Financial management and control in order to maximise the scale of organisation at global level is recognised as global finance (Turner, 2017). Business entities whether small or large keep trying to explore their financial operations in order to expand the business at domestic and international level. This report focuses on such aspects which are associated with global finance management to explore and enhance the business scale at international level. The report is divided in two parts as Part A and Part B. A financial plan is critically analysed with benefits and disadvantages of main source of funds in the part A. Equity and debts markets are focused areas in part A. Risk factor while funding and international transactions are covered in part B. Use of derivatives considering the future, forwards, options and swap to hedge foreign exchange risk are categorised in the B part. Pros and cons of various derivatives in managing FX risk and mitigating FX risk are also covered in this report. Diageo plc a British multinational alcoholic beverages company is taken to understand the concept of global finance.
Several countries are attempting to forego systematically unorthodox fiscal policies set up to promote stabilization, while some are widening the scope and scale. The main elements of international finance are the large international organizations, like the Global Investment Fund as well as the International Monetary Fund and various national institutions and government agencies, such as central banks, finance departments, and those business companies that operate internationally (Drezner, 2015). A failure of governments to coordinate priorities and reach international agreement on issues such as financial regulation also perpetrated the risk of a global financial structure. Whereas the global financial system is heading towards increased flexibility, specific domestic and international requirements must be addressed by governments. Emerging economy officials address a precision task as they must cautiously enforce sound macroeconomic strategies amid unprecedented market volatility while forcing shareholders to withdraw their resources to weaker markets.
Diageo plc is a listed organisation in UK. The company is currently trading at £10 per share and 10 million shares in issue. The total market value of the issued share capital of the company is £100 million. CFO Kathryn Mikells is requested to frame a report to the board of director’s subject to raising an additional funding of £50 million for better growth and sustainability for international projects. Before understanding the requirements of additional funding and appropriate funding options.
Source of funding
Organisations needs vast amount of financial needs and sometimes the internal funds remain insufficient to fulfil the requirements of business. Appropriation of financial sources at required time of span helps business to grow not only at national but also at international level too. Sometimes, companies need to collect funding or equity financing, grow their companies into foreign markets or places, invest in R&D, or ward off competitors. although businesses tend to use the proceeds of existing business activities to finance these ventures, it is always more desirable to try outsourced creditors or shareholders. For all of the discrepancies between the thousands of firms in the world throughout different industries, only a few streams of funds are accessible to all companies. Various type of funding alternatives is defined as follows:
This is of the alternative of source of funding for fulfilling the capital needs of business. Equity funds are raised by issuing share certificate to shareholders and investors. An offer of purchasing of equity shares is given to buyers in consideration of cash (Lall, 2015). The equity investment remains certified by publishing shares of company in general public. It is issued in proportionate of amount investment by the investor in business. Equity holders get dividends on their equity holdings. This is one of the way to generate the fund with in operations. However, the dynamics of equity funds states the ownership of business in the form of holding the equities.
Advantages: The main benefit of equity funding is less liability to repay the payments of equity holders. Significantly, the business generates the effective and aspects of spreading the business with more than one channels. If the organisation is not being able to pay their consideration back than it may issue right shares that prevent the risk of low liquidity. There is no extra payment is required to made to equity holders like bonds and debentures. In loss conditions organisation is not require to pay dividend and profits.
Disadvantages: Main drawback of equity financing is distribution of ownership and control of business in stakeholders. Profit for organisation also get decreased
This is one of the common alternative of source of finding for business development and growth. The loans remain divided in two sections as short term loans and long term loans. If the duration of repayment of loan is more than one year than it is considered as short term loan. However, organisations take long term loans to fulfil the large business objectives. Various financial banks and financial institutions provide low interest loans and credit policies to companies that wants to grow at international level (Visser, Clapp and Isakson, 2015). Commercial loan is one of the unique concept added by investment banks and financial institutions. The duration of these loans vary in between to 3 to more than 20 years. These loans works as a booster for start-up organisations. However, the low interest rates are the key attraction point of this source of alternative.
