To calculate the FX position of Company A, we need to sum up the confirmed exposures and the foreign exchange contracts:

QUESTION

Part A FX Risk 10 points

Calculate the FX position of Company A based on the values in the following chart. Explain the benefits

this company will experience according to its FX position.

Part B: Identify and describe four types of political risks giving an example of a country which exhibit each. 4 points

Part C: A Swedish travel services company is analyzing the feasibility of opening a branch office in Malaysia. They have developed the following economic risk profile: 6 points

a. Complete the chart with the associated threat values.

b. Rank the risks in order of priority.

c. If the organization decides to introduce strategies to reduce its economic risk, what is one strategy that it could implement?

ANSWER

Part A: FX Risk

To calculate the FX position of Company A, we need to sum up the confirmed exposures and the foreign exchange contracts:

Confirmed Exposure:
Cash: $340,000
Accounts receivable: $1,200,000
Firm orders – sales: $6,400,000
Accounts payable: ($155,000) [Note: The negative sign indicates a liability]
Firm orders – purchases: ($1,500,000) [Note: The negative sign indicates a liability]

Total Confirmed Exposure = $340,000 + $1,200,000 + $6,400,000 – $155,000 – $1,500,000
Total Confirmed Exposure = $6,385,000

Foreign Exchange Contracts:
FX forward contracts used to sell U.S. dollars: ($5,200,000) [Note: The negative sign indicates a short position]

Foreign Exchange Position = Total Confirmed Exposure + Foreign Exchange Contracts
Foreign Exchange Position = $6,385,000 – $5,200,000
Foreign Exchange Position = $1,185,000

Explanation of benefits according to FX position

Company A has a net positive FX position of $1,185,000. This means that they have a higher value of foreign currency receivables (in USD) than payables. Having a positive FX position can bring several benefits:

Exchange Rate Gains: A positive FX position means that Company A is a net holder of foreign currency. If the value of the U.S. dollar weakens against other currencies, the company will benefit when converting foreign currency into USD. This can lead to exchange rate gains, increasing the company’s bottom line.

Hedging against Currency Depreciation: With a positive FX position, Company A is naturally hedged against adverse exchange rate movements. If the U.S. dollar depreciates, the impact on the company’s overall financials may be mitigated, as the value of its foreign currency assets would increase when converted back into USD.

Enhanced Competitiveness: If a significant portion of Company A’s sales revenue comes from foreign markets and is denominated in foreign currencies, having a positive FX position can provide a competitive advantage. A weaker U.S. dollar can lead to higher competitiveness in international markets, as the company’s products may become relatively cheaper for foreign buyers.

Reduced FX Risk Exposure: With a net positive FX position, the company is less vulnerable to currency risk compared to a company with a net negative position. It means they are less reliant on favorable exchange rate movements to protect their financials.

Part B: Political Risks

Regulatory and Legal Risks: This type of risk involves changes in laws, regulations, or government policies that can negatively impact a company’s operations. These changes may include new taxes, trade restrictions, or compliance requirements. Example: India is known for frequent changes in tax laws, which can pose challenges for foreign companies operating in the country.

Political Instability: Political instability refers to uncertain or unpredictable political conditions in a country, such as civil unrest, government changes, or geopolitical tensions. These uncertainties can disrupt business operations and investment plans. Example: Venezuela experienced political instability due to frequent leadership changes and protests, affecting foreign investments in the country.

Sovereign Risk: Sovereign risk is the risk associated with a country’s ability to meet its debt obligations or honor contracts with foreign entities. It includes the risk of default on government bonds or expropriation of assets by the government. Example: Greece faced a sovereign debt crisis that affected its ability to repay debts, leading to financial turmoil and uncertainty in the Eurozone.

Corruption and Bribery: This risk involves unethical practices within a country’s government or business environment, such as bribery, embezzlement, or favoritism. Corruption can lead to unfair competition and create barriers for foreign companies. Example: The bribery scandal involving the Brazilian state-owned oil company Petrobras affected investor confidence and business operations in Brazil.

Part C: Economic Risk Profile

Threat Values

Negative economic growth – Rank: 3 (Critical)
Unfavorable exchange controls – Rank: 2 (Serious)
Implementation of new unfavorable laws or trade agreements – Rank: 1 (Catastrophic)

Ranking of Risks in Order of Priority

Implementation of new unfavorable laws or trade agreements – Rank: 1 (Catastrophic)
Unfavorable exchange controls – Rank: 2 (Serious)
Negative economic growth – Rank: 3 (Critical)

Strategy to Reduce Economic Risk

One strategy that the Swedish travel services company could implement to reduce its economic risk is diversification. Diversification involves expanding its range of services and markets to reduce reliance on a single market or industry. By operating in multiple countries and offering a variety of travel-related services, the company can spread its risk exposure. If one market faces negative economic growth or unfavorable regulations, the company can still rely on other markets and services to maintain its overall financial stability.

For example, the company could explore opportunities in neighboring countries or other regions with stable economic growth and favorable regulatory environments. Additionally, the company could expand its offerings to include not only travel services but also related areas like travel insurance, event planning, or destination management services. This diversification strategy can help mitigate the impact of economic downturns or adverse changes in specific markets, ensuring the company’s long-term sustainability and profitability.