Applying the Euro
Applying the Euro
Order Instructions:
Applying the Euro
As a financial analyst, you are asked to advise a MNC about its one-year investment plan next year in Germany. Because the investment is denominated in euros, you are asked to forecast how the euro’s value may change against the U.S. dollar over the 1-year period. For your assessment, use all of the three major forecasting techniques.
• Fundamental forecasting
• Technical forecasting
• Market-based forecasting
Note: Students should form different teams. Each team should be responsible to assess the next year move of a major currency against the U.S. dollars as noted below, applying the scenario you just read
SAMPLE ANSWER
Table of Contents
Japanese Yen against US Dollar. 3
2.0 The Multinational Companies Investment Plan Next Year in Japan. 4
3.0 Movements of Exchange Rate and Its influences on MNC.. 5
4.0 Forecasting the Exchange Rate: Forecasting Techniques. 5
4.1 The Technical Forecasting. 6
4.2 Fundamental Forecasting. 8
4.3 A Market-Based Forecasting. 8
5.0 Exchange Rate Risk Management 9
6.0 Summary and Conclusion. 11
Japanese Yen (JPY) against US Dollar
1.0 Introduction
As a financial analyst, it is critical for the Multinational Corporation (MNC) to consider certain factors in their one-year investment plan in Japan. Bearing in mind that the MNCs investment will trade in a predominant country that is primarily dominated by the Yen, it is essential to articulate the fact that emerging markets in most cases depend upon the Yen and dollar exchange rates in carrying out their functions (Cullen, & Parboteeah, 2009). This requires the management of the MNC to determine essential issues for this international company since, during the last decades, the Yen-USD exchange rates have been dramatically changing, a factor that would affect the company in an instance where it fails to mitigate its financial exposure. This paper, therefore, seeks to determine an approach that can be decisively employed by an MNC in its one-year investment plan in Japan considering the fact that the currency of the country may change against the U.S. dollar over the period of its investment in the country.
In trade markets that happen internationally, the capital markets, and the foreign exchange markets, the Yen is considered the third most extensively used money after the dollar and the Euro with its role steadily increasing in the international markets (Cullen, & Parboteeah, 2009). The share of the Yen in the global foreign exchange market reserve has increased steadily over the years but is still substantially less as compared to the market share of the dollar and the euro which are constantly growing. In addition to this, the Yen has firmly established its status, a factor that has been noticed since the year 2005 where it accounted more than 10 percent of the debt that were in terms of securities – bonds, money market instruments – dispensed in currencies which were dissimilar from the borrowing country (Cullen, & Parboteeah, 2009).
2.0 The Multinational Companies Investment Plan Next Year in Japan
Fluctuations in normal exchange rates of the dollar and the Yen have a way of affecting the economy of Japan through a number of ways that MNCs need to be fully aware. The fluctuations, in this case, impact the real exchange rates of the economy that may generate expenditure shift effects between the domestic and foreign goods; a factor that may affect the net export of a multinational company (Dow III & Kunz, 2010). In line with this, it is critical to determine the fact that MNCs always have access to local as well as international money and capital markets. This, therefore, means that corporations have the capacity to finance themselves in Japan where it intends to run its functions. Besides this, such a corporation also has that ability to control their costs by ensuring that they buy and sell their foreign currencies through the use of different techniques of the trade. In line with this, the most critical job of an MNC is in ensuring that the cash management process is effective in order to avoid the foreign currency risks (Dow III & Kunz, 2010).
In the event that the dollar appreciates as compared to the Yen in Japan, the chances are likely that domestic goods will turn out to be expensive as compared to the foreign goods. On the other hand, when the dollar depreciates than the Yen, the domestic goods will be cheaper as compared to the foreign goods. This aspect, therefore, requires that the MNC develop approaches of changing their pricing approaches to merge the foreign currency exchange rates, a factor that will make their production cheaper (Ibnu, 2015). The MNC can, therefore, utilize this approach due to the fluctuation of the dollar and the Yen rates that makes commodities either cheaper or expensive and how to manage such conditions. The use of forecasting tools and hedging techniques is an efficient approach that MNCs can utilize under such circumstances to take advantage of the foreign currency fluctuation rates in Japan during their period of operation.
3.0 Movements of Exchange Rate and Its influences on MNC
Multinationals that seek to carry out their functions in Japan should realize that their operations are at the mercies of global currency fluctuations. As in this case, the changes in conversion rates of the dollar and the Yen can wipe out the profits of an organization or increase its gains (Ibnu, 2015). An example of this can be portrayed in a case scenario where a MNC which is based in the US makes ¥20 million. It is evident that the firm is likely to end up with more or less than they expect depending with the movement of the ¥ against the US $ in the exchange rate.
In this case, the MNCs should consider evaluating the risks of carrying out their businesses in Japan before venturing into the market. An instance of this can be seen in the example of an MNC that saw the sales in Japan increased in the year 2011, with the yearly profits dwindling as a result of the weakening of the Yen (Jones & Wermers, 2011). This, therefore, proves that investing this year in Japan requires caution considering the fact that the US dollar has strengthened recently and has the chances of continuing so over a period of time.
