Exchange Rate Risk: Financial Decision Making in China - Case Study

This case study analyzes the financial decisions of an Australian investor establishing a language school in Beijing, China, focusing on the impact of exchange rate differences between the Australian dollar (AUD) and the Chinese Yuan. It explores the advantages and disadvantages of the exchange rate systems in both countries, strategies for repatriating profits from China to Australia, and potential implications of a financial crisis. Furthermore, the study discusses funding options for business growth, currency choices for loans, methods for mitigating foreign exchange exposure, and alternative expansion strategies such as joint ventures and international franchising. The analysis covers critical aspects of setting up a business in China, including financing, growth plans, and risk management, emphasizing the importance of careful consideration of various factors for effective decision-making. Desklib provides access to a variety of solved assignments and past papers to aid students in their studies.

AN ASSIGNMENT ON
THE FINANCIAL DECISION
BASED ON EXCHANGE RATE
DIFFERENCE
Student Name:
Professor Name:
University:
Semester:

TABLE OF CONTENTS
• INTRODUCTION AND BACKGROUND
• ANSWER TO QUESTION NO. 1
• ANSWER TO QUESTION NO. 2
• ANSWER TO QUESTION NO. 3
• ANSWER TO QUESTION NO. 4
• ANSWER TO QUESTION NO. 5
• ANSWER TO QUESTION NO. 6
• ANSWER TO QUESTION NO. 7
• CONCLUSION
• REFERENCES

INTRODUCTION AND BACKGROUND
• Exchange rate difference is a key factor based managerial
decision, very common for MNC’s entering international
transactions.
• Examples of such transaction includes purchase or sale of goods or
services, extending or acquiring loans from the foreign countries or
sometimes making or receiving foreign investments in the
business.

INTRODUCTION AND BACKGROUND – CONTD.
• Given case: An Australian investor has made an investment of
AUD$60000 in the China for setting up school in Beijing to teach
the spoken English to the Chinese people (Bena, et al., 2017).
• The revenue and expenses of this Australian subsidiary are
denominated in the in the Chinese Yuan.
• Major share of this profit is sent back to the Australia.

QUESTION NO. 1
• Major advantage and disadvantage of the exchange rate systems
in place in Australia and China has been shown below.
• The exchange rate between the AUD $ and Chinese Yuan is
AUD$1= Yuan 4.8450 as on December 28, 2018.
• Chinese Yuan is undervalued in comparison to the Australian
Dollar, that shall make the export cheaper for the China to
Australia and at the same time it shall make imports costly
between the same.

QUESTION NO. 1 – CONTD.
• Similarly, Australian exports are costlier for China and imports
are cheaper on the other side (Alexander, 2016).
• Impact on business: China shall show its investment from
Australia in equivalent to Yuan 290700 and the Australia shall
be able to earn more Yuan.

QUESTION NO. 2
• Purpose: Bringing back the profits earned in China back to Australia.
• Major strategy to be used (Option 1): Payment of dividend to the
Australian investors.
• Requirements or pre-requisites for the same: huge amount of
documentation like the annual audit, annual tax report in china and
the same is allowed only after the settlement of the carry forward
losses from the business (Choy, 2018).
• Rate of WHT to be applied in China: 10%.

QUESTION NO. 2 – CONTD.
• Major strategy to be used (Option 2): pay 25% corporate tax profits
on the profit earned from business in China and set aside 10% of the
remaining fund in the reserve to be reinvested in the future.
• Requirements or pre-requisites for the same: withholding tax @ 10%
as has been prescribed in the tax treaty (Werner, 2017).
• Major strategy to be used (Option 3): Payment of the royalty fees to
the Australian Investor.
• Requirements or pre-requisites for the same: withholding tax @ 10%,
thereby less tax burden as compared to dividend.

QUESTION NO. 3
• Assuming that there is a repeat of the Asia Financial Crisis that took
place in the late following would be the implications:
• PBC action:
 Chinese Yuan too shall be depreciated and thus it shall make its
currency a weaker currency that shall favor its export and
adversely affect its import.
 Selling of the AUD$ and buying the Yuan
 Raising the rate of interest so that the foreign investor can invest
more in the Chinese economy to earn more rate of Return on
such investment (Linden & Freeman, 2017).
 Provide some fundamental assurance to the investors.

