addition to that, ICBC also thought that Chinese companies not just could raise its money but it could improve corporate governance and transparency, and bring a global recognition in the global marketplace.

 The advantages of such a move:

It is inevitably true that when ICBC lists its shares in the global capital markets such as Hung Kong, and Shangai stock exchange then it would attract a large pool of investors for raising capital. Another advantage for ICBC is that it would create high competition markets that could bring financial innovation and diversity both domestically and globally.  Hence, having said this, it would strengthen the capital markets through competitiveness of its service, and there are many changes to emerge new advantages in days to come.

The disadvantages of such a move:

In spite of its advantages, there are some disadvantages too. One disadvantage is that it could be very risky to create a diversified market for all investors from different countries. Another challenge is to maintain the security investments, and it is also difficult to adhere in accordance with international standards if not managed well. In the same way, Hong Kong was already matured in the stock exchange but for the markets like Shanghai stock exchange were just beginners so that it could be very dangerous to set up all the requirements and strictly adhere to reporting and government standard.

The attraction of the ICBC listing to foreign investors, and the risks for investing in ICBC

The attractions of the ICBC listing to foreign investors:

The ICBC listing fascinated considerable interest from foreign investors, who thought that investing in Chinese economy was beneficial for them. It is also true that ICBC was offering a secure place for investment with a nationwide bank networks. For example, the listing on Hong Kong attracted some $350 billion in orders from global investors, more than any other offering in the history of Hong Kong. The attraction for foreign investors is changing market trends with huge opportunities and cheap labor costs. Another attraction could be growing Chinese economy with massive oversubscription that enabled ICBC to raise the price per share so that foreign investors can earn more than they think.

The risks for a foreigner associated with investing in ICBC:

It is certainly true that although there are many benefits to invest in ICBC for foreign investors, many investors are still hesitant to invest in ICBC because there are also some risks to be considered. First, although we live in a relatively globalized and connected world, transaction costs can still vary greatly depending on various foreign markets. It includes brokerage costs, stamp duties, levies, clearing fees, taxes and exchange charges. Second, currency risks refer to volatility of currency. If there are changes in exchange rate it may hamper the investors because investors cannot trade (buy or sell) stocks in their domestic currency, they must convert it into dollars. Third, liquidity risk could be very high for investing in foreign markets like ICBC because there is risk of not being able to sell shares promptly for getting money. Last but not the least, there are higher government regulatory and standards which must be compiled by all foreign investors to be engaged in trading of shares. Thus, these potential risks must be taken into account before entering into foreign stock exchange for better productivity.

                                                   Summary and Conclusions

While it is true that ICBC was better off to raise its capital required for developing Chinese economy and to give Chine's industry leaders global recognition, some of the reporting and government procedures must be followed to comply with international standard. Like every potential businesses, investing in ICBC has also some sorts of risks and rewards that must be taken into account before entering into it. By understanding these risks and rewards in these markets, an investor should be able to position him/herself to minimize these risks. Lastly, I think that ICBC did a great work to enhance China's capital markets through initial public offering(IPO) as offering was massively oversubscribed.

References

Hill, C. W. (2011). International Business: Competing In the Global Marketplace. New York: McGraw- Hill .

(n.d.) Retrieved September 9, 2015 fromhttp://www.investopedia.com/articles/basics/11/biggest-risks-international-investing.asp