Currency exchange risks- What should we do to cope with?

International trade is the common trend toward the globalization of world economy. It brings many benefits to the firm.

European companies invested in Asia countries got many chances to gain more profit by reducing costs. First is the labor resource. Some low- developed countries like Nigeria, Laos, Cambodia has a huge source of labor, who are unemployed. They are willing to work for foreign companies to pay off their expenditures. On the other hand, land resource also is plentiful, provides good conditions to infrastructure aspect.

In contrast, developing countries like Vietnam, Thailand as well got benefits from this trend. By expanding market share to over the world, companies can approach more potential customers, get more opportunities to gain profit.

According to figures from the US Commerce Department, United State, the largest economy reported an increasing up to 2.5% in the third quarter of the year 2011, partly due to the international trade (BBC, 2012).

However, is international trade always good, always brings benefits to organizations?

Following theory, one issue raised is the risk from currency and tax.

First is the tax burden. With different policies, tax rate may differ from countries. For example, car manufacturer like Mercedes Benz needs to consider the real estate tax rate before deciding to build its factory, in which tax rate in Cambodia is 0%. In Thailand, a tax of 12.5% is levied on the appraised rental value of real property while real estate tax is imposed at a flat rate of 12% on annual rental income of the leased property in China. Because of different policies, real estate tax in Vietnam is more flexible, which is decided by the occupation of the real property (Tax rates, 2012). In my opinion, if real estate tax rate is the unique issue needed to concern, so investment in Cambodia seems to be the best choice.

Another risk organizations may meet while trading or selling goods across countries is currency exchange risks. The risk is divided into three categories.: transaction, translation and economic risks.

According to European Economy, transaction risks refer to the influence of exchange rate toward the value of committed cash flows (cash flow decided in the contract). Risks rise because of unfavorable foreign currency fluctuation.

Translation risk is about the impact of exchange rate fluctuations on the valuation of foreign assets or liabilities. The risk occurs due to the internal reason, when parent company translates figure of asset or liabilities of foreign subsidiaries. Fluctuation of exchange- rate day by day can have high influence to performance of the firm.

The last economic risk is the impact of exchange rate movement on company’s performance compared with its competitor due to the unfavorable changes of exchange rates in short or long term.

The exchange- rate brings many obstacles to businesses during its operation. Journal “Strong yen hits Japanese carmakers” by Jorn Madslien on 2^nd December, 2011 reported the situation of Japan.

car industry. The world’s largest carmaker Akio Toyota even stated that "The current exchange rate has really made it difficult to be profitable making cars in Japan,". He also intended to reconsider Toyota’s commitment to produce three million cars per year in Japan.

Many discussions risen to discuss the solution for the problem, in range of business itself or even globally. The term “hedge” is used to replace for dealing with the currency exchange risks.

In range of organizations, solutions could be:

-       Insisting: foreign customers commit to pay contract in company’s home currency.

-       Intra- organizational currency is set by multinational companies.

-       Forward market (includes wide range of currencies) or futures (includes limited range of currencies) hedge: currency exchange is chosen at a fixed time in future.

-       Etc…

In range of global, global currency is now discussing. Economics editor Stephanie Flanders from BBC News listed out some facts.

“The US overtook Britain as the largest economy in the 1870s, but the dollar didn't truly displace sterling as the world's anchor currency until the 1930s”.

Or, “In the 1970s, Germany and Japan resisted a larger role for the D-mark and the yen for similar reasons. And in the lead up to the 2008 crisis, China had exactly the same reasons for holding back on the internationalisation of the yuan”.

(BBC News, 2012)

With many inadequate, that could be the reason why United Kingdom’s Government decides to use its own currency Pound, instead of using Euro currency as other European countries.

So, what is the solution for the problem?

Should Government find more solutions or just do nothing, and simply take the risks, hoping for favourable foreign exchange rates??

Facebook OPI: Good news or bad news?

Capital is a necessary element for any business for its continuous operation. A business may raise money by selling share. That is the way that Facebook- the world’s largest social networking site has already used. Achievement of the organization is clear with totals 845 million members. They have shared more than 100 petabytes (100 quadrillion bytes) of photos and videos with Facebook a day.

Therefore, Facebook filed paper an initial public offering (OPI) to raise $5 billion is the hottest event. The event as well opens a new phase for the organization history.

It is said that Facebook is a successful business with the total revenue up to $3.7 billion and $1 billion profit last year. The data is much higher than Google- another famous network site was when it debuted on public market.