4.0 Forecasting the Exchange Rate: Forecasting Techniques
It is essential to consider the fact that the operations of the MNC are distributed in regards to the currency fluctuation, a factor that explains the reasons why companies would want to refrain from losses (Jones & Wermers, 2011). However, through the use of forecasting techniques, MNCs can secure their futures from losses since these techniques can estimate the events that come in the future. The main forecasting techniques include: the Technical Forecasting, Fundamental Forecasting, and the Market Based Forecasting.
4.1 The Technical Forecasting
Technical forecasting method assumes that history repeats itself. It employs historical exchange rate data for instance charts and statistical tools in extracting trends as well as patterns to predict exchange rates of the future (Jones & Wermers, 2011). The following table illustrates the Japanese Yen to US Dollar Exchange Rate from January 2016 until November 2016 (Exchange Rates UK, 2015):
Table 1: USD $ to JPY ¥ exchange rate history in tabular form
| Month | JPY (¥) to USD ($) | |
| 1 | January 2015 | 117.55 |
| 2 | February 2015 | 119.36 |
| 3 | March 2015 | 119.04 |
| 4 | April 2015 | 119.46 |
| 5 | May 2015 | 124.19 |
| 6 | June 2015 | 122.42 |
| 7 | July 2015 | 123.88 |
| 8 | August 2015 | 121.22 |
| 9 | September 2015 | 119.93 |
| 10 | October 2015 | 120.05 |
| 11 | November 2015 | 119.26 |
Figure 1: USD $ to JPY ¥ exchange rate history graphically
By using this historical exchange rate, the future exchange rate could be determined. It is notable that MNCs often tend to make limited use of the technical forecasting since this forecasting method focuses only in the near future, which may not be helpful in the development of corporate policies. Mostly, the technical forecast applies only to short durations since the patterns in the exchange rate movements are systematically based (Madura & Murdock, 2012). In the event that the MCN plans to carry out its operations over a period of one year, it is essential to note that the technical forecasting approach may not suitably meet the needs of the firm. In addition to this, the technical forecast also provides fewer point estimates to project possible future values. Since the technical analysis only provides the corporation with point estimates of the possible future values, this approach may not typically estimate the future exchange rate in a precise manner, a factor that underscores its inadequacy as a forecasting tool in managing the MNCs.
4.2 Fundamental Forecasting
The fundamental forecasting, on the other hand, is primarily based in the fundamental relationship between exchange rates and economic variables. Considering the current value of these variables and the historical impact that lies on a currency’s value, the corporations will have the capacity to develop a projected exchange rate (Madura & Murdock, 2012). A forecast, therefore, arises from the valuation of the degree in which the universal activities in economic differences in Japan may impact the exchange rates. Through a statistical approach, forecasting would primarily base its findings on the quantitative measured impact of the market exchange rates.
In as much as the fundamental forecasting, in this case, determines and accounts for the expected fundamental relationship between the currency’s values, MCNs should consider the limitations of this approach (Madura & Reiff, 2009). For instance, the precise timing of the impact of the value of the currency may not be known, a factor that makes the full impact on the elements of exchange rates occur in a period of two, three, or even four quarters. This, therefore, requires that the regression model is adjusted in accordance.
4.3 A Market-Based Forecasting
The procedure of developing a market-based forecast relies upon certain indicators in the market that are based upon the spot rate or the forward rate. The spot rate is utilized as a forecast approach on a spot rate that exists for a future date (Madura & Reiff, 2009). The present spot rate or future rate contains the required information given that the market is highly efficient. In order to determine the usefulness of market-based forecast, assuming that the Yen is anticipated to appreciate against the dollar encourages the MCNs to buy the Yen with US dollars today with the anticipation that this will appreciate, a factor that would force the value of the Yen to rise up.
On the other hand, if the Yen is expected to depreciate against the dollar, MCNs will in this case sell off their Yens with the hope of purchasing them back at the lowest price when they decline in value, a factor that may cause the Yen to depreciate with immediate effect (Madura, & Reiff, 2009). Thus, the current value of the Yen reflects the expectations of its value in the near future. As such, MCNs can make use of the spot rate to forecast since this represents the market’s expectations in accordance with the spot rate in the near future.
5.0 Exchange Rate Risk Management
In order for the MCNs to understand the risks that they are prone to in the Japanese market during their period of operation, it is essential for the management of this corporation to consider the fact that the technical forecast approach that may work for one multinational company may not essential work well for the other (Madura & Reiff, 2009). Considering the abundance of technical models that are in use today, some may generate speculated profits in a given period. However, if the pattern of the currency value appears to be random over a period of time, then the element of technical forecasting may not be effective for the MCN.
