An analysis of currency internationalization from the perspective of purchasing power parity

An analysis of currency internationalization from the perspective of purchasing power parity

作者：谢咏秦1

场景：玛莎大学

省：吉隆坡

邮编：50470

Introduction

Purchasing power parity (PPP) is an economic concept that sheds light on potential dangers that shifts in currency values may impose upon international trading and commercial institutions. It will, however, explain how such changes may prove detrimental to such companies. According to PPP theory, prices must be the same across countries when expressed in internationally recognized currencies without restrictions on trade barriers or transport costs.

1related notion

In economics, the Purchasing Power Parity (PPP) theory postulates that if the costs of transporting an item or any other hindrances are ignored, all comparable items will have the same prices when converted into an accepted universal currency in different countries. The concept is usually used to explain how variations in exchange rates can cause economic problems for businesses and people dealing with international trade (TUMIWA et al., 2020). It is a change in the cross-rate between the value of one country's money and its competitor's. This can cause considerable fluctuations in purchasing power between companies and customers involved in border deals. Such influence is sometimes called economic exposure. Economic risks arise as a result of exchange rate swings.

1.1Importers and Exporters

Foreign currency fluctuations affect the price levels charged for imports and earned from exports. The appreciation or strengthening of domestic currency would translate into more purchasing power for the firm when it imports goods from another nation (Vo, 2023). This, therefore, results in a decrease in importation costs. However, weaker domestic currency (subject to depreciation) leads to increasing prices of imports. If the domestic currency strengthens, exporters might encounter some difficulties because it might increase their products' cost in the international business arena. As a result, this might result in lower demand for their products in the market. On the contrary, it might boost market competitiveness for exporters when the value of the local currency declines due to this factor.

1.2Inflation Differentials

The PPP theory postulates that currencies must adjust over a long period for a nation's inflation rate to change against other countries. For instance, when a country experiences a higher-than-normal trade partner's inflation rate (such as buying power parity), the country's currency is expected to lose value over time. In such surroundings, organizations may face uncertain forex rates that would have to be factored into future revisions to pricing plans.

1.3Exchange Rate Risk

Volatility in exchange rates adds an element of uncertainty in international transactions. The business entities are uncertain about the precise rate at which they will convert their foreign incomes to their domestic currencies (Hebous et al., 2021). Uncertainty of presence could lead to economic exposure, primarily the downward move of foreign exchange rate affecting the firm's performance.

1.4Hedging and Risk Management

Corporations often resort to hedging strategies when managing their economic exposure; these could be forward contracts, options, and other financial instruments to shield corporations against adverse exchange rate changes. While some such practices can be useful in risk management, some costs and difficulties may arise.

1.5Consumer Purchasing Power

Exchange rate fluctuations have purchasing power implications for persons and households while purchasing some imports of foreign goods and during overseas tourism trips. For instance, a stronger domestic currency could help people afford to travel overseas and buy imported items (Rahman, 2021). Conversely, this may be detrimental because their purchasing power of imported items might reduce at a lower exchange rate.

2Empirical discussion on the factors affecting currency internationalization

2.1Empirical method and model construction

Sales Revenue Growth and Operating Profit Margin:

The company anticipates its sales revenue to increase by 8% from Rm 3 billion.

It is expected to result in a 15% operating profit margin.

Expected sales revenue of 2023 = RM 3,000 million * 1.08 = RM 3.24 billion

EOP = RM 3.24*0.15 = RM 486 million

Capital Investment Requirements:

i. Working capital required = (RM0.1 x expected sales revenue of 2023) = RM0.1 x RM3.24 billion = RM324 million⌁ convert this sentence from ai written to human written

ii. Depreciation amount means (25% of non-current assets) equals (65% of 25% *Rs 500 million= Rs 65% of 125 million).

iii. Extra non-current assets = (RM 0.20*expected sales revenue of 2023) = RM 0.20*RM 3.24 billion = RM 648 million

iv. Small project investment is RM 80 million.

The total capital investment requirements will stand at (RM 1.177 billion). = RM 324 million + RM 125 million + RM 648 million + RM 80 million.

Income from TTY Co:

TTY Co expects to produce and market a specialized tool in 4 million units.

Each tool incurs a fixed cost of RM40 million and a variable of producing the unit for RM36.

