International Finance Assignment : Diageo plc

GLOBAL FINANCE

Table of Contents
INTRODUCTION...........................................................................................................................3
PART A...........................................................................................................................................3
PART B...........................................................................................................................................8
Use of derivatives to hedge foreign exchange risk......................................................................8
Advantages and disadvantages of forwards, future, options and swap to hedge foreign
exchange risk.............................................................................................................................10
CONCLUSION..............................................................................................................................12
REFERENCES..............................................................................................................................13
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INTRODUCTION
Financial management and control in order to maximise the scale of organisation at global level
is recognised as global finance (Turner, 2017). Business entities whether small or large keep
trying to explore their financial operations in order to expand the business at domestic and
international level. This report focuses on such aspects which are associated with global finance
management to explore and enhance the business scale at international level. The report is
divided in two parts as Part A and Part B. A financial plan is critically analysed with benefits and
disadvantages of main source of funds in the part A. Equity and debts markets are focused areas
in part A. Risk factor while funding and international transactions are covered in part B. Use of
derivatives considering the future, forwards, options and swap to hedge foreign exchange risk are
categorised in the B part. Pros and cons of various derivatives in managing FX risk and
mitigating FX risk are also covered in this report. Diageo plc a British multinational alcoholic
beverages company is taken to understand the concept of global finance.
PART A
Several countries are attempting to forego systematically unorthodox fiscal policies set up to
promote stabilization, while some are widening the scope and scale. The main elements of
international finance are the large international organizations, like the Global Investment Fund as
well as the International Monetary Fund and various national institutions and government
agencies, such as central banks, finance departments, and those business companies that operate
internationally (Drezner, 2015). A failure of governments to coordinate priorities and reach
international agreement on issues such as financial regulation also perpetrated the risk of a global
financial structure. Whereas the global financial system is heading towards increased flexibility,
specific domestic and international requirements must be addressed by governments. Emerging
economy officials address a precision task as they must cautiously enforce sound
macroeconomic strategies amid unprecedented market volatility while forcing shareholders to
withdraw their resources to weaker markets.
Diageo plc is a listed organisation in UK. The company is currently trading at £10 per share
and 10 million shares in issue. The total market value of the issued share capital of the company
is £100 million. CFO Kathryn Mikells is requested to frame a report to the board of director’s
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subject to raising an additional funding of £50 million for better growth and sustainability for
international projects. Before understanding the requirements of additional funding and
appropriate funding options.
Source of funding
Organisations needs vast amount of financial needs and sometimes the internal funds
remain insufficient to fulfil the requirements of business. Appropriation of financial sources at
required time of span helps business to grow not only at national but also at international level
too. Sometimes, companies need to collect funding or equity financing, grow their companies
into foreign markets or places, invest in R&D, or ward off competitors. although businesses tend
to use the proceeds of existing business activities to finance these ventures, it is always more
desirable to try outsourced creditors or shareholders. For all of the discrepancies between the
thousands of firms in the world throughout different industries, only a few streams of funds are
accessible to all companies. Various type of funding alternatives is defined as follows:
Equity funds
This is of the alternative of source of funding for fulfilling the capital needs of business.
Equity funds are raised by issuing share certificate to shareholders and investors. An offer of
purchasing of equity shares is given to buyers in consideration of cash (Lall, 2015). The equity
investment remains certified by publishing shares of company in general public. It is issued in
proportionate of amount investment by the investor in business. Equity holders get dividends on
their equity holdings. This is one of the way to generate the fund with in operations. However,
the dynamics of equity funds states the ownership of business in the form of holding the equities.
Advantages: The main benefit of equity funding is less liability to repay the payments of
equity holders. Significantly, the business generates the effective and aspects of spreading the
business with more than one channels. If the organisation is not being able to pay their
consideration back than it may issue right shares that prevent the risk of low liquidity. There is
no extra payment is required to made to equity holders like bonds and debentures. In loss
conditions organisation is not require to pay dividend and profits.
Disadvantages: Main drawback of equity financing is distribution of ownership and
control of business in stakeholders. Profit for organisation also get decreased
Bank loans
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This is one of the common alternative of source of finding for business development and
growth. The loans remain divided in two sections as short term loans and long term loans. If the
duration of repayment of loan is more than one year than it is considered as short term loan.
However, organisations take long term loans to fulfil the large business objectives. Various
financial banks and financial institutions provide low interest loans and credit policies to
companies that wants to grow at international level (Visser, Clapp and Isakson, 2015).
Commercial loan is one of the unique concept added by investment banks and financial
institutions. The duration of these loans vary in between to 3 to more than 20 years. These loans
works as a booster for start-up organisations. However, the low interest rates are the key
attraction point of this source of alternative.
