International Financial Management - Essay Example

International Financial Management Part 1) As per the scenario, there are two options for the leader to go for speculation in the market which are dealing with either forwards or options (currency futures is not given in the question). Both the scenarios are discussed in the following: Currency Forwards As far as currency forwards are concerned the currency 12-month forward rate available to the company is $1.3705. So Dollar will likely be appreciated in the future. But the leader is quite optimistic and views that the Dollar will become stronger as compared to Euro such that the leader can anticipate the Euro trading for $1.41. In this way what exactly the leader can do is to invest $500,000 in the forwards such that after 12 months, whatever be the prevailing price of Euro, the Euro would be provided by the other party at $1.3705. Assuming that, at that point of time, the Euro comes to $1.

41 then the leader can earn some good returns by buying the Euros at the forward price of $1.3705 and sell them in the open cash market at $1.41. However, if the price decreases, the leader would have to incur losses. Currency Options In case of currency options, the leader can buy a call option (right to buy) at 1.3705 for a period of 12 months. If the current market price remains lower than 1.3705, then the leader would let the option expired because he/she can buy the Euros at lower price from the cash market (Investopedia, 2011).

For that matter, the only loss that would have to be incurred by the leader is the premium price paid on buying that call option. However, if the price reaches to $1.41, then the call options can be exercised such that the leader will buy Euros at $1.3705 from the call option it purchased earlier and immediately selling those Euros at a higher rate of $1.41 in the open cash market. 2) The amount return is as followed if the desired price of $1.41 is achieved: Buying   Amount in Dollars 500,000 Exchange Rate 1.

3705 Amount in Euros 364,830 Selling   Amount in Euros 364,830 Exchange Rate 1.4100 Amount in Dollars 514,411 Dollar Sales 514,411 Dollar Invested (500,000) Net Return in Dollars 14,411 Net Return in Percentage 2.88% 3) As discussed above, the two opportunities are available to the leader such that both have different risk features. For instance, in case, if the leader intends to go for speculation through forwards, there are some high risks elements involved in that deal such that the agreement is binding from both the sides, liquidation risk of either party is also possible etc (Investopedia, n.d.).

Hence, the forwards are more risky in their nature and should be avoided especially when investment is going to be made with speculative mindset. On the other hand, if the leader is interested in earning higher returns but with a lower level risk then currency options are the best choice for the leader. The currency options provide a choice to the investors to exercise their options at their own discretion. Not even this, the investors are also provided a facility to let their currency options expired if exercising those options is likely to result in losses.

So there is a kind of guarantee available to the investors that they can avoid losses. If the currency options go into favor of the investors, they can exercise their options and buy at option rate which is a lower rate and sell immediately at the prevailing rate in open cash market. It is important to note that the investors have to pay the premium irrespective of the gain, loss or even in case of letting those options expired without exercising them. 4) The inflation rate has a negative or inverse relationship with the returns (Investopedia, 2010).

For instance, if the inflation rate increases at a rate higher than the rate of return, then real rate of return of would be decreased thus the investor may not be having any advantage of earning the normal return. However, if the inflation rate remains lower than the rate of return earned by the investor, in that case the investor remains successful in generating the real rate of return such that his/her purchasing power increases and the $1 can buy him/her more items than earlier before. Part 2 In order to extend the credit facility to the importer of the goods, two main documents are used for this purpose (Letter of Credit Forum, n.d.).

These are letter of credit and a bill of exchange. 1. Letter of Credit This document facilitates the importer such that the importer is allowed some extension in making payments to exporter by the importer’s bank. The importer’s bank pays the exporter the amount of goods on behalf of importer through letter of credit and receives the payment from importer at a later stage. 2. Bill of exchange This document is issued by the exporter with the importer’s approval to pay the amount of goods at a specified time when the bill of exchange is presented by the exporter to its bank.

The exporter’s bank makes the payment to the exporter and keeps the bill of exchange. Later on, when importer makes a payment then that payment is returned to the exporter’s bank which had earlier released funds by accepting the bill of exchange. 3. Export-Import Bank of United States This institution is a famous bank especially in facilitating both the exporters and importers. The biggest reason for its establishment is to serve those exporters and importers which cannot be exposed to any credit risk (Export-Import Bank of United States, n.d.).

The other important reason for existence of this bank is that it does undergo any competition with other commercial and private lenders in respect of appropriate credit facility and the interest rates. Since it provides the most secure financing services especially to the exporters, therefore the interest rates charged by the bank are generally different from the commercial lenders. References Export-Import Bank of United States. (n.d.). Global Access for Small Business. Retrieved April 13, 2012, from Export-Import Bank of United States: http://www.exim.gov/smallbusiness/ Investopedia. (n.d.). Currency Forward.

Retrieved April 13, 2012, from Investopedia: http://www.investopedia.com/terms/c/currencyforward.asp#axzz1s7UDuB00 Investopedia. (2011, September 25). Investopedia. Retrieved April 13, 2012, from Getting Started In Forex Options: http://www.investopedia.com/articles/trading/04/101304.asp#axzz1s7UDuB00 Investopedia. (2010, August 11). The International Fisher Effect: An Introduction. Retrieved April 13, 2012, from Investopedia: http://www.investopedia.com/articles/economics/10/international-fisher-effect.

asp#axzz1s7UDuB00 Letter of Credit Forum. (n.d.). DIFFERENCES B/W BILL OF EXCHANGE AND DRAFT? Retrieved April 13, 2012, from Letter of Credit Forum: http://letterofcreditforum.com/content/differences-bw-bill-exchange-and-draft