Problem Facing the Firm
The Global Management Company, the Japanese Equities Fund’s investment manager, was facing a problem of the rise in the hot money rapid movement out of and in the Fund. As reported in the case, the Japanese Equities Fund had faced considerable cash outflows and inflows from the investors. David Smith, the Japanese Equities Fund’s portfolio manager, alleged that the stockholders were trying to raise their profits through timing the stock exchange market. In other words, these shareholders were trying to take the advantage of the difference between the New York and Tokyo Stock Exchanges’ closing times. Sofia Herrara, the Global Management Company’s Chief Financial Officer, was considering the strategies to control the hot money flows. In other words, Herrara was considering the strategies to limit the short-term trading the Japanese Equities Fund was experiencing. The increased short-term trading activity by the shareholders was a vast problem since it would lead to market instability if the Global Management Company would not restrain it.
Analysis of Issue
Hot money can be described as the money, which flows between the financial markets as the shareholders try to make sure that they obtain the highest returns. The international stockholders make significant gains by moving money between different nations with different rates of interest. Hot money can essentially move very rapidly out of and in the markets and, thus, result in market volatility. As described in the case, the wave of cash, which was moving out of and in the Japanese Equity Fund appeared to be high. Consequently, this demonstrates that this market was experiencing the hot money flows. Smith alleged that maybe some stockholders were moving their money quickly from one fund to the other in the complex so as to raise their profits. As a result, the increased activity by these stockholders could be resulting in higher fund expenses. As described in the case, the Global Management Company discovered that the temporary trading was to some extent likely to take place in the funds, which were focused on one form of investment or in the volatile funds. Consequently, this would result in hot money flows.
The failure of the Global Management Company to control the increase in the hot money rapid movement out of and in the Japanese Equities Fund would result in some dire consequences. One of these consequences would be the harm to the Japan’s exports as it would make them more expensive. As a matter of fact, the hot money inflows are associated with the inflation. Some economists argue that capital inflows fuel inflation. The flow of the United States dollars to Japan would create inflation as Japan would be required to print more money to buy the additional dollars. In other words, the abrupt inflow of great amounts of the United States dollars would increase the Japanese monetary base. As a result, this would facilitate the creation of a credit boom and eventually result in inflation. The inflation would, in turn, make the Japanese exports expensive. The hot money flows would also produce surplus liquidity and, as a result, lead to an asset boom in Japan, which would lead to additional long-lasting problems.
The other dire consequence, which would result from the failure of the Global Management Company to control the increase in the hot money rapid movement out of and in the Japanese Equities Fund would be the collapse of the value of Japanese currency, Yen. As a matter of fact, the hot money outflows would essentially deflate the asset prices and, as a consequence, collapse the value of the Japanese Yen.
Strategic Alternatives and Recommendations for Strategy
The Japanese government could control the hot money inflows and the resultant effects through utilizing different techniques. These techniques include capital controls, decreasing the rates of interest, regulating the capital flow, fiscal tightening, and appreciating the exchange rate. It could adopt the capital controls that would prevent the inflow of the hot money. For instance, the Japanese government could implement capital controls that would limit the investment of the United States dollars in the Japanese Equities Fund. The other alternative could be adopting the interest rate reduction policy. The Japanese central bank should have lowered its interest rates to prevent the inflow of hot money. Consequently, this would reduce the stimulus for hot money inflow.
The other technique that Japan could utilize to slow the hot money influx would be regulating the capital flow. The Japanese government could have tightened the restrictions of the influx of the foreign capital in the country. It could also utilize fiscal tightening to limit the inflationary effect of capital inflows. In particular, the Japanese government could make use of the fiscal restraints to reduce the hot money influx and eventually curb the inflationary impact. The appreciation of the country’s exchange rate would also help Japan control hot money influx. As a matter of fact, the appreciation of the Japanese exchange rate would control the inflow of the United States dollars and, as a consequence, help Japan curb the inflationary impact. Japan should implement all these alternatives as they would help it deal with the consequences of the hot money inflows.