Many people are filled with the aspiration to the success of the organization. I- Spy, which used to send nearly all of its clients' marketing budgets in Google's direction, is now putting about 10% on Facebook, and expects that to grow. Jim Brigden, I-Spy's CEO, also showed his belief in the success of the firm.

Lawrence Summers, the former secretary of the Treasury thought “it is a major sign of maturation”. He recognized that would be Mark Zuckerberg’s remarkable achievement as Zuckerberg just built a global institution in a very short time.

Facebook’s IPO could not be the biggest IPO in America history but it is definitely the biggest ones in Internet and technology’s history, said by David Kirkpatrick, author of "The Facebook Effect."

However, Facebook IPO- is it really a good news???

There are some obstacles available for Facebook’s Board of Management while doing OPI.

Firstly, regulation under SEC requires the firm to provide fully information about certain financial position. It means the firm cannot keep its finances private anymore. “By going public, Facebook loses some of is mystery and cool, having to declare profits and losses and answer to shareholders every quarter”.

On the other hand, with the target to raise $5 billion and the company’ stock market valuation is in the expectation $75 billion to $100 billions, it means “that only 5 to 7 percent of the company’s shares will be available to public investors”. I think that it will be a challenge for the firm to create an amazing, incredibly change, especially in short time.

Additionally, with previous achievements, the public has the rights to expect more in the performance of the firm.

Company was reported with doubled $1.6 billion revenue as well as $500 million net income. It is a nice result but parties like Wall Street still want to see another thing different.

“Can Facebook continue to grow its fast? That is the question”, said Michael A. Yoshikami, chief executive of wealth management firm YCMNET Advisor.

What is Facebook going to do for sustainability and growth?

There are two main activities for Facebook to earn profit. One of them is advertising. Trip Chowdhry, an analyst at Global Equities stated that “much of its potential advertising revenue is dependent on the frequency of sharing”. However, IPOs are not always successful. Look back the history, case of Zillow is an example, in which the company priced its IPO at $20 per share, with the stock ending its first day at $35.77. Another case is Pandora offered its shares at $16 when it went public in June. Now, the stock trades around $13.

Deciding to become a public company, Facebook must put more effort to gain more profit.

It is calculated that, although Facebook IPO is an interesting topic, it still cannot excite people due to its threat.

Stock market efficiency- Would you be willing to gamble?

Stock market now plays an important role in the economy, as it is a useful source for organizations to raise capital, investors to trade their shares and gain more returns. An ideal stock market is the one, which is fair- play, shares brings the same opportunities as well as benefits to investors. It is called efficient market, in which up- to- date information influences to the share price, quickly and rationally. It means that if the information is positive, the share price will follow the upward trend, and fall when a bad news is announced.

However, in real situation, a perfect market rarely exists. Fama (1970) classified market efficiency into three levels. In strong form level, share price reflects all kinds of information, even it is privately held. The lower level is semi- strong form, in which share price reflects fully the relevant publicly information. Finally, the weak form, where current price just reflects all information contained in past price movements.

                                                                                                    

Related to the theory, one question has been raised, in which have share prices always have positive performance toward its related good news?

When looking at the De Beers, there is evidence to prove that it is a semi strong form of efficiency. Information made available had influenced to the performance of the organization share’s price. In 2011, after Diamond producer De beers announced a surge in profits as Chinese and US shopper snapped up its gems, its share capital and reserve increased from $3,279 in 2010 to $3,996 in 2011. Following a report by the world’s biggest distributor of diamonds, the average market prices rose by 35 per cent (Financial times, 2011). It means that the firm gained more investments from investors, led to an increasing in profit up 62% to $698m (£443m).

However, there are some other real data proved that the stock market is not really efficient. According to the Wall Street Journal (2010), on may 6^th, the Dow jones Index fell nearly 1,000 points only to rebound rapidly by the end of the day. In the same year, Internet stocks vertically to zero after rising to phenomenally high prices. One noticeable thing must be remembered is that there was no announcement about these changes. I think it is a great example of the lack of efficiency. The case also follows the concept of “random walk”, in which share price movement cannot be predicted based on the past data.

Through two examples given out, in my point of view, I do not believe in the theory of stock market efficiency. It is dangerous for any investor to make investing decision just based on published information.

The theory also is not applicable especially under the competitive pressure nowadays. If stock market is efficient, people do not need to compete, just seeking and following strictly information published, their shares will be fairly priced. In fact, people tend to find the undervalued shares, make analysis and gain more the returns.

In point of view of Kendall (1953), share prices move randomly, without any patterns or trends. Trend of share prices is compared as a “drunken man”. So, we cannot base on the previous information to predict what might happen in the future. We also cannot completely believe in new information to define the future share price. It is confusing or even gambling to assess share price.

