Last week I have wrote about how to raise the finance in a corporation due to particular reasons such as intended to expand its business. Now, I am going to share regarding this week's lectures involving the foreign currency exchange rate and the tax issue to see how a corporation is able to manage these things.
First of all, we have to understand what is 'foreign exchange rate' in which it is define as the conversion of one currency for another currency. Changes in foreign currency exchange rate might cause the increasing of uncertainty related to the income from abroad's operations or trading internationally. Therefore, a company which is planning to expand its business widely to other country has to face several risks that could occur regarding the currency exchange if they still insist to expand their business globally. It is because, shifting in foreign currency exchange rate could impair the competition position and wreck its profit.
In addition, there are some possible impact due to the exchange rate changes on several firm's activities such as, income that a company will get from overseas is uncertain, amount of paying money to the importer at future date also uncertain as the time of deal may be struck, the valuation of foreign assets and liability could change easily due to the foreign exchange movements, the viability of foreign operations in the long-term period unpredictable and the acceptability or otherwise of abroad's investment project volatile due to the future currency changes might have great impact on estimated NPV.
Who is involve in trading? They are the exporters or importer, tourists, fund managers, governments, central banks, speculators and banks. However, the major players are the large commercial banks and speculators as they are dealing on behalf of the clients therefore, they are holding their own proprietary transaction in order to gain profit by taking a position in market. This unstable of exchange-rate movements can give a bad effect for the business and shareholders if it could not manage the possible risks as shown by HSBC Bank in Malaysia where they have managed the foreign exchange rate by first; having a clear understanding of their foreign exchange risk which are describe in 3 types or risks:
a) transaction risk = risk that occur when a company has commitment whether the amount to pay or receive money in foreign currency are depends on the foreign exchange rate movements which ultimately related to imports and exports of goods on credit. Other than that, investing abroad or borrow in a foreign currency also can create the transaction risk.
b)translation risk= when there is a foreign subsidiaries, the companies need to translate the figure in the consolidated accounts into the parent company's currency.
c)economic risk= risk is arises when a company loss in competitive strength because of foreign exchange movements and thus lead to decrease of the economic value of the company.
Other than that, they also have to understand the solution for the risks, developing any strategy using the combination of spot, forward exchange contract and currency options and then implementing the plan quickly in order to protect the profit. These foreign exchange protection are also might be important for those who are exporters or importers, the owners of overseas assets or joint venture and partnership and companies that have more than one country
However, there are also a number of strategies that company (especially a firm with a number of characteristics such as those companies that seek for growth opportunities, financing policy, liquidity, expand their business size and those who have multinational transaction) could hedge themselves by :
- invoice foreign customer and pay money to foreign company in a firm's home currency
- do nothing by bear the risk and hoping that the exchange rate movements will deliver a good news for the company
- netting where multinational subsidiaries of company settle the debt base on net amount instead of gross amount with the parent company
- matching is involve both group and third parties that matches inflow and outflow in different currencies caused by trade.
- leading and lagging- the speedy up or delay the payment between now and the original due date of payment
- forward market hedge which is regularly used by exchanging two currencies at fixed time in the agreement contract
- money market hedge which involve borrowing money from the money market.
Why a company needs to hedging itself? This is because it has implications on hedging such as to ensure the availability of funds for investment opportunities, and could reducing some of these matters; the financial distress, incentives to under invest, managers' risk and cost to adjust capital structure. Apart from that, the most significant reasons for most companies are due to maximising the shareholder value and the tax function. This include the tax because most international company may want to minimise the overall worldwide tax burden for their long-term strategic planning, long and short term cash flow and investment or project portfolio. What most companies do in order to lessened the tax burden include the transfer pricing where this method could manipulate where the profit arise so, they will pay less tax.
Overall, a good corporate management would make people in the corporation always glad to work in the organisation...
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