INTERNATIONAL FINANCIAL MANAGEMENT

Discuss the motives of such decision and its implication on Poland and Eagle Trust PLC.

A free float exchange rate regime is the predominant foreign exchange rate system in the world today as the progress in globalization has made more countries to abandon the currency pegs and permit their respective currencies to freely float. There are a number of motives for a country to adopt a free float exchange rate regime. The first motive is the ability to have market determined rates. In a free float exchange rate regime the market determines the exchange rate between two currencies. The market sets the exchange rates on a real time basis depending on the inflow of new information (Brealey et al. 2014). This reduces the need for Poland to set up elaborate mechanism that helps in ensuring the rates of exchange remain within a given range. Although the Central Bank may have to interfere in the markets when only necessary, their interference may negatively or passively impact Eagle Trust PLC. It may result in increased cash outflows or reduced cash inflows.

Another motive is independence. Adopting a free float exchange rate regime allows Poland and its Central Bank to have a great degree of independence and does not have to act in tandem with other nations’ central banks. This is because the monetary policies they set have influence and can be influenced by the other nations’ economic conditions (Clark, 2012). The exchange rate regime presents Poland with the opportunity to pursue policies that are appropriate for the local economy without the fear of conflicting with the external policies. For instance, with a free float exchange rate regime Poland does not have to make necessary changes should the dollar increase its interest rates. By choosing not to have its currency pegged to other currencies, for instance, dollar, Poland has a far greater degree of independence (Eiteman et al. 2016). On the other hand, it ensures the currency remains stable hence there is less likelihood of speculative attacks. This ensures the cash flows for Eagle Trust PLC does not vary too much. The adjustments in the exchange rate occurs on a minute to minute basis which ensures the gap between the market value and the underlying fundamentals does not widen so much for to give the speculators an opportunity to launch a rapid attack. The freely floating exchange rate system can change with the changes in the external shocks such as oil prices; therefore, it reduces the negative effects of the external shocks on the Eagle Trust PLC (Sercu, 2011). Therefore, a free float exchange regime prevents the multinationals from suffering huge financial losses should the exchange rate go against their projections.

Ina addition, a free float exchange regime ensures there is no crisis in the financial market due to automatic stabilization. There is automatic elimination of the possibility of global monetary crisis that originate from the fluctuation in exchange rates. The change in the rate of exchange automatically corrects the country’s disequilibrium in the balance of payment (Shailaja, 2008). The depreciation in the currency corrects the deficit in the country’s balance of payment. This makes the exports of the country cheaper which increases the demand for the Eagle Trust PLC’s products. However, it makes the imports expensive which decreases the demand for the products of Eagle Trust PLC thereby reducing its sales and revenues. Additionally, a freely floating exchange rate system helps a country in avoiding inflation. It insulates Poland from inflation in the US as Poland cannot import inflation in terms of higher prices of imports. On the other hand, Poland is not able to import inflation from the deficit nations.

Finally, the exchange rate regime ensures that Poland’s Central Bank does not hold huge reserves because they have no need of conducting active trading operations so as to maintain their currency’s value. This makes the regime more convenient to the country. However, it implies more volatility due to the change in the value of the currency on a real time basis (Tavlas, 2012). A free float exchange rate regime can be prone to huge fluctuations in value which causes uncertainty for companies as it adversely affects trade and investment. Since the foreign exchange market in unregulated, the values of currencies may hit rock bottom or skyrocket in just few minutes thus impacting the ability of Eagle Trust PLC to take part in foreign trade. Additionally, the uncertainty of the movements in the currency market has the ability to cause a massive dent in the company’s profits.

Managing the exchange rate exposure

Maria could employ techniques for hedging against the exchange rate exposure that result from the change in the currency regime. Firstly, she needs to stress that its customers in Poland pay in the domestic currency of the parent company and that the entity pay for all of its imports in the domestic currency as well (Horváth, 2006). This technique does not eliminate the exchange rate risk but just pass it to the customer; however, this may not be a realistic approach in a competitive environment because the customer would look for alternative supplier. Therefore, Maria needs to use leading and lagging approach. Maria needs to delay payment in case she expects the exchange rate to depreciate in case of cash outflows. On the other hand, she may attempt to get payment immediately in case she expects that the currency she is due to receive is going to depreciate (Gibson, 2008). This approach may be realized by agreeing to offer the customers discount for immediate payment.

On the other hand, Maria can decide to use a wide range of financial products in managing the exchange rate exposure resulting from the change in the currency regime. The first method is forward contracts which effectively fix the predetermined exchange rate. Although the technique hedges against unfavorable movement in exchange rate, it eliminates the opportunity to gain from favorable movements in the rates of exchange (Evrensel, 2013). In addition, Maria should use money market hedges as it helps in avoiding future uncertainty in rates of exchange by making the exchange at the current spot rate instead. The approach will enable Maria to borrow or deposit the foreign currency until the cash flow of the actual commercial transaction occurs thereby shielding the company from unfavorable future movements in exchange rate (Eun & Resnick, 2014).

 

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