Is it the case that we need professional analysts, who have expertise and knowledge to guide us?

Here, importance of the analyst is more concerned.

I think analysts do have an important role in this situation. Although it is said that share price is unpredictable, opinion of analysts still is useful. By having more knowledge as well as experiences about changes of share price, they can give us recommendation and reasonable investigations. On the other hand, they also are able to give investors an overview about companies as well as the global economy. It could be useful information before any investing decisions. That is the reason why economic analysts always are respected.

To summary, based on real situations, I believe that stock market efficiency does not and should not exist in this competitive life to ensure the fair for people. They should base on their knowledge, expertise or even lucky to gain returns from their investments. However, they still get support form analysts to be more successful.

Shareholder wealth in Royal Bank of Scotland

Objective of each business is to maximize the value of the firm for its owners, that is to maximize shareholder wealth. It is successful if manager can maintain as well as balance rights and benefits of all stakeholders in the organization.

BBC News Journal published on January 30, 2012 mentioned case of Royal Bank of Scotland (RBS) as an example illustrated for the shareholders wealth, in which the issue was not concerned effectively.

According to Sternberg (1998: 95), “organisations, including corporations and particularly businesses, should not be run to serve the interests of their owners, but for the benefit of all their stakeholders. However, in the situation, Stephen Hester, chief executive of RBS received a bonus of £1m, irrespective of the difficulties of the organization.

Personally, I think that the reward is not reasonable because it just concentrated on benefits of the leader while ignore other stakeholders. A large amount of money was used with wrong purpose, instead of saving the situation of the organization. In 2008, at the moment Mr. Hester was appointed, the Bank was in its worst performance ever, which reported the largest loss in UK corporate history of £24.1 bn. It also is the year, the firm fully got loss. The performance still not got better in next years, with the continuous loss of £3.6bn in 2009 and £1.13bn in 2010.

“Shareholder wealth is represented by the market price of a firm’s common stock” (McGuigan, 2009). The chart below represented for the negative share performance under Mr. Hester management.

It is easy to see the downward trend of the share price through 2009 to 2011 of the organization. “Under Mr Hester, its shares have fallen substantially to about 27p currently. Its stock fell 48% last year. In 2007, RBS shares were worth about 370p”.

Another evidence shows the unfair of the Managers to different types of shareholder is the way of fund distributions. Except £1.2m base salary, chief executive of the Bank also was awarded a large amount of £6.5m of share, while staffs got difficulties with the decisions. Unable to manage number of employees, RBS announced a redundancy of 3,500 jobs from its global banking division. It means the firm had removed more than 11,000 employees, pre-credit crunch headcount of 24,000. David Fleming, national officer for the Unite union, considered it as an hypocrisy of the Board of Management, which has sacked over 21,000 staff, while still attempting to pay bumper bonuses to the bosses."

There is a huge criticism of the payment to Mr. Hester. More than 90,000 people had opposed violently this decision. Brendan Barber, general secretary of the TUC evenly describe the bonus as a “huge mistake” especially when the Bank met difficulties in operation as well as the freeze and cut down of pension entitlement.

However, an argument has been made to debate for the event. At first, we cannot deny the effort of Mr. Hester toward the recovery of the Bank. For the first 9 months of 2011, RBS made pre- tax profits of £1.2 bn. Management of the organization thought that the reward is worth his achievement of reducing the firm’ risks and made it less vulnerable to external shocks (potential meltdown of Eurozone). Chairman Sir Philip Hampton is even adamant that the bonus paid to him less than his peers.

On the other hand, the reward seems reasonable when making comparison with other rivals. Barclays, for instance paid its chief executive Bob Diamond up to £10m bonus, compared with a total payout £6.5m in the previous year.

When considering the case of RBS, decision of rewarding Mr. Hester £1m has both good side and bad side. It can be said that the decision is toward the shareholder wealth, at least the chief executive for his devotement to the Bank. However, it did not consider carefully other parties (employees) as well as the real situation of the Bank. Employees’ benefits were neglected. Although the reward could be worthy with the chief executive’s previous achievement, it still is a risk with the decreasing of staff number and slow recovery of the Bank. “Financial manager have the primary responsibility for acquiring funds (cash) needed by a firm and for directing funds into project that will maximize the value of the firm for its owner”. So, the decision could be a long term plan of manager for better performance of the organization as well as increase shareholder wealth.
Source of information:
McGuigan, J (2009) Contemporary Corporate Finance, 11th edn. Cengage Learning
BBC News