QUESTION NO. 3 – CONTD.
• Reserve Bank of Australia (RBA) action:
 Devaluation of AUD as and when it becomes stronger than the
Chinese Yuan as it may impact the Australian exports to China.
 In such case an Australian investor shall be able to earn less
amount of profit from its business in China (Goldmann, 2016).

QUESTION NO. 4
• Objective: Pursue the idea for the further growth of the
English language school business.
• The financial market provides the platform to raise funds in
the foreign country as well as the domestic country to raise
the fund for the foreign investment by issuing securities in
the form of shares and debentures etc.

QUESTION NO. 4
• Major financial market instruments include Global depository
receipts, foreign currency convertible bonds and the external
commercial borrowings (Heminway, 2017).
• External commercial borrowing can also be used considering
debt from international market, which would also help in
keeping the debt cost lower.

QUESTION NO. 5
• Purpose: Currency to be chosen for funding and its advantages and
disadvantages.
• The investor would like to raise the fund in the Chinese Yuan.
• Major Advantage: Large amount of Yuan can be raised as the
Chinese Yuan is currently depreciating and it can be easily invested
in the business of china which deal with the Yuan (Jefferson, 2017).
• Major Disadvantage: In future if the value of the Yuan starts
appreciating due to the measures taken by the Chinese government
then in terms of interest and repayment of loan higher amount of
outflow may cause it costly.

QUESTION NO. 6
• Purpose: Mitigating the risk of foreign exchange exposure for loan
payments in AUD.
• To mitigate this risk, the hedging instruments can be used like
futures and forwards.
• The future contracts are the standardized contracts specifying the
conditions for currency exchange that includes the expiry date,
amount and rate of exchange. Futures are traded on the market and
is available in major currencies only (Kok, et al., 2017).
• Forward contracts are the one which is having the same feature as
that of the future with the only difference is that these are much
customized one but are much more risky than the futures.

QUESTION NO. 7
• Purpose: Other ways of growing the business and funding the
expansion.
• Expansion can be done via entering into the joint venture with the
Chinese renowned schools or international franchising.
• The international joint venture has the advantage that it can help to
acquire the control in the foreign entity on a cost sharing basis and it
shares the amount of risk or reduces the amount of risk as the joint
venture partner too partially bear the same.
• It has the disadvantage that the full control over the foreign entity is
not possible which is shared with the Co joint venture.

QUESTION NO. 7 – CONTD.
• The other form of the business expansion is international franchising.
• The major advantage in this case is that there is no significant
capital contribution to be made rather the earning s being generated
through the franchisee fee.
• In this case there is huge possibility of the quality degradation of
service as no control over the foreign entity remains in hand (Kew &
Stredwick, 2017).

CONCLUSION
• The presentation covers all the important and critical aspects of
business setting up in China with the head office and the owner in
Australia.
• It requires a careful analysis of the several factors keeping which in
mind the managers need to take the decision.
• The presentation covers the aspects like financing of the concerns,
expansion and growth plans, mitigating the foreign exchange
exposure and various other aspects.

REFERENCES
Alexander, F., 2016. The Changing Face of Accountability. The Journal of Higher Education, 71(4), pp. 411-431.
Bena, J., Ferraira, M., Matos, P. & Pires, P., 2017. Are foreign investors locusts? The long-term effects of foreign
institutional ownership. Journal of Financial Economics, pp. 21-35.
Choy, Y. K., 2018. Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis.
Ecological Economics, p. 145.
Goldmann, K., 2016. Financial Liquidity and Profitability Management in Practice of Polish Business. Financial
Environment and Business Development, 4(3), pp. 103-112.
Heminway, J., 2017. Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and Organic
Documents. SSRN, pp. 1-35.
Jefferson, M., 2017. Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland. Technological
Forecasting and Social Change, pp. 353-354.
Kew, J. & Stredwick, J., 2017. Business Environment: Managing in a Strategic Context. second ed. London:
Chartered Institute of Personnel and Development.
Kok, U., Ribando, J. & Sloan, R., 2017. Facts about Formulaic Value Investing. Financial Analysts Journal, 73(2),
pp. 14-23.
Linden, B. & Freeman, R., 2017. Profit and Other Values: Thick Evaluation in Decision Making. Business Ethics
Quarterly, 27(3), pp. 353-379.
Werner, M., 2017. Financial process mining - Accounting data structure dependent control flow inference.
International Journal of Accounting Information Systems, 25(1), pp. 57-80.