Financing International Trade Assignment Instructions
“Financing International Trade” Please respond to the following:
- Compare two (2) methods that a company can use in order to finance international trade.
- Examine the advantages and disadvantages of financing with a portfolio of currencies.
- Provide two (2) examples of how companies or MNCs finance international transactions by using their own “bank” or by keeping currencies on hand (marketable securities).
- Analyze Interest Rate Parity (IRP) and two (2) methods for forecasting exchange rates.
- Determine the primary manner in which they all affect a company’s short-term financing decision.
- Read also International Trade and Foreign Exchange Rates Speech
Support your response with one (1) example of the manner in which IRP and forecasting exchange rates methods affect a company’s short-term financing decision
Methods of financing international trade
Open account terms
This is a financing method in the international trade which may be accorded in a situation of regular or trustworthy customers. First the goods are dispatched and then paid for at a later date, or on a quarterly or monthly basis (Baker, 2003). While the high purchase method is carried on the basis that the customer makes a deposit or a down payment and then make regular payments for the hire for a specific term. The customer is immediately given the possession of the goods, though, the ownership of the item remains with the seller until the payment of the last installment.
Advantages and disadvantages of financing with a portfolio of currencies
Many currency financing strategies aim at profiting from the trends that are completely unrelated to other asset classes, therefore they also generate a return series which are uncorrelated to the returns from other asset class (Collins, & Fabozzi, 2009).
A number of profit making investment strategies aim at taking the advantage of perceived valuation of differentials across the currency pairs.
Even though diversification reduces the amount of risk involved in the investment of a portfolio of currencies, it is disadvantageous due to dilution.
The currency exchange risk is another big disadvantage in the use of a portfolio of currency. Changes in the exchange rates between one currency to another can result into a reduction of your return on the foreign investment in converting the proceeds.
Interest Rate Parity (IRP)
Interest Rate Parity (IRP) is used in the analysis of the relationship between the spot rate and a corresponding forward (future) rate of currencies (Madura, 2009). The IRP theory states the interest rate differentials between two different currencies as reflected in the discount or premium for the forward exchange rate for the foreign currency where there is no arbitrage.
Methods for forecasting exchange rates
Purchasing Power parity (PPP)
The Purchasing Power parityforecasting method works on the basis of the theoretical law of One Price, which stipulates that identical goods in different countries should have identical prices (Moosa, 2010). Based on this principle, the Purchasing Power parity method predicts that the exchange rate will change to offset price changes as a result of inflation.
Relative economic strength approach
This approach give the insight of the strength of economic growth in the different countries with an aim of forecasting on the direction of exchange rates (Moosa, 2010). The short-term financing decisions of a company can be affected by the relative economic strength approach on the basis that a strong economic environment and a potentially high growth attracts investments from foreign investors.