Corporate Finance: United Automobiles Company
My firm, United Automobiles, is based in the United States. It will be exporting automobiles, especially passenger cars, to different countries across the globe. Its primary target market is Canada due to its high population that relies on the private transport system. For the interest of the business, it is essential to analyze various factors that can influence the balance of trade between the United States and Canada. Besides, the same factors may influence the demand for automobiles in Canada and consequently dictating the company’s success.
Factors that affect the balance of trade between the United States and Canada
Trade policies/ Regulations
The success of UA Company will significantly be influenced by trade policies between Canada and the United States. Trade barriers limit the number of passenger cars exported to Canada. Policies that limit imports from the United States to Canada reduces the total amount of passenger cars exported. Further, subsidies on exports reduce the relative price of cars, therefore, making imported cars in Canada less attractive. Besides, in case Canada applies import quotas on cars from the United States, the prices of UA Company cars will be raised hence reducing demand. Such occurrence means a loss to the company
Factors endowments
Export of passenger cars from the U.S to Canada will highly depend on labour, land and capital as factors of production in the two countries. Labour, in this case, describes the features of the workforce in a country. Land refers to natural resource endowment in a country. Lastly, the export of passenger cars to Canada is significantly influenced by capital resources such as infrastructure and production capacity. If Canada has a high capital resource, it will have high purchasing power, therefore high demand for cars. On the other hand, the availability of capital resources will fasten the rate of cars production in UA Company.
Exchange rates, foreign currency reserves and inflation
After analysis of the Canadian market, it was noted that the domestic currency of Canada had appreciated significantly. This presents a threat to UA Company exports to the country since the cost-competitiveness will increase. The firm may be forced out of the market and be priced out of the Canadian export market. For foreign currency reserves, it was noted that Canada has adequate forex, and this creates a favourable competitive market.
It is vital to note that in all the factors that influence the balance of trade between the two countries, the most important and influential one if inflation. It was noted that the Canadian automobile market experience galloping inflation and this would significantly reduce the demand for passenger cars in the country.
Foreign Exchange Market
UA Company intends to use the cash market to trade for immediate delivery. The firm will exchange Canadian dollars into US dollars in the Royal Bank of Canada (RBC) that has a quotation of 108.86 CAD +0.060 (0.055%). When necessary, the firm may require services from the standard forward market for future delivery. In this case, UA Company intends to use a forward market for pricing. The forward price will be derived from the difference in interest rate between Canadian currency and the U.S currency. For interest-rate forwards, UA Company prices will be based on yield curve maturity. Don't use plagiarised sources.Get your custom essay just from $11/page
Monitoring Movements in the Foreign Currency’s Value
The Canadian currency value is affected by various factors such as;
- Interest rates
- Commodity prices
- Supply and demand of both Canadian dollars and U.S dollars
- Gross Domestic Product
- Balance of Payments
Using Currency Futures and Options
UA Company intends to hedge exchange risks using currency futures by buying USD-Canadian dollar futures. In this case, when the Canadian dollar depreciates, the U.S dollar appreciates hence the value of USD-Canadian Dollar goes up. Further, another way is to construct a synthetic forward contract using the money market hedge.
Also, the firm plans to use currency options to get the right to sell or buy specific currency in a particular amount or before the expiration date at the strike price.
The prevailing futures price of foreign currency- according to Bloomberg 1USD=1.32244 CAD
Monitoring Central Bank Intervention
If the Bank of Canada strengthens the Canadian Dollars in the foreign currency market, then UA Company’s business will gain due to stability in the market price. On the other hand, if the currency is weakened, the firm will incur a loss. The actions of the Bank of Canada, such as monetary and fiscal policies had direct impacts on UA exports.
Assessing Spot and Forward Rates
The Bank of Canada spot rate of foreign U.S dollars quote is 1USD=1.32244 CAD. In the rate is at C$1 = US$ 0.7265 in Royal Bank of Canada. From the above, it can be noted that the exchange rates vary with banks.
Current quote from Royal Bank of Canada= 82.00-0.35 (-0.43%)
One-year focus
Previous Close 82.35
Open 82.39
Bid 0.00 x 900
Ask 0.00 x 1800
Day’s Range 81.91 – 82.44
52 Week Range 65.76 – 82.58
Volume 608,218
Avg. Volume 949,975
Market Cap 117.676B
Beta (3Y Monthly) 1.05
PE Ratio (TTM) 13.04
EPS (TTM) 6.29
Earnings Date Nov 30, 2016 – Dec 5, 2016
Forward Dividend & Yield 3.21 (3.90%)
Ex-Dividend Date 2019-10-23
1y Target Est 88.84
Interest rates comparison
2019-05-29 02:00 PM BoC Interest Rate Decision 1.75% 1.75% 1.75% 1.75%
2019-07-10 02:00 PM BoC Interest Rate Decision 1.75% 1.75% 1.75% 1.75%
2019-09-04 02:00 PM BoC Interest Rate Decision 1.75% 1.75% 1.75% 1.75%
2019-10-30 02:00 PM BoC Interest Rate Decision 1.75% 1.75% 1.75% 1.75%
2019-11-21 01:40 PM BoC Gov Poloz Speech
2019-12-04 03:00 PM BoC Interest Rate Decision 1.75% 1.75%
2020-01-13 03:30 PM BoC Business Outlook Survey
Determining whether IFE Holds
By comparing Canada and Unites States interest rates, we would be able to determine whether the expected disparity between their exchange rates are approximately equal to the difference between their countries nominal interest rates. The graph below provides a summary of Canadian interest rates.
