Possible risks of foreign currency exposure for Wal-Mart
Expanding into New Zealand will result in several foreign currency risks for Wal-Mart. The first type of risk that Wal-Mart will be exposed to is the translation exposure. This exposure regards the sensitivity of real domestic currency value of assets and liabilities. These items, which appear in the financial statements of Wal-Mart, will be affected in terms of value due to unanticipated changes in exchange rates. This risk will affect managerial decisions such as performance measurement for bonus plans, hiring and promotion plans (Giddy, 2012). Given that the management of Wal-Mart will be estimating the financial value of these items, any fluctuation in exchange rates will have a direct effect on the financial value of the benefits. If the value of New Zealand Dollar increases, the real financial value of these employee benefits will reduce. This is due to the fact that the management of Wal-Mart will base its measurements on the US dollar equivalents in its home country. An increase in the value of New Zealand Dollar, therefore, will lead to a negative impact on employee morale. The other effect of this exposure is in terms of income tax (Greave & Barnes, 2011).
There will be a gap between the period when income tax computations are done, and execution of payments, there is a chance that the value of the New Zealand Dollar will have changed. This implies that Wal-Mart will be making a payment of a different financial value to that at the time of computation. An increase in the NZD value implies that the multinational will be paying a high real value while a decline in the value of NZD implies that Wal-Mart will be filing returns of a low financial value. The strategy for managing this risk is through hedging. In this case, management of Wal-Mart should substitute an open future exchange risk with a current exchange rate. This strategy will provide a fixed cost of hedging the operation (Giddy, 2012). The implication for this strategy is that Wal-Mart will have the option of using a forward market hedge or a money market hedge. Using these tools will provide this multinational with a chance of hedging huge amounts in its portfolio. Another implication for this multinational is that the strategy will reduce the chances of loss out of exposure in the foreign exchange market.
The other risk for Wal-Mart will be the transaction/ contractual exposure. This is the sensitivity of real domestic currency value of assets and liabilities in the event of liquidation (Grant, 2012). The unanticipated changes of exchange rates affect importing and exporting firms. Since Wal-Mart will be exporting most of its store merchandise, this type of exposure is very critical. Items such as electronics will be imported from its home country. This is an implication that the value of its inventory will be moving in line with the value of the New Zealand Dollar against the US Dollar. If the value of New Zealand Dollar decreases relative to that of the US Dollar, value of the merchandise will decline. In order to manage this risk, Wal-Mart can apply risk shifting. This can be done by pricing all its products in New Zealand Dollars. The benefit of this strategy is that Wal-Mart will not lose to foreign exchange market fluctuations (Greave & Barnes, 2011). The implication of this strategy for Wal-Mart in this country of expansion is that will be trading like other local companies. This strategy will involve a detachment of New Zealand operations from operations in the US.
The final risk of foreign currency exposure for Wal-Mart is the economic exposure. This risk comes in the sense of the extent to which the cash flow based value of Wal-Mart will change from exchange rate fluctuations. This implies that an increase in the value of New Zealand Dollar relative to the US Dollar will reduce the real value of cash flows and hence the real value of Wal-Mart. The strategy that should be applied in managing this risk is leading and lagging (Giddy, 2012). In this case, management of Wal-Mart should decrease its net exposure in soft currency. This multinational should increase its net exposure in hard currency. This implies that Wal-Mart should increase its reserves of New Zealand Dollar and reduce its reserves of US Dollar. This will reduce the exposure of this multinational to foreign currency risks. The implication of this strategy to this multinational is that it will reduce the chances of financial loss due to fluctuations in the foreign exchange market (Greave & Barnes, 2011). Increasing the hard currency reserves will lead to increased profits for this multinational. This will be achieved by minimizing losses in the foreign exchange market.