Advantages: Bank credit and overdrafts are a very important origin of business funding,
with loans to small and medium-sized enterprises (SMEs) forming a large part of the dealings of
banks. Banks tend to give competitive debt service levels but typically have a credibility which is
respected and secure. A major benefit, as with any form of debt, is there is no evaporation of
equity or influence relative to the sale for a stake in the company. In several countries, debt also
provides a tax break, because repayments on mortgages are excluded before determining a
personal tax expense, thus increasing it.
Disadvantages: As banks tend to engage in corporate lending, entrepreneurs are left
aside. Banks have low risk levels for other networks we're going to talk about. it remains focused
on medium and small-sized businesses of proven reputations–and of course the obvious
companies–and try to avoid late-stage enterprises with healthy balance sheets or past
transactions. A further problem with bank credit is that its advantages are restricted to providing
money alone - it arrives without any hedge fund experience, nor the exposure of a crowdfunding
site. Sharing of profits reduces retain reserves and the accessibility to run the operations with
effective financial stability.
Crowdfunding
Generally, the meaning of crowdfunding states the fulfilling finance needs from general
public. Crowdfunding provided investors with the opportunity to increase hundreds of thousands
or millions of pounds from anyone with money to invest (Inderst, 2016). Crowdfunding offers a
platform for those with the intention of selling it before shareholders are awaiting. A person who
tried to create a new recipe for coleslaw was one of the more humorous ventures to receive
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funding. This alternative is rapidly used by small and growing organisations. This alternative is
basically based upon three models as project initiator who allows the public to invest in their
proposed fund and individual groups supported with moderating organisation. Entrepreneurial
ventures and creativity also helps in communicating the project.
Advantages: In contrast to the alternate financial sector as whole, equity crowdfunding have
seen a significant increase in popularity as businesses leverage the public's financial power to
penetrate traditional equity barriers (Christophers, 2016). The diverse approach permits for a
wide scale of investors, supplying the community with new possibilities and allowing late-stage
companies to quickly fill financing holes, with company. In certain conditions, businesses can'
adequately fund' as the impetus of a crowd funding campaign soaks up interested shareholders,
moving over their expected goals.
Disadvantages: The abundance of funding sites is a glut of businesses from which to
choose, and while the system itself is cost-effective and moment-efficient, extensive work should
be carried out into the correct system to choose from. Similarly, businesses should be vigilant
about network abuse and insure that no step to protect their privacy has also been provided.
Although funding initiatives can be effective advertising, businesses need to remain aware that
expectations are not achieved–the funding may be back at square one after raising.
Angle Investors
There is a specific categories of entrepreneurs who are working successfully at national
and international level. These investors invest in new ideas or plans. If the plans consist future
sustainability and growth opportunities. These may be an individual person or group of investors.
They reserve the right to oversee the practices of the company for losing their money.
Essentially, it often includes a board of director’s role and accountability protection.
Advantages: Industries are provided with insights and a community of stakeholders by
hooking with seasoned Angels. The presence of Angels also grows the economy within the
system from all those involved (Winecoff, 2017). It makes sense to change the lead of the
Angel–with such a mutual interest, their investing expertise and history enable stakeholders to
highjack this insight for the advantage their portfolios. Demons will function for your company
as advocates, arrange funding and continue to provide their critical business acumen.
Disadvantages: The pluses of getting funding from deities should be measured
cautiously against the constraints and sacrifices tied to it. This is not a benevolent investment on
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their part–any requires a gain, and they're often in a negotiating and administrative role to exert
control and requests on businessmen. Conveying the aim and objective of business plans remain
quite difficult to such investors. It contains an extra cost to organise an event or meeting to
address the business idea and future goals to these investors. One of the major disadvantage of
angel investors is seeking for new business ideas and goals they do prevent to invest in already
established or stabled business.
Debt funding
Debentures and bonds are also recognised as an alternative source of funding for business
wants to explore at international level. This source is similar like bank loans. Debts are issued to
investors with a significant rate of interest at which organisation is liable to pay interest even
after having losses. Debt funding remain risky in term of exploring the business at large level
because the interest is required to pay in both loss or profit situation.
Advantages: the ownership remain stable in the hand of business owners. the rate of
interest also remains lenient comparatively to other commercial loans and advances
(Lagerwaard, 2015). Consideration of debt is paid in the form of interest which is deductible
form revenues before payment of taxes and dividends. There is no excessive burden remain on
business to repay the bonds or debentures. The interest rates also remain stable as decided in
contract before issuing debenture.