One hundred forty-four million on a total variable cost of units amounting to 4,000,000 at RM 36 per unit.

TYT Co's profit stands at RM 56 million, where its total variable costs are RM 144 million and total fixed costs are RM 40 million of its total sales of RM 240 million.

Siri Bhd gets 80% of TTY Co.' 's earnings.

pided TTY Co = 80% of profit TTY Co = 80% X RM 56 million =RM 44.8 million

Total Funds Available for pidends:

After deducting the necessary capital investment, add up the anticipated operational profit and the pidend from TTY Co. to determine the total amount of money available for pidends:

Expected Operating Profit + TTY Co pidend = Total Capital Investment Requirements.

pidend Funds Available = RM 486 million – RM 44.8 million – RM 1,177 million = RM (645.2) million.

In the year ending, the estimated pidend amount as the cash amount is approximately RM 645.2 million. It will not be possible for Siri Bhd to declare pidends to its shareholders if it proceeds with the significant project without injecting debt or equity. The corporation might consider alternative funding avenues or amend the implementation scope and duration to support constant pidend payouts.

2.2Coping strategies for related currency risks

one of the risks accompanying the change in currency rates is that Siri Bhd will receive approximately US$ 200 million within three months from their equity stake sales. Therefore, we suggest implementing various strategies to manage this risk with hedging practices assumed to mitigate this issue. Considering the state of the market and the financial instruments that are accessible, the following course of action are suggested:

Currency Forward Contracts: Siri Bhd must hedge the receivables in USD, within this current environment, by employing Currency Forward Contracts. However, using a currency forward contract can be sure that the number of RM will remain. To this extent, Siri bb will use a three-month forward contract to hedge against depreciating USM for the period the corporation takes about it.

Choice of Forward Rate: Quoted forward rates for the next three months as at the market will be RM 3.855-RM 3.861/USD. Siri Bhd can select the forward rate that falls in the range that it believes represents the most accurate RM/USD exchange rate estimation, as well as an acceptable amount of risk preference.

Execution: Siri Bhd should enter into a forward contract by selling the USD 200 million at the above-mentioned exchange rate of $176/$. In this manner, the company ensures that it will guard against the negative shocks of currency movements and have the RM equivalent of the earned US Dollar amount.

Advantages: Hedging strategy removes exchange rate risk associated with the money necessary for operations and the significant project amount converted into euros under a fixed exchange rate.

Cost: Siri Bhd needs to note that the gap between the forward rate and the spot rate reflects probable extra costs with the forward contract. The total financial analysis of this hedging strategy must also include this additional cost.

The hedging strategy described above will ensure that Siri Bhd is shielded from the currency risk associated with RM/USD exchange rate fluctuations since these should not influence the cash proceeds following the equity sale. This move ensures that this organization's strategic goals and financial stability are maintained.

2.3Determinants of the financial status of the SIRI BHD project

To find out how much the proposed RM 400 million project of SIRI BHD will affect the General Finance Status. In its assessment, the group needs to be cautious enough to ascertain if it can sustain the pidend policy and satisfy the appropriate prerequisites for its cost of money. Below is the examination of the primary determinants:

Evaluation of pidend Capacity (Before the Project): Siri bhd pidend that is predictable based on the information up to Feb-28-2023 before commencing this mega endeavor. The current calculations demonstrate a net cash outflow position of approximately RM 645.2 million within Siri Bhd. If an organization has no extra cash to sustain itself, the company would not be able to pay pidends.

Expected pidend and Growth (Post-Project): After incurring a cost of RM 400 million, Siri Bhd will likely channel some cash flows via pidends' allocation. The pidend for the year ending 28-Feb-2024 should remain around Rm 203,770,000, as in the previous year. The annual pidend growth rate is estimated at 7%, starting in February 2025.

Cost of Capital: As a result, the required rate of return for Siri Ltd is 12% per annum. In this case, it implies the minimum rate of return that the company has to record to satisfy the requirements of its stockholders.

Assessment of Project's Worth: Investing RM 400 million in this proposed project is considered huge by most organizations. The pre-project operating cash-flow position does not allow project implementation with new debts and equities. The payment for the cost of capital and the pidend distributions become challenging to implement owing to the high costs and a negative cash flow attributed to the financial constraints (Beladi et al., 2021). In relation to this, Siri Bhd should also scrutinize the possible importance and term of the resulting money streams alongside its nature. It is better to look at other alternative financing options; initially, it may be worthwhile to phase out the execution of the project.

