US International Monetary Relations

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The recently observed decrease of the exchange rate between the U.S. dollar and the Brazilian real has several political and economic conditioning factors. Concerning political matters, first of all, the Brazilian presidential elections should be taken into consideration. The instability that accompanied them in 1998 and 2002 decreased the real exchange rate from 1.2 to 4.0 real for $1. As soon as the elections were over, political stability appeared in Brazil, and this was the impact on the development of basic economic factors. After 2002, the Brazilian real has been on the way towards a steady strengthening of the U.S. dollar, and the growth of the international investment caused by the political stability and the expected highest interest rates as compared to Europe and the United States. Therefore, the inflow of the international capital supports the strengthening process of the Brazilian real.

Given the situation with launching a branch of the General Mills Company in Brazil, the major investment calculations will be considerably affected by the change in the exchange rates for the Brazilian and American currencies. Thus, the calculation of the net present value (NPV) and return on investment (ROI) will display worse results, in respect to the profitability for General Mills, as far as the general formula for NPV calculation presupposes the division of the cash flow amount by the exchange, or discount, rate, and ROI is the sum of gain and cost o investment divided by the cost of investment. Therefore, if the cash flow is at the same level, suppose $20,000, and the exchange rate increases from $0.25 per real to $0.50, the NPV will decrease about twice:

NPV = cash flow/exchange rate

NPV = 20,000/0.25 = 80,000

NPV = 20,000/0.50 = 40,000

Assuming that the cost of investment at the exchange rate of $0.25 per real was $10,000, at the rate of $0.50 it will raise to $20,000. Accordingly, the ROI decreases given the stable gain from investment at the level of $40,000:

ROI = (gain from investment + cost of investment)/ cost of investment

ROI = (40,000 + 10,000)/10,000 = 5%

ROI = (40,000 + 20,000)/20,000 = 3%

Given the two contracts payable in Brazilian reals and Japanese yens, to maximize the company’s profit it is necessary to obtain adequate exchange rate projections and decide on either spot or forward transactions to be carried out under each contract. Thus, given the potential growth of real about a dollar, the Brazilian contract demands a forward transaction, while the Japanese contract needs a spot transaction.

In more detail, the Brazilian forward contract is concluded at the rate of $0.559037/real on July 1, but its effective date is September 3 when the exchange rate is $0.530959. To increase the company’s profitability it is better to carry out a forward transaction on the originally agreed terms:

1,250,000 reals x $0.559037 = $698,796.25 (Original forward transaction terms)

1,250,000 reals x $0.530959 = $663,698.75 (Actual exchange rate for forward transaction)

Accordingly, the forward transaction on original terms, in this case, will bring an additional $35,095.5 to the company as compared to a forward transaction based on the actual rate observed on September 3. As for the Japanese contract, the original forward transaction exchange rate of $0.00921025/yen is advantageous compared to actual September 14 rates, i. e. $0.00976975/yen:

$1,250,000/$0.00921025 = 135,718,358 yen (original terms)

$1,250,000/$0.00976975 = 127,945,956 yen (actual exchange rate)

Thus, as the contract is payable in yen, it is more reasonable for the company to pay the whole sum according to the originally agreed contract terms than according to the actual exchange rate, as the value of the dollar about yen is decreasing and if actual September 14 rate is taken as a benchmark, the company will need to spend more dollars to pay the same amount of yens.

Apart from exchange rate fluctuations, in both contracts, the political stability in Brazil and Japan, the potential for selling the goods bought from Japan, and investing the money received from Brazil should also be considered in choosing between the spot and forward transactions.

The extra cash reserve of $100,000,000 should be invested either in Japanese or Euro Area banks based on long-term interest rates, dynamics of their change, and the spot and forward rates observed in the areas reveal that the Euro Area is the most applicable destination for $100,000,000 investment. In more detail, the US and Canadian long-term interest rates fell from 4.5% to 3.5% and this trend is developing, therefore investing $100,000,000 to the US or Canadian bank, after 6 months Intel will receive:

$100,000,000 + (3.5 x 6) = $121,000,000

The interest rates in Japan are lower, only 1.5%, but the country’s financial climate is stable and has displayed little fluctuation since 2004. Therefore, an investment in a Japanese bank will bring:

$100,000,000 + (1.5 x 6) = $109,000,000

Finally, the Euro Area has displayed steady growth in long-term interest rates since the second half of 2008, and the current rate is 4.5%. Therefore, investing in a Euro Area bank will give Intel:

$100,000,000 + (4.5 x 6) = $127,000,000

Accordingly, it can be advised to Intel to invest the extra cash in a Euro Area bank because this is displays rates’ stability and can benefit the company more than other areas discussed.

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US International Monetary Relations

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