Disadvantages: The option of debt financing remain costly for business because the
principle and interest eventually paid to debenture holders. The payment also reduces the
possibility of having less reserves and surplus (Dymski and Kaltenbrunner, 2016). Excessive
debts enhance the financial leverage that remain risky for business to stabilize financial
performance of business. The impact of working capital also enhance the maturity of debt
financing.
From the above description of source of alternatives, it is examined that equity and debt
financing are considered adequate source of funding. Creditors and shareholders generally prefer
low expenses-to-equity levels because, throughout the case of a business loss, their assets are
better protected. As the CFO of Diageo is seeking to raise fund of £50 million. The debt and
equity financing ratio must be between 1 to 1.5. If the proportion rises, creditors fund the
company rather than from its own funding assets, which can be a bad trend.
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PART B
Use of derivatives to hedge foreign exchange risk
In present time, there are number of risk and other contingencies related with expansion
of business for a company, that are needed to be determined and resolved with the best
derivation so that productivity and profitability keeps of increasing. When business expand to
different part of world, the major problem or any risk faced by companies are related with
receiving or making payment (Puetter, 2016). Therefore, manager focuses to implement and
include various meaningful derivations such as forwards, futures, options and swaps that are
beneficial to determine and reduce the risk factor or circumstance in context to payment dealing
at international boundaries. As Diageo, conduct business abroad, it might just face exchange rate
risk: the currency rate may adjust as foreign money is converted back into national currency.
There are major four types of derivation that are as follows:
Forward: The basic form of derivatives currently available in market are forward
transactions. These are considered to be most advanced form of derivatives that mainly deal of
developing an agreement to sell anything in nearby time. The parties involved in forward
contract makes a decision that is to fix the price of transactions on the same date when it actually
take place. Moreover, forwarded contracts are even more versatile as when the partners can
determine the specific product and the product volume and the settlement date. These kind of
contract mainly takes places among two counter parties which defines that exchange is not
negotiator in the context of forward transactions due to which there are more chance of
counterparty credit issues to the respective firm. It is also stated that this agreement helps to the
both parties to fix the exchange currency rate at the same time of contract which is beneficial to
buy or sell the respective currency on a predetermined future date.
Future: This kind of derivation are totally different form the forward contract such as the
future transactions are mainly traded on central exchange rate in fact of over then counter market
that results to effective and faithful determination of prices. It is related with more standardized
instrument that mainly specify the delivery of right quantity of particular goods on appropriate
time and place on decided date (Storm, 2018). Business deals on futures exchange and is liable to
regular transaction. Future contracts have developed from forward contracts which have many of
the same functionality as it deals in structured markets. This business transaction are different
from forward contract as they are related with process of regular settlement which helps in easy
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business of Diageo in particular time frame. Future contracts, furthermore, are mentioned on the
exchange list stating that such it acts like as an n intermediary agreement. Such agreements are
therefore prepared of generic form and there is no way to change these types of business
transaction. Another crucial note to be added in term of futures contract is that the sellers and
buyers are not part of any kind of agreement as they are needed to enter into a trade deal.
Option: The third derivative type is known as option which differs significantly from
other mention above derivation (Boako and Alagidede, 2016). Both parties are obligated by the
agreement to perform a certain obligation at a certain date in forward and future business
contract. But on the other side Option agreements are deemed to be asymmetrical, in which
binding on one partner is important and requiring the another party to determine the appropriate
future date for making a contract that must be before the expiry of that agreement. Therefore, at
future date, another party seems to have the obligation to sell and buy while the other party have
a option to make specific decision. This option contract has two type call and put option which
means that Call option offers company the option but never the responsibility to purchase
anything at a particular price on the future date. On the other side put option offer the right and
determine that it is not necessary to trade anything on predetermined rate at a specific time
period.
Swaps: Swaps are financial transactions allowing both parties to swap inflows and
outflows of cash. The swaps typically involve exchanging for a variable income in relation to a
set of specific company cash flow. Interest rate swaps, product and currency swaps seem to be
some of common forms of swaps. Swaps allow businesses, among other risks, to reduce foreign
exchange risks. On the market, swap deals are not typically traded (Visser, 2015). These are
personal agreements signed by two parties. Investment bankers usually act as intermediaries for
these deals. It can be understandable by the example of risk mitigating interest rate swap as it is
assumed the notional principle of 1000000, apart from credit risk, fixed flows are risk free, cash
flow which will remain uncertain at initiation in orange. The formation of 1-year rate happened
to equal today’s forward interest rates, increasing in short duration parallel to today’s forward
interest rates. Increase in short term rates will increase and V.V. as cash flow in interest rate
swap for four years will remain fixed at £19925.20 and floating for 1st year £13250, 2nd year
£20763.90, £23764.90 for 3rd year and 22253.30 for 4th year. The receiver of floating payer fixed
protected against will enhance in short term interest rates. Gains on swap offset business losses
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due to rise in rates. Receiver of fixed payer of floating protected in respect of protected will fall
in long term interest. Gains on swap offset business losses due to decreased in rates. As the
interest rates are parity relations with currency swaps with credit exposure.
