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Examine The Risks Of Joint Ventures Economics Essay
China followed a fixed exchange rate system till the 1980s.With advent of technology and economic development and the opening up of the Chinese economy. China had a dual exchange rate system between the period of 1988 – 1993 and the official rate co existed with the market determined rate. Swap centres were established in 1988 where in the exporters, importers and other parties with foreign exchange supplies or needs could transact at a market determined exchange rate. In 1994 the official exchange rate was devalued and unified with the exchange rate at swap centres and the exchange rate system was officially changed into a floating rate exchange system. China followed a floating exchange rate system since then .Understanding the exchange rate is a subdued task due to the complexity of the forces determining the exchange rate. A different approach is to study the long run and short run movements in a unified frame work, where it is modelled as an endogenous variable that responds to the various structural shocks. This could provide a better understanding of the evolution of the real exchange rate. For a developing economy like China, fiscal policy is substantially much more important, when its exchange rate is under tight scrutiny. But as the economy is not under any major foreign debts and also has modest budget deficits, it does not come under any immediate fiscal sustainability. But even with a significantly progressive economy, n an ageing population means that there are losses are predictable in the state run banking system, inevitable expenditures in healthcare and education, and demanding pressures of the pension funds pose as a medium term challenge. The piling up of such contingent liabilities could mean that major structural reforms to exchange rate system are necessary.
A fixed exchange rate is usually used to stabilize the value of a currency, against the currency it is pegged to. This makes trade and investments between the two countries easier and more predictable.
It can also be used as a means to control inflation. However, as the reference value rises and falls, so does the currency pegged to it. In addition, as per”Mundell-Fleming model, with perfect capital mobility, a fixed exchange rate prevents a government from using domestic monetary policy in order to achieve macroeconomic stability”.
The only problem with expanding into a country like china with fixed exchange-rate system is that when a trade deficit occurs, there will be increased demand for the foreign (rather than domestic) currency which will push up the price of the foreign currency in terms of the domestic currency. That in turn makes the price of foreign goods less attractive to the domestic market and thus pushes down the trade deficit. Under fixed exchange rates, this automatic re-balancing does not occur. Instability of interest and exchange rates are unstable as greater unpredictability means a “greater potential gain for the option holder and a greater potential loss for the option writer”, a higher premium is therefore charged.
Corporate finance: principles & practice By Denzil Watson, Antony Head
As per the Bretton Woods system in 1973, real exchange rates have begun to fluctuate greatly. As instability increased exporters and importers where not unable to judge the prices of their products and services. This uncertainty prevailing doubts and affects the profit earning capacity and thus adversely influence their decision to trade. Exchange rate uncertainty has been shown to have affected trade flows between countries and across sectors. It is in a way boon and bane when considered different studies done. Increased instability has had important propositions in measuring the costs and benefits of various exchange rate establishments, as well as of exchange rate controls.
2 b)Companies should focus on the main business they are in and take steps to minimize risks arising from interest rates, exchange rates and other market variables.(Hull,2002) There are number of in which a firm hedges their exposure. Balance sheet exposure is hedged by matching the Currency denomination of assets and liabilities or by using financial instruments like swaps. Forwards and options are financial instruments used for hedging the cash flows, and profit and loss by matching the currency denomination of inflows and outflows.
Hedging by options:
Options is another way used for hedging purposes be it small hedge, long hedge, which in essence are buying and selling products. It involve taking a position in an option and a position in the underlying bond in such a way that changes in the value of one position will offset any unfavourable price movement in their position. Points to be taken into consideration while using options for hedging are, Determining the option contract that is the best hedging vehicle.
To find the appropriate strike price
Determine the number of contracts.
It is a choice to either buy or sell the asset at an agreed price at some future date.
Money market hedge involves taking a money market position to cover a future payables or receivables position.
Money market hedge on payables occurs when a firm has excess of cash. It deposits the cash in foreign currency for a short term period and utilizes it for future needs. While money market on receivables occurs when a firm is expecting the receivables in a foreign currency, it can hedge this position by borrowing the present value of the receivables now in that foreign currency and converting the amount in to the home currency.(Madura,2007)
When exchange of cash flow in two different currencies between any two companies occurs it is called as Swap Market Hedge. This type of swap that accommodates a company’s needs to cover its transaction risk is currency swap. In this swap one company provides a certain principal in one currency to another company in exchange for an equivalent amount in a different currency to cover its transaction risk .(Kim,2002)In a currency swap it makes it possible for the companies a chance to gain the usage of foreign currency and to avoid any exchange rate risk.
2 c) The only problem with expanding into a country like china with fixed exchange-rate system is that When a trade deficit occurs, there will be increased demand for the foreign (rather than domestic) currency which will push up the price of the foreign currency in terms of the domestic currency. That in turn makes the price of foreign goods less attractive to the domestic market and thus pushes down the trade deficit. Under fixed exchange rates, this automatic re-balancing does not occur.
For the kind attention of the Managing direct
3A) Benefits and Limitations of:
A business expands organically means that the company is using internal funds to expand the business, rather than purchasing another business or thru other partner-sharing business. An example of organic growth will be increasing capacity using the own money.
Below are some advantages of organic growth:
Organization strategic goals can be achieved - Through organic growth, the management team are able to guide and lead the business according and in-line with the strategic goals of the company.
No crashes in culture - There will be no culture clashes as the company employees are all either hired from the start of the business or being transferred to the newly setup business. the culture and norms of the business will be maintained.
Cheaper compared to acquisitions - Very often when a company buys another business. they'll need to pay a premium, and that premium itself can sometimes wipe out the whole value of the acquisitions rather than increasing shareholder's value.
Disadvantages of organic growth are:
Longer time - Organic growth business needs longer time to grow as they need to start from scratch including setting up the whole business, hiring and recruiting human capital, investing in machineries, and etc.
More risky – There is no spreading of risk and the business will be bearing the whole risk by themselves.
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