Introduction
It is important to note that international finance is a complex and multifaceted subject. An individual seeking to understand the field and its dynamics needs to be able to explore the methods used to conduct international business in the multinational financial environment. He or she needs to have knowledge to describe the background and corporate use of international financial markets. When it comes to specifics, one should know how to explain the purchasing power parity (PPP) theory and its implications for exchange rate changes. This assessment will also explore the techniques for forecasting exchange rate and evaluate the performance, and the assessment of long-term financing in foreign currencies adjusted for bonds. The analysis revealed that acquisition is better for multinational corporations (MNCs) compared to licensing. Many MNCs still have many opportunities because they can expand horizontally. The PPP theory is about price level changes between two economies, where the equilibrium is reached, such as inflation making the local currency depreciate more. Techniques of exchange forecasting include forecasting through analytics, relative economic strength, and econometrics.
Discussion
I think that foreign firms acquisition will result in greater growth for a multinational corporation than licensing. The main reason is that the benefits of the first option outweigh the advantages of the second one, when accounting for the risks. Foreign firms acquisition happens when a company enters a new international market by buying the local business to sell its product and services. However, licensing refers to allowing a foreign company to sell a product and services of one providing the license. In simpler terms, acquisition means a foreign company is bought and owned, but licensing is similar to renting and representing. When it comes to acquisitions, it is stated that “foreign acquisitions have a negative impact on corporate performance. However, the negative impact of foreign acquisitions disappears under two circumstances” (Agyei-Boapeah, 2019, p. 1). These conditions include “(1) when domestic firms undertake foreign acquisitions; and (2) when highly experienced multinationals undertake foreign acquisitions … the benefits (costs) associated with foreign acquisitions are greater (lower) … for highly experienced multinationals” (Agyei-Boapeah, 2019, p. 1). In other words, MNCs do not face as much risk as mid-sized businesses.
Licensing offers a number of benefits as well, but the risks are significant. The advantages are that it requires low capital investment, lower risk of expansion, less political risk, extra income on technical know-how (International Business, n.d.). However, the problem is that it leads to lower income, potential loss of quality, ruined reputation and brand image, and possible competition (International Business, n.d.). Thus, in simpler words, licensing does not need too much investment, but it also leads to too little gain. The biggest damage can be done to brand identity, image, and company reputation. I think this part is the most problematic aspect of licensing sharing how to run a business does not guarantee that the foreign firm will be able to execute it. In other terms, the local business’s environment in unique and special, which is why the technical information might require some adjustments. The daughter company might not have resources or experience to adapt the strategy to the local market, and the parent company gains too little from it.
Therefore, usually, foreign firms acquisition carrier more risk than licensing, but not for MNCs as shown by evidence above. For multinational corporations, licensing is riskier because reputation is highly valuable and no damage to it can be tolerated. Bad news about a MNC in a foreign nation can impair its sales and performance in other countries. Also, a MNC does not make a lot of money from licensing. That is why I conclusively state that acquisition is better, more profitable, and less risky for an MNC.
MNCs, such as Coca-Cola or PepsiCo, still have numerous opportunities for international expansion because their brands are very well-established across the world. Any person in almost any nation recognizes Coca-Cola or PepsiCo. Although they have successfully expanded internationally, they still can sell new products other than soft drinks. Using the value of their decades long marketing and international brand image expansion, MNCs can start to sell new products or services. The fact that they specialize in beverages in the United States does not mean they cannot sell, for example, food or toys in other nations. They are not necessarily limited by the competition of the U.S.-based firms in foreign markets.
Put simply, MNCs began to sell a specific product or service in their homeland market because they were competing and excelling in this one thing. Then, they became very good at it, which is why they started to expand internationally by selling their core product or service abroad. MNCs invested into their marketing so heavily to the point where they brand becomes recognized almost anywhere. However, foreign markets might not and do not have the same competition as the homeland market. Therefore, if there is nothing stopping MNCs from expanding horizontally or entering completely new markets in a foreign nation, then they are able to do it. The latter means that there is still a massive opportunity for MNCs to expand internationally by using the internationally recognized brand and product awareness to outcompete the local businesses.
In order to better illustrate the provided point, I would state that Coca-Cola is a U.S.-based MNC, and in the United States it competes with other MNCs and mid-sized businesses as well as smaller firms. The US market is much more saturated and competitive than a developing nation’s market. It means that Coca-Cola entering this new foreign market will have to only compete with other MNCs and weaker local businesses. Coca-Cola also can explore introducing new types or categories of products, which have poor competitiveness from the local businesses. For example, Coca-Cola could open a fast-food chain burger joints in a market, which McDonald’s or other food company was not able to enter. This action would be impossible in the US, but possible and even plausible in a foreign market. Moreover, using information provided in the Part 1, I would also like to add that some MNCs might be operating by licensing their products or services instead of completely owning the local business. This additionally offers an opportunity to expand better and more thoroughly.