This gives the illusion that unless the historical trends in the exchange rate movements are identifiable, the examination of the movements that have been there over the past may not be essential in determining the future movement. Many foreign market exchange participants, therefore, consider this as a technical forecasting approach in the event that this approach leads to a speculated profit, a factor that may change once this approach is used by a different firm (Martin, Madura, & Akhigbe, 2008). In essence, this leads to the trading approach which is based on the model of recommendation that will ensure the currency value is pushed to a different position. The use of technical exchange rate forecasting in addition to this is prone to incur large transactional costs due to the frequencies in trading. The monitoring of currency movements in order to determine a systematic approach is essential since it guides the MCN into avoiding the losses that may be rampant in the Japanese market (Wright, Madura, & Wiant, 2002).
It is essential that in carrying out its operations in Japan over the next year, the MCN should try to hedge the expected detrimental effects as a result of currency exposures which can be forecasted. Considering the fact that the political, economic and other conditions may affect the MCN and its goals, it is crucial that the firm copes with the conditions of the market (Richie & Madura, 2006). The MCN should develop four essential approaches with the aim of counteracting the exposure of the currencies.
The first approach is to monitor the changes in the fluctuation approaches in the market, an element that can be achieved in an instance where a firm may have a high risk in a market’s fluctuations that are determined by the manner in which the Yen and the dollar are sold. Secondly, another element is to lock into the exchange market rate over a lasting duration. In the event that the market’s exposure approximations are correct, the approach may be considered as beneficial for the MCN (Richie & Madura, 2006). MCNs should also consider purchasing currencies in advance if they are aware that they will be making numerous purchases. The other option is to hedge against such exposures through the derivatives. In as much as this approach may be complicated, it may turn out to be effective in limiting the exposure of volatility and also give a precise and clear picture of the operations of the company in the Japanese market.
Lastly, firms may also make the choice of managing their currency exposure rates through engaging in business practices (Richie & Madura, 2006). This helps in managing the losses that can be made when a currency falls, a factor that clearly provides the security of recovering in the event that the other rises. It is, therefore, essential to articulate the fact that dealing with currency exposure entails the management of risks since fluctuations may turn out to be unpredictable.
6.0 Summary and Conclusion
It is critical for a Multinational Corporation to consider certain factors in its one-year investment plan in Japan. The management of the MNC should determine essential issues for this international company considering that in the last decades, the Yen-USD exchange rates have been dramatically changing, a factor that would affect the company in an instance where it fails to mitigate its financial exposure. The Japanese Yen currently exists as a component of account and as a store of value. The Yen is considered the third broadly used currency after the dollar and Euro with the Yen’s role steadily increasing in the international markets. Fluctuations in normal exchange rates of the dollar and the Yen have a way of affecting the economy of Japan through a number of ways that the MNC needs to be fully aware of. Considering the current value of these variables and the historical impact that lies on a currency’s value, the corporation will have the capacity to develop a projected exchange rate. It is essential to consider the fact that the operations of the MNC are distributed in regards to the currency fluctuation; a factor that explains the reasons why companies would want to refrain from losses. However, through the use of forecasting techniques, the MNC can secure their futures from losses since these techniques can estimate the events that come in the future. Forecasting techniques include the technical forecasting, fundamental forecasting, and market-based forecasting. In carrying out its operations in Japan over the next year, the MCN should try to hedge the expected detrimental exposures which can be forecasted.
7.0 References
Cullen, J. B., & Parboteeah, P. (2009). International Business: Strategy and the Multinational Company. New York: Routledge.
Dow III, B. L., & Kunz, D. (2010). Accessing International Capital Markets AT SLC. Journal of the International Academy for Case Studies, 16(3), 125-130.
Exchange Rates UK. (2015). USD (Dollar) to Japanese Yen (JPY) exchange rate history. Retrieved from http://www.exchangerates.org.uk/USD-JPY-exchange-rate-history.html
Ibnu, K. (2015). The Global Stock Exchange and Its Influence toward The Indonesia Stock Exchange After The Global Financial Crisis In 2008. International Journal of Organizational Innovation, 8(1), 133-154.
Jones, R. C., & Wermers, R. (2011).Active Management in Mostly Efficient Markets. Financial Analysts Journal, 67(6), 29-45.
Madura, J., & Murdock, M. (2012). How and why corporate divestitures affect risk. Applied Financial Economics, 22(22), 1919-1929. doi:10.1080/09603107.2012.688937
Madura, J., & O’Brien, T. J. (2001). International Diversification for the Individual: A Review. Financial Services Review, 1(2), 159.
Madura, J., & Reiff, W. (2009).A hedge strategy for international portfolios. Journal Of Portfolio Management, 12(1), 70-74.
Martin, A. D., Madura, J., & Akhigbe, A. (2008).A note on accounting exposure and the value of multinational corporations. Global Finance Journal, 9(2), 269.
Richie, N., & Madura, J. (2006).Evidence of Overreaction among International Exchange-Traded Funds. Journal of Financial Service Professionals, 60(5), 66-78.
Wright, F. W., Madura, J., & Wiant, K. J. (2002).The differential effects of agency costs on multinational corporations. Applied Financial Economics, 12(5), 347-359.doi:10.1080/09603100210124984
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