(Confidence and Lawrence 2019, n.d )
Current rates are as follows Actual Previous Consensus TEForecast
2019-05-29 02:00 PM 1.75% 1.75% 1.75% 1.75%
2019-07-10 02:00 PM 1.75% 1.75% 1.75% 1.75%
2019-09-04 02:00 PM 1.75% 1.75% 1.75% 1.75%
2019-10-30 02:00 PM 1.75% 1.75% 1.75% 1.75%
2019-12-03 01:40 PM 1.75% 1.75% 1.75% 1.75%
2019-12-04 03:00 PM 1.75% 1.75% 1.75% 1.75%
The united interest rates are as follows
Calendar GMT Actual Previous Consensus TEForecast
2019-06-19 06:00 PM Fed Interest Rate Decision 2.5% 2.5% 2.5% 2.5%
2019-07-31 06:00 PM Fed Interest Rate Decision 2.25% 2.5% 2.25% 2.25%
2019-09-18 06:00 PM Fed Interest Rate Decision 2% 2.25% 2% 2%
2019-10-30 06:00 PM Fed Interest Rate Decision 1.75% 2% 1.75% 1.75%
2019-12-04 03:00 PM Fed Quarles Testimony
2019-12-05 03:00 PM Fed Quarles Testimony
2019-12-11 07:00 PM FOMC Economic Projections
(Confidence and Lawrence 2019, n.d )
(Confidence and Lawrence 2019, n.d )
From the exchange rage analysis for the two countries it can be noted that international fisher effect holds for disparity between Canada and United States exchange rates are approximately equal the difference between their nominal interest rates.
Monitoring Exchange Rate Trends
The value of the Canadian Dollar concerning USD
For the last few years, the Canadian dollar has not changed that much, over the previous five years it fluctuates around 0.75 United States dollar implying that 1 Canadian Dollar= 0.75 United States Dollar (CAD per 1 USD, n.d). The value is noted to have increased in 2019 from 0.74 realized in 2017. On April 25, 1974, the Canadian dollar attained its maximum value of US$1.0443 that have never been realized ever since. On January 21, 2002, the Canadian dollar reached its lowest value of US$ 0.6179, that was an all-time low. From the beginning of 2019, the Canadian dollar has been one of the major currencies to be up against USD (Valdez-Lafarga, Schmitz and Englin, 2019, p62). It has increased in value and investors are keenly watching. The Bank of Canada has the sole responsibility to implement appropriate monetary policies to ensure that the value of the Canadian dollar does not reduce lower than expected. As the United Automobiles Company strategizes to export automobiles to the Canadian market, the current value of the Canadian Dollar regarding United States Dollar is desirable as compared to any other counties.
Recognizing Exposure to Exchange Rate Risk
As an international company, United Automobiles is exposed to transaction foreign exchange risks. This will occur because the company will be operating in the world market, and the global market has the chance to exchange risk fluctuations that may reduce the value of Canadian currency anytime. Further, the company will be exposed to economic exposure risk that is due to unexpected currency changes. The extent of exposure may increase as foreign exchange volatility reduces or increases. However, the company plans to counter this risk through operational strategies and currency mitigation plans. Lastly, the company forecast translation risks due to fluctuations in exchange rates that may result in a loss in company transaction and a financial statement such as balance sheet holdings. Further, as the firm intends to have most of its assets, equity and liabilities in the Canadian dollar, the translation risk exposure is increased. This is because, at one time, the firm will have to translate the assets, equity and liabilities to USD.
Hedging with Forwarding Contracts
The currency exchange risk can be mitigated through a currency forward contrast which is a foreign exchange tool used to solve movement between two currencies. In this case, United Automobile Company will sign a contract with the Canadian automobile dealers to complete the Canadian transactions at a future date with current favourable exchange rates. Through currency option, the firm will make an agreement that grants right but not obligation to buy currency at specified Canadian Dollar exchange rates. This will help the company mitigate the economic and translation currency exchange risk exposures.
Denominating Receivables in U.S. Dollars
If the receivables are dominated by U.S dollars, the transaction and economic currency exchange exposure will be significantly reduced. Operating in U.S dollars implies that the number of exchange transactions will be reduced hence limiting the impacts of Canadian Dollar exchange fluctuations. Further, with US dollars, the foreign exchange volatility will be reduced. This will, in turn, reduce the economic risk exposure of the company. Even though the currency exchange risk is mitigated, the firm will still face risk because it operates in the global market.
Establishing a Subsidiary in Foreign Country
As the company continue to grow in the lucrative Canadian market, creating a subsidiary would be appropriate to help reduce the foreign currency exchange risks. It will also reduce operation cost by cutting export expenses. Besides, the subsidiary will help stabilize, expand and explore the Canadian market at a faster rate. This will finally improve sales, profit margins and finally the company profits. In the automobile industry, subsidiaries are appropriate given the nature of the automobiles exported. Some cars are delicate, expensive and bulgy to export, and such problems are solved by establishing a subsidiary in Canada. However, creating subsidiaries in a foreign country may be costly and involves tiresome processes.