2.4Siri Bhd Value-added services of the project

The proposed method of financing the RM 400 million project by Siri Bhd, which involves using funds from the sale of its equity investment in a U.S. company and cash flows generated from normal business activities over the next two years, raises several important issues that need to be considered further:

Appropriate funding during the initiation of a project is essential in ensuring a successful project that will be sustainable.

Equity Financing: One type of funding is equity financing, which denotes the process of issuing shares in the company to the investors. This process does not lead to any obligation that must be paid back but reduces the ownership stake of current shareholders. In this regard, losing control is one major thing that should be considered. Getting external investors also involves relinquishing a lot about decision-making. This may, in turn, fail to accord with the project's original idea as envisaged. Moreover, the company faces financial constraints when its project fails to perform as expected since it has obliged shareholders with pidends or share appreciation rights.

Debt Financing: Debt financing is a type of borrowing in which interest has to be paid back. Although this helps the firm retain sole possession and jurisdiction over its assets, excessive borrowing poses a risk of financial crisis. The high-interest rates and stringent payback provisions may become burdensome if a project takes more time to realise revenues than planned. Failure by a company to pay its loans may impair its creditworthiness and potential borrowing in the future.

Crowdfunding: These days, for instance, crowdfunding platforms enable businesses to borrow a little cash from many inpiduals simultaneously. This may attract initial investors quickly and get an insight into market interests but might not give substantial money needed for more significant undertakings (Kgoroeadira et al., 2019). Also, dealing with a lot of small-time investors becomes problematic. Moreover, most profitable crowdfunding endeavors entail substantial advertising and a persuasive presentation that may be redirected elsewhere.

Grants and Subsidies: Projects targeting social and environmental aspects may also acquire grants and subsidies from government units/non-profit organizations (Yang, 2022). While this money may come from several perse channels, it can be challenging in terms of the submission requirements for such programs and abiding by specific stipulations. Besides, getting approval may take time, resulting in project delays.

Conclusion

The prospects and challenges associated with Siri Bhd sum up the multi-million project worth RM 400 million. This issue is of considerable concern because of the negative cash flows preceding the project and the obligation to set aside money to pay pidends and costs associated with assets. However, carefully considering these effects, such as those of different cash inflows, hedging, and alternate ways of raising capital, should be carried out. Also, it is essential to consider other issues regarding the sustainability of pidends and their tax implications. Siri should undergo a broad inspection with regard to its suitability in relation to project finance, organizational vision, and the long-term financial sustainability of the company.

References

Beladi, H., Deng, J., & Hu, M. (2021). Cash flow uncertainty, financial constraints, and R&D investment. International Review of Financial Analysis, 76, 101785.

Hebous, M. S., Klemm, M. A. D., & Wu, Y. (2021). How does profit shifting affect the balance of payments? International Monetary Fund.

Kgoroeadira, R., Burke, A., & van Stel, A. (2019). Small business online loan crowdfunding: who gets funded and what determines the rate of interest? Small Business Economics, 52, 67-87.

Rahman, A. A. (2021). Initiating a True International Currency. Global Currency Initiative.

TUMIWA, K. G., Koleangan, C. A., & Montolalu, A. A. (2020). THE INFLUENCE OF EXCHANGE RATE, FOREIGN EXCHANGE FLUCTUATION AND FOREIGN EXCHANGE RESERVES TOWARD PURCHASING POWER PARITY Indonesia Rupiah on United States of America Dollar Period of 2015-2019

 (Doctoral dissertation, UNIVERSITAS KATOLIK DE LA SALLE).

Vo, H. L., & Vo, D. H. (2023). The purchasing power parity and exchange‐rate economics half a century on. Journal of Economic Surveys, 37(2), 446-479.

Yang, J. T. Y. (2022). GRTs in Quebec: a unique model for non-profit housing delivery: The documentation of Group of Technical Resources (GRT) Model in Quebec, exploring the adaption of the third sector social, affordable housing delivery model in housing policy transition.

1，华中师范大学素质教育研究与国家数字化学习工程技术研究中心高级研究员，毕业于深圳大学、北京语言大学、武汉理工大学、武汉大学，双学位，曾在新加坡、马来西亚留学，双硕士。

1