MNC Company To Prevent Its Exposure To Foreign Currency Risk Assessment Answer
The following study is designed in such a way that it implements for an MNC company to prevent its exposure to the foreign currency risk. The uses of various financial products to hedge the foreign currency risk and the factors that create and affect the foreign currency risk of the company. The following study help in understanding various aspects related to foreign currency risk.
The product of the company
The company is involved in providing IT services to the various companies working in the united states the company is involved in providing other business-related technological services and business solution services to the various companies. The IT services include the supporting services of various software's and the business expansion services on social platforms, these products are highly demanded in the small companies and the mediocre companies of the United States (Srinath, &Krishnaprabha, 2020).
Key factors that affect the value of the main foreign currency that is Saudi Riyal in which the country is exposed off
There are various factors that affect the price of the Saudi Riyal in the market and affect the exposure risk of the company over a period of time these factors that affect the foreigncurrency risk areas below-
1. Inflation– The inflation in the country will increase the value of the foreign currency and decrease the value of the home currency it will make the foreign currency costlier and increase the exposure of the company in the foreign currency.
2. Foreign currency payments – the payments of the foreign currency or the market factors such as demand and the supply affect the value of the foreign currency most. These factors also increase or decrease the exposure in the foreign currency of the firm.
3. Interest rates - interest rates, inflation rates, and an exchange rate of the country and the market is interrelated, thus these interest rates and the swap rates also decide the foreign currency risk of the company in the particular country.
4. Geopolitical stability and natural stability – It are seen over some time and it is evident that the geopolitical situations and the natural stability make the situation of the currency stronger and on the other side the countries that have the unstable government have a lower value of the currency in the country.
5. Import and export value – the import and the exports of the country also impact the value of the currency, if the company has more exports than its imports then the currency gets stronger and if the imports are high as compare to the exports then the value of the currency is fallen (Plessen,&Bemporad, 2017).
Spot and forward rate of the currency and the Interest rate parity
The spot price and of the Riyal/Lira is 2.09 and, in the forward, the one-year forward rate of the Riyal/Lira is 2.17 that specifies that the rate of Saudi Arabia currency is priced at a discount rate as compare to the prices in the forward market. It shows that in the upcoming future the rates of the currency has increased over a period of time.
The interest rates are also very deciding at the current prices the interest rates' impact on the foreign currency is understood by the interest rate parity concept of the organization.
Interest rate parity is an equation between the interest rates and the exchange rates the interest rate parity is working on the basic principle that there are no free profits or arbitrage profits in the market and the currency rates and the interest rates are such as that the pay off in either the currency will be same (Song, 2017).
According to the interest rate parity the forward price = Spot price *(1 + Interest rate in the country a) / (1+Interest rate in country b)
In the current rate, it can be seen that the forward rate is higher than the spot price thus it shows that the country is in a good position and the interest rate in the Saudi economy will be lower than the Interest rate of the Turkish economy. According to the interest rate parity, the interest rate of the strong currency is lower than the interest rate of the week currency.
Thus, the interest rate parity makes the prices of the currencies at market equilibrium.
Business exposure Is a transaction exposure, economic exposure or translation exposure, reasons for the risk of the business
Transaction exposure – Transaction exposure is the easiest form of exposure that an MNC can face and it can be easily identifiable by the individuals. The transaction exposure of a company is originated from the actual transaction of an MNC company in the foreign currency. This risk occurs when the company has foreign debtors or foreign creditors or any loan due to the foreign company.
Exposure risk – The exposure risk is the risk of the foreign country and the economy of the foreign country. The economic conditions and the geopolitical situation of the foreign company will affect the currency of the foreign company and it also impacts the foreign currency exposure of the MNC company (Song, 2017).
Translation Risk – The translation risk of the foreign currency is also known as the accounting risk it is not the actual risk of the foreign currency risk, this translation risk increased because of the fluctuation in the foreign currency this loss is calculated to the change in the price of the option. The translation loss is only accounting and bookish loss that occurred due to the translation of books of accounts it can be reversed in the next year in the shorter run or in the longer run.
The MNC company in the current case is involved in the transaction exposure and the translation risk, the transaction exposure is there because the company has an exposure to the Saudi riyal in the future and on the other hand when the debtors in the foreign currency are converted into the home currency the company also have a translation risk in the country and in the economy.
Hedging of the foreign exposure
The company has a foreign currency exposure toward the Saudi riyal currency, the company has a foreign currency receivable exposure thus the company has a risk that the future value of the Saudi riyal decreased. Thus, to hedge the current risk of the company can adopt the following ideas-
Options – Buying a put in the foreign currency will provide safety towards the hedge with the foreign currency. The risk that the company has with Saudi riyal is hedged with the profits of the put if the price of the currency is fallen.
Forward rates – contract in the forward rate, the company can make a sale contract at the forward rate to hedge its exposure.
Interest rate – the interest rate swaps will also help the company to hedge its foraging exposure risks.
Financial factors and political risk affect the country risk
There are various financial factors and political factors that affect the country risk of the company the financial factors that affect the country risk includes the inflation risk of the country, the interest rates of the company the financial liquidity, and the export deficient are also other reasons because of this the country risk to the company arises. The financial risk is the financial situation of the company that impacts the country's risk (Yavuz, &Özdemir, 2018).
There is a various political risk that also impacts the foreign currency risks of a company that includes the unstable government, the democracy issues, and other internal factors of the country and the government. The views on the economy of the government also impact the country's risk of the company (Fall, Ndiaye, &Sene, 2019).
The foreign currency risk is the major risk in the Multinational companies there are several companies that have exposure to the various countries thus for the companies it is required to hedge all of its foreign currency risks through the various available resources in the financial risk. The companies having risks in various countries can use the netting technique to reduce foreign currency exposure.