Purchasing Power Parity Theory (PPP) holds that the exchange rate between two currencies is determined by the relative purchasing power as reflected in the price levels expressed in domestic currencies in the two countries concerned. Changes in the exchange rate are explained by relative changes in the purchasing power of the currencies caused by inflation in the respective countries. The concept of Purchasing power parity theory (PPP) is traced to David Ricardo, but the credit for stating the law in an orderly manner is given to the Swedish economist Gustav Cassel who proposed it in 1918 as a basis for resumption for normal trade relations at the end of First World War. The Purchasing Power Parity Theory is stated in two versions : The stronger absolute version of Purchasing Power Parity, and The diluted relative version of Purchasing Power Parity. Absolute Version of Purchasing Power Parity The absolute version of Continue reading
International Finance
International finance is the branch of economics that studies the dynamics of foreign exchange,foreign direct investment and how these affect international trade. Also studies the international projects, international investment and the international capital flow .International Finance can be broadly defined, as the study of the financial decisions taken by a multinational corporation in the area of international business i.e. global corporate finance. International finance draws much of its background from the preliminary studies in the topics of corporate finance such as capital budgeting, portfolio theory and cost of capital but now viewed in the international dimension.
Foreign Currency Swap or Foreign Exchange Swap
Each entity has a different access and different needs in the international financial markets. Companies receive more favorable credit ratings in their country of domicile than in the country in which they need to raise capital. Investors are likely to demand a lower return from a domestic company, which they are more familiar with than from a foreign company. In some cases a company may be unable to raise capital in a certain currency. Currency swaps are also used to lower the risk of currency exposure or to change returns on investment into another, more favorable currency. Therefore, currency swaps are used to exchange assets or capital in one currency for another for the purpose of financial management. A currency swap transaction involves an exchange of a major currency against the U.S. dollar. In order to swap two other non- U.S. currencies, a dealer may need to arrange two separate Continue reading
Short-Term Financing of Multinational Corporations
Financing the working capital requirements of a multinational companies foreign affiliates poses a complex decision problem. This complexity stems from the large number of financing options available to the subsidiary of an MNC. Subsidiaries have access to funds from sister affiliates and the parent, as well as external sources. This article focuses on developing policies for borrowing from either within or without the companies when the risk of exchange rate changes is present and different tax rates and regulations are in effect. There are four aspects of short-term overseas financing strategy namely; Identifying the key factors, Formulating and evaluating objectives, Describing available short-term borrowing options and Developing a methodology for calculating and comparing the effective after-tax dollar costs of these alternatives. 1. Identifying Key Factors There are six key factors in short- term financing the MNCs they are deviations of interest rates, exchange risk, degree of risk aversion, borrowing strategy Continue reading
Earnings Management – Meaning, Definition, Motives and Strategies
Over the past two decades there has been collapses in corporate sector affecting various companies including Enron, American International Group (AIG), HIH Insurance and National Bank of Fiji. Due to these collapses, the need for proper management of the earning or revenue generated by the company has become the very significant part as main objective of every company. Along with this objective, managers of the organization have different incentives to manage the earning of the company. Management of earnings means structuring the financial transactions and statements in the manner so as to have maximum benefit. It tries to mislead the users of the financial statements by presenting the earnings as budgeted or thought by the management instead of presenting the actual performance made by the company during the period. The different incentives for earnings management are – increased managerial remuneration, management buyout and managing the regulatory concerns imposed by different authorities. Continue reading
European Monetary System
After the break down of the Bretton Woods System in 1973, several European countries attempted various mechanisms to fix their exchange rates to each other. While allowing their currencies to float against the dollar, these European countries tried progressively to narrow the extent to which they let their currencies fluctuate against each other. Six members of the European Economic Community (EEC), including France and Germany, jointly floated their currencies against the dollar. The currencies of the participating countries were allowed to fluctuate in a narrow band with respect to each other (1.125% on either side of the parity exchange rate), and the permissible joint float against other currencies was also limited (to 2.5% on either side of the parity). This fixed exchange rate system that arose concurrently with the fall of the Bretton Woods System was called the “snake” as this gave the currency movement the look of a “snake”. Continue reading
Foreign Exchange Control – Definition and Objectives
Exchange controls, like currency devaluations, form a part of expenditure-switching policy package. Because, they, too, like devaluation, aim at directing domestic spending away from foreign supplies and investment. Exchange controls try to divert domestic spending into consumption of domestically produced goods and services on the one hand and into domestic investment on the other. Exchange controls represent the most drastic means of BOP adjustment. A full-fledged system of exchange controls establishes a complete government control over the foreign exchange market of the country. Foreign exchange earned from exports and other sources must be surrendered to the government authorities. The available supply of foreign exchange is then allocated among the various buyers (importers) according to the criterion of national needs and established priorities. From a purely BOP standpoint, the sole purpose of exchange controls, is to ration out the available supply of foreign exchange in accordance with national interests. There are Continue reading