International risk management is a subcategory of risk management, which primarily focuses on managing, evaluating, identifying, and mitigating risks of multinational organizations operating on the international scale. International risk management is mainly concerned with different factors, such as country or foreign market-related risks, payment and delivery risks, and foreign exchange risks (Banco Santander, 2020). The company I chose for this question is McDonald’s, which recently dealt with three risks stated above all at once when leaving Russia. For example, after Russia invaded sovereign Ukraine, the Russian market became a country risk with political instability. In addition, the war and involved nations became less economically accessible financially and logistically due to international backlash against the war. Also, the Russian Ruble became an unreliable currency with too many risks attached to it. Therefore, McDonald’s conducted a risk management assessment of its international markets, specifically Russia, and made a decision to leave the market completely
It is important to note that McDonald’s play a unique and special role in Russia. In 1990, the company opened its first restaurant in Soviet Union, which marked the very initial arrival of capitalism to the socialist and communist nation (Turak, 2022). McDonald’s has a strong brand identity and image around the world, which makes it highly recognizable as a leader in a fast food industry. The international risk management decision to leave Russia permanently and completely was also motivated by the fact that not doing would severely damage the brand reputation of the MNC. In simpler words, the company would have lost too much from Russian market itself compared to potential losses in other markets.
The need for risk management increases as an organization transforms. It is vital for a company to have a holistic view of risk in order to assess and determine the level of risk. The case of McDonald’s illustrates that they assessed their international risk systematically and holistically. In general, in the risk management process, organizations use limited information about risks and their quantitative analysis. Risk analysis and management is used to identify risks, prepare a risk management plan, and mitigate or eliminate them (Banco Santander, 2020). Leaving Russia was the best option to mitigate the risk of reputational, country-related, logistical, and foreign exchange-related risks. In order to reduce the potential risk, when calculating and developing a risk management strategy, the probabilities of a certain risk event are often used. Risk can be defined as the probability of an event occurring in relation to opportunity cost or financial loss. Similarly, risk management can be defined as the prevention of events related to resources, such as investments and brand image.
The purchasing power parity theory or PPP is about the costs of good differences between two countries. It states that “exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries … the exchange rate … equal the ratio of … price level” (Werner Antweiler, 2019, para. 1). In other words, PPP refers to the notion of equilibrium of exchange rate being tied to a nation’s price level. For example, if one nation’s price levels increase due to inflation, then the exchange rate needs to depreciate to establish the equilibrium of PPP. On the basis of this theory, one can firmly say that a general forecast of the values of currencies in countries with high inflation is depreciation. For instance, if a price level in Europe increases due to inflation, then EUR must depreciate in relations to USD. Thus, for illustration, if 1 USD was equal to 0.9 EUR before the inflation, after the latter, the values should be 1 USD = 1.1 EUR depending on the rate of inflation and price level increases.
In general, countries with high inflation rates will experience an increase in exchange rates from their currency’s perspective. It is a form of a law of one price across different economies based on natural supply and demand market forces. In simper words, the PPP theory explains why exchange rates fluctuate and how they are connected to inflation or price level changes. However, the theoretical framework has a limited application because it does not work for all goods. For example, houses are not impacted by it since these goods an immobile and untradeable for the most part. Also, local services are less affected by the PPP theory as well. The main reason is that they are cannot be traded or moved between two different countries. Thus, a housing market of a separate economy is mostly determined by this nation’s internal demand and supply for houses.
The main purpose of purchasing power parity is to obtain real international comparisons of GDP and its components. Production is the most important indicator of a country’s economic importance, and GDP per capita is an indicator of the level of well-being of citizens. PPP enables international comparisons of GDP and its components by eliminating differences in price levels between countries. The validity, reliability, and reasoning of the recommendations are provided by the use of normative and integrated approaches to the study of effectiveness. Knowledge of retrospective, systemic and functional-structural analysis, observation, and classification is important. The basis of the theory under consideration is that even if the country’s exchange rate in the short run does not reflect purchasing power, then in the long run it should be equal to this parity. To achieve a real effective exchange rate, it is necessary to calculate the percentage of external inflation. When calculating, one must take into account such an important factor as the choice of using a price index. Another point is the determination of the base year for the price index. The exchange rate of the base year should be set taking into account the stability of the trade load of a number of countries.
The four common techniques used to forecast exchange rates include forecasting through analytics, PPP, relative economic strength, and econometrics. The first one refers to the use of predictive mathematics and statistical analytics on exchange rates themselves. In simpler terms, the method focuses on the graphs, trends, tables, and predictive analysis instruments by looking into past exchange rate data. The second one is about what was described above, where inflation and price level increases are monitored. A person who uses the PPP theory will most likely look into inflation differences the price changes for the fixed goods in both economies to determine the future exchange rates.