Advantages and disadvantages of forwards, future, options and swap to hedge foreign exchange
risk
Forwards
Advantages: These can be measured towards the coverage duration as well as the
exposure's cash weight. Forwards are custom-made and it can be prepared for any length and
number (Rethel, 2017). It's offering a full protection. This not only provide price protection but
also remains easy to understand for users. These remain high form counter products. Transaction
cost in some cases remain avoided in and there are no restrictions on less sales. The risk free rate
is used for borrowing and lending. Arbitrage options are deflated whenever it arises. Price
movement risk is being controlled through forwards.
Disadvantages: There is a lack of liquidity remain associated with private contract. The
risk of defaulting of counterparty remain high with forward contracts. These type of contracts
remain unorganised which creates complexities while framing the contracts. Once the contract is
breached than entering in new contract become difficult for contractors. It is recognised that the
tying up capital remain required at high level due to which liquidity get decreased and cash flow
before settlement get misbalanced.
Future contracts
Advantages: Big volumes of securities exchanged on a daily basis, there is still a great
opportunity to position trading requests very rapidly. For such a reason, jumping a jump to
something like a new level is unusual for the rates, and trade in futures contracts is very active.
Therefore, the profit needed to hold a futures market is low and, if he correctly predicted that
buying pressure, he earns huge profits (Wolff and Zachmann, 2015). Time duration is one of the
major advantage for users in case of volatile assets in most of the cases the trading cost remain
fixed which mitigate the risk of changing interest rates.
Disadvantages: These are made especially useful for both the danger-tolerant small
investor by their standard functionality and also very high pay-out rates. For example, future
might not be the greatest way to purchase shares, but is a good way to purchase different assets
like resources, currency and indices. The volatility allows these stakeholders to engage in
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industries they would otherwise never has had exposure to. Time period remain already set in
future projects due to which certain investments remain worthless and reduce credibility for
users.
Options
Options are derivative methods that investors and traders use before paying compensation
to protect the risk of price movements. The major benefits and drawback of option contract for
respective company are discussed below:
Advantages: Buying and selling options gives both buyers and sellers flexibility as it
could be used to earn a profit of the ever-changing market in a broad range of techniques
(Bassens and Van Meeteren, 2018). With the help of this derivation investors are able to control
any kind of risk associated with investment and it also support in reducing these potential risk.
Option contract are treated to be less risk as compared to any other contract option or trading
techniques. It is most beneficial to avoid large loss to company due to limited risky factors
within option premium.
Disadvantages: The main drawback of option trading is that it gets expired on a
particular time that leads to huge losses to the following party those are part of purchase option
(Sassen, 2016). Option contact are more complex rather than any other trading instrument
therefore it requires a closer overview and maintenance.
Swap
In present time the concepts of currency swaps are in more demand and trend because it
provides extreme level of additional flexibility. In many complicated situation swaps also
enables the both parties arbitrage across different matrix of currencies and various short term
maturities. There are number of advantages and disadvantage of Swaps for Diageo that are
discussed below:
Advantages: This mainly depends on the standard of competitive value analysis through
which one lender replaces the competitive advantage they have to the other lender's supply and
demand (Langley, 2018). The defined results between both parties is beneficial to arrange funds
at lower cost. It is used to gain advantage of the new finance platform for both parties by
disclosures of competitive advantage. It is also used by management of Diageo to hedge risk
such as any down fall in the current interest rate then manager are needed to replace fixed rate
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obligations with floating rate. Swap contracts can solve risks due to interest rate variations and
can exchange treaties could also be reached in specific time period.
Disadvantages: The main drawback of SWAP contract is that early termination of swaps
even much before the time of maturity that may create the chance of breakage cost. There is
more possibility of lack of liquidity.
CONCLUSION
The above report discusses about the concept of global finance in order to determine the
aspects of international expansion of business with optimum source of fund. The report covers
the criteria in two sections as first section is able to correlate the requirement of source of
funding for global expansion. Critical evaluation and description of source of funds provides an
idea that which source of funding is beneficial for company to maintain the financial leverage in
adequate level. Considering the cases in the given report, equity and debentures are best option
for source of funding. Second part of report is able to critically compare different derivative
alternatives to hedge foreign exchange. It is evaluated that each derivative has its own
advantages and disadvantage that mitigate the risk in different scenarios.
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