Functions of international banking system
The international banking system will be a fundamental platform for Wal-Mart. The first function of international banking system is a facilitation of imports and exports for Wal-Mart through trade financing. Wal-Mart will have an opportunity to raise funds through trade financing through this financial market. The other function that Wal-Mart will gain is that it will arrange for foreign exchange transactions. The multinational will be in a position to handle cross-border transactions and foreign investments (Giddy, 2012). For this function, Wal-Mart will have a professional platform to execute its transactions.
Handling its investments in New Zealand will be assisted by the international banking system in that Wal-Mart will be exchanging its currency in a fast and efficient manner. This contrasts to the option of looking for bureaus in which such business would be conducted. The third function of the international banking system is hedging exchange rate risk. The international banking system will be the platform where the hedging strategy will be executed (Greave & Barnes, 2011). Wal-Mart will consult this financial market for the best hedging strategy. The other function is that Wal-Mart will be in a position to trade foreign exchange products for its own account. In this case, Wal-Mart will make profits by investing in the foreign exchange market. The other tools that Wal-Mart may make investments in are futures and forward contracts.
Wal-Mart will use this financial market to raise funds for its global operations. The first option will be the use of bonds. Wal-Mart can use this debt instrument to raise funds to finance its operations. This multinational will be in a position to raise debts in the financial market based on the value of its assets. The other option is to use equity financing. One of the options is to issue shares in the New Zealand Stock Exchange. This will add onto the funds that the company has for expansion (Greave & Barnes, 2011). The advantage of this issue is that Wal-Mart will have a potential for raising a high amount of funds. The other option is the use of money market. Wal-Mart can use short-term instruments such as treasury bills and commercial papers. These investments will give Wal-Mart a chance to earn a monthly fixed interest rate. The plan that can be adopted for these instruments is investing a proportion of its cash in them. This multinational may adopt a plan of maintaining a certain balance in its short term instruments account in order to finance its global operations (Grant, 2012).
Financial strategy to support long term financing
The financial strategy that is appropriate for Wal-Mart is an improvement in its liquidity. This will assist the multinational in maintaining flexibility in accessing long term financing. With regard to portfolio management, Wal-Mart will improve its ability to obtain funds in line with its requirements. The financial strategy of improving liquidity will be achieved by balancing its asset portfolio (Giddy, 2012). Having highly liquid short term assets will improve the liquidity of Wal-Mart. On the other hand, having a sizeable fraction of long term assets will increase the portfolio returns. As far as capital budgeting is concerned, improvement in liquidity of Wal-Mart will improve its ability to finance its obligations. This multinational will have the benefits of meeting its obligations without fines, penalties or high interest costs. Foreign direct investments decisions will be affected by adopting a financial strategy of improving its liquidity. With a high level of liquidity, Wal-Mart will improve its ability to capture emerging opportunities in New Zealand. This multinational will be in a position to finance ventures in its retail chain, and hence add onto its profits (Greave & Barnes, 2011).
Final recommendations
Based on my findings, Wal-Mart should seize the chance of expanding into New Zealand. This is because this multinational will have a chance of success against its two major competitors – Progressive Enterprises Limited and Foodstuffs NZ Ltd. This is based on the fact that Wal-Mart has a strong financial base from its retained earnings from its US operations (Greave & Barnes, 2011). From the economic trends in New Zealand, Wal-Mart has an opportunity of substituting imports from Australia by providing them conveniently and in a relatively cheap manner. With regard to impact of globalization, Wal-Mart stands to benefit from automation and skills exchange. This will minimize its operational costs and hence improve its profitability. For the monetary system, Wal-Mart will be facing a flexible exchange rate system. This increases the currency risk for this multinational corporation. However, the solution lies in hedging its risk by use of forward and futures contracts.
References
Giddy, I. H. (2012). Exposure of Foreign Exchange Risk. Global Financial Markets, 51-53.
Grant, P. (2012). The Role of Finance in the Strategic-Planning and Decision-Making Process. The Journal of Finance, 33-35.
Greave, E., & Barnes, B. (2011). The Workings of The World's Currency, Money and Capital. International Finance Guide, 67-68.
