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Globalization - Business Operations On International Level

   

Added on  2020-03-13

11 Pages2813 Words98 Views
Running Head: Assignment-2Assignment-2

Assignment-22IntroductionThe increased level of globalization has made it easy for the corporations to expand their business operations to the international level. However, the expansion of business to the international level is opens up new avenues for the corporations but at the same time it also givesrise to several risks. Therefore, it is critical for the firms to analyze and form strategies so that therisk could be kept minimized. Question-1 (a)The interest rate parity theory states that the return on investments in the two different countries would be same despite there being difference in the rates of return (Keown, 2002). The interest rate parity theory stipulates that the interest rates may be different in two different countries but the overall return earned by the investor would same in both the countries. This is due to the impact of exchange rate differences between the two countries. As per the interest rate parity theory, the currency of the country would be at discount if the interest rates are higher and due to this relationship, the high return would get set off against the high loss on account of foreign exchange (Keown, 2002).The interest rate in Argentina is 30.25% while that in UK is 1%. Apparently, it seems thatan investor can earn higher amount by investing in Argentina as compared to UK but it is not necessarily the reality. The exchange rate differentials between Argentina and the UK could be higher than the difference in the interest rates. Argentina has interest rates higher than the UK, which means that its currency would be at discount against the UK’s currency. Therefore, the return earned on investments in Argentina could get wiped out due to loss on account of foreign exchange (Kurth, 2011).

Assignment-23Question-1 (b)A firm operating in the UK and considering expanding its operations in Argentina would have ample business opportunities but at the same time it would also be exposed to several risks (Chen, 2009). The firm, by expanding the operations to Argentina, could get access to the international market that would help it to increase the market share. Further, it will add diversification to the firm’s business. Due to the increased diversification, the business loss would be reduced which help it to enhance the sustainability. Further, the firm could get the benefits of cheaper business resources such as cheaper labor, land, and business facilities (Chen, 2009).Further, with the entrance in the international market, there emanate various risks such as foreign exchange risk, credit risk, and political risk. The UK based firm trading with Argentina will face risk of loss due to unfavorable changes in the foreign exchange rates. For example, if the firm sells goods to Argentina, it will carry a risk of loss due to decrease in the foreign exchange rate of GBP and ARS. Further, there would be a risk of amount being not realized due to debtor’s default. The political environment is also different in different countries. Thus, when the firm decides to expand the operations to Argentina, it will bear the risk of political changes (Chen, 2009). Question-1 (c)The derivatives could be used in hedging the risk of loss. In order to hedge against the foreign exchange loss, the derivatives such as future contracts, option contracts, and forward contracts are used (Madura, 2011). A company that imports beef from Argentina would have payables due for payment in the currency of Argentina (foreign currency). This payment of

Assignment-24payables in Argentina’s currency would be due after a few months. If during this intervening period, the currency of Argentina appreciates against the home currency of the company, it will incur a loss. In order to avoid this loss, the firm could take a forwards contract, option contract orit may enter into a forward rate agreement with the bank to buy ARS (Argentina currency) at the specified rate on the payment date (Madura, 2011). Question-2 (a)Exchange ratesGBP=19.5ARSGBP=1.3USDUSD=14.25ARSUsing Cross rates between GBP USD and USD ARS:GBP=18.525ARSThus, in one market GBP is selling at ARS 19.50 and another it could be bought at ARS 18.525, which means that there exist an opportunity for arbitrage profit.Suppose, Mr. X has ARS 1000 Purchase USD @ 18.25 using ARS 1000 70.18USDPurchase GBP @ 1.30 using USD 70.18 53.98GBPSell GBP 53.98 @19.50 1,052.63ARSProfit:Investment 1,000.00ARSRealization 1,052.63ARSProfit 52.63ARS

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