Thus, the proposed methodology allows not only to predict the exchange rate, but also indicates the specific causes and factors of crisis phenomena in the foreign exchange market, the analysis of which is necessary to develop a set of measures to improve the monetary sphere. At the same time, the accuracy of the forecast depends on the international position of the dollar, euro and other currencies. Therefore, possible sharp fluctuations in these world currencies due to political or economic shocks cannot be taken into account in forecasting and may reduce the accuracy of the calculations made. With the weakening of the currency restrictions in force in the country, increasing the accuracy of forecasting the exchange rate is the most important direction in improving the functional component of the currency regulation mechanisms.
The third technique is focused on overall analysis of two nation’s economies. If one country has a healthy and strong economy, whereas the other has weak and crumbling one, then it is more likely that the former nation’s currency will appreciate. The fourth method is about economic theory, where economic factors are tracked or used to analyze the exchange rate. For instance, a person can look for GDP values to understand and assess the exchange rate.
The use of econometric models in forecasting the exchange rate of the national currency makes it possible to take into account the specifics of exchange rate formation in the country in terms of pegging to a basket of currencies and, in combination with the predictive extrapolation method, to increase the effectiveness of the current mechanism of currency regulation. The proposed approach can be used by the commercial banks of the participating countries to manage currency risks, as well as by central banks to determine and further implement the strategic goals of the monetary and foreign exchange policy of the integrating states on the basis of forecast plans for the most important macroeconomic indicators for a specific period.
The major factors to consider when issuing a floating rate bond denominated in a foreign currency interest rates for the currencies involved. It is also important to conduct a forecast for each currency in a relation to home currency. For example, a US firm issuing such a bond in the UK must analyze the interest rates in both United States and United Kingdom. He or she also needs to forecast the possible fluctuations in the future by converting them into USD to see a clear picture. Floating rate bond denominated in a foreign currency offer higher risk and higher reward potential, but the risk management needs to account for economic stability and strength of the foreign country. In simpler terms, issuing a floating rate bond denominated in a foreign currency is dependent on many factors. One can heavily suffer if the foreign currency appreciates rapidly, because the obligation was made to pay in the local currency.
The risk of issuing a floating rate bond is higher than the risk of issuing a fixed rate bond because market forces of exchange rates can greatly cause losses. It is stated that “investors in floating-rate securities will receive lower income if rates fall, because their yield will adjust downward. Investors in individual floating rate bonds lack certainty as to the future income stream” (Kenny, 2021, para. 11). In other words, a person who bought a floating rate bond trades a guaranteed stream of money for higher potential yields if interest rates go up. It should be noted that floating rate bonds have almost no risk of interest rate compared to traditional bonds, but they underperform whenever interests decrease.
Therefore, if a person wants to buy floating rate bonds, he or she should do it when interest rates are low at the moment. The main reason is that if the rates are low, then they will likely to go up, which brings more income as a result from floating rate bonds. However, a traditional or fixed rate bonds might be more attractive if the interest rates are already high and they are likely to go down. For the latter scenario, a fixed rate bond investor will get more yield since his or her income will not be affected by reduced rates.
Conclusion
In conclusion, MNCs have massive potential to expand internationally due to the lack of competitiveness in foreign markets, which restrained them in their homeland markets. Acquisition is a better deal for MNCs than licensing, because they have more control and ownership over their own company than a licensee. The same is not true for mid-sized businesses because they do not have higher brand awareness, resources, or power to do what a MNC can do. International risk management focuses of metrics, such as country or foreign market-related risks, payment and delivery risks, and foreign exchange risks. The PPP theory predicts exchange rate by relying on the equilibrium element, where inflation in one nation depreciates its local currency compared to the other economy. Other methods of exchange forecasting include forecasting through analytics, relative economic strength, and econometrics. Issuing a floating rate bond denominated in a foreign currency requires factoring in currency stability factors as well as interest rates. A floating rate bond has higher than the risk of issuing a fixed rate bond when interest rates decrease, but they also yield higher income if the rates go up.
References
Agyei-Boapeah, H. (2019). Foreign acquisitions and firm performance: The moderating role of prior foreign experience. Global Finance Journal, 42, 1-37. Web.
Banco Santander. (2020). Risk management. Web.
International Business. (n.d.). Reading: Licensing. Web.
Kenny, T. (2021). Investing in floating-rate bonds. The Balance. Web.
Turak, N. (2022). Goodbye, American soft power: McDonald’s exiting Russia after 32 years is the end of an era. CNBC. Web.
Werner Antweiler. (2019). Purchasing power parity. Web.