Advantages: Bank credit and overdrafts are a very important origin of business funding, with loans to small and medium-sized enterprises (SMEs) forming a large part of the dealings of banks. Banks tend to give competitive debt service levels but typically have a credibility which is respected and secure. A major benefit, as with any form of debt, is there is no evaporation of equity or influence relative to the sale for a stake in the company. In several countries, debt also provides a tax break, because repayments on mortgages are excluded before determining a personal tax expense, thus increasing it.
Disadvantages: As banks tend to engage in corporate lending, entrepreneurs are left aside. Banks have low risk levels for other networks we're going to talk about. it remains focused on medium and small-sized businesses of proven reputations–and of course the obvious companies–and try to avoid late-stage enterprises with healthy balance sheets or past transactions. A further problem with bank credit is that its advantages are restricted to providing money alone - it arrives without any hedge fund experience, nor the exposure of a crowdfunding site. Sharing of profits reduces retain reserves and the accessibility to run the operations with effective financial stability.
Generally, the meaning of crowdfunding states the fulfilling finance needs from general public. Crowdfunding provided investors with the opportunity to increase hundreds of thousands or millions of pounds from anyone with money to invest (Inderst, 2016). Crowdfunding offers a platform for those with the intention of selling it before shareholders are awaiting. A person who tried to create a new recipe for coleslaw was one of the more humorous ventures to receive funding. This alternative is rapidly used by small and growing organisations. This alternative is basically based upon three models as project initiator who allows the public to invest in their proposed fund and individual groups supported with moderating organisation. Entrepreneurial ventures and creativity also helps in communicating the project.
Advantages: In contrast to the alternate financial sector as whole, equity crowdfunding have seen a significant increase in popularity as businesses leverage the public's financial power to penetrate traditional equity barriers (Christophers, 2016). The diverse approach permits for a wide scale of investors, supplying the community with new possibilities and allowing late-stage companies to quickly fill financing holes, with company. In certain conditions, businesses can' adequately fund' as the impetus of a crowd funding campaign soaks up interested shareholders, moving over their expected goals.
Disadvantages: The abundance of funding sites is a glut of businesses from which to choose, and while the system itself is cost-effective and moment-efficient, extensive work should be carried out into the correct system to choose from. Similarly, businesses should be vigilant about network abuse and insure that no step to protect their privacy has also been provided. Although funding initiatives can be effective advertising, businesses need to remain aware that expectations are not achieved–the funding may be back at square one after raising.
There is a specific categories of entrepreneurs who are working successfully at national and international level. These investors invest in new ideas or plans. If the plans consist future sustainability and growth opportunities. These may be an individual person or group of investors. They reserve the right to oversee the practices of the company for losing their money. Essentially, it often includes a board of director’s role and accountability protection.
Advantages: Industries are provided with insights and a community of stakeholders by hooking with seasoned Angels. The presence of Angels also grows the economy within the system from all those involved (Winecoff, 2017). It makes sense to change the lead of the Angel–with such a mutual interest, their investing expertise and history enable stakeholders to highjack this insight for the advantage their portfolios. Demons will function for your company as advocates, arrange funding and continue to provide their critical business acumen.
Disadvantages: The pluses of getting funding from deities should be measured cautiously against the constraints and sacrifices tied to it. This is not a benevolent investment on their part–any requires a gain, and they're often in a negotiating and administrative role to exert control and requests on businessmen. Conveying the aim and objective of business plans remain quite difficult to such investors. It contains an extra cost to organise an event or meeting to address the business idea and future goals to these investors. One of the major disadvantage of angel investors is seeking for new business ideas and goals they do prevent to invest in already established or stabled business.
Debentures and bonds are also recognised as an alternative source of funding for business wants to explore at international level. This source is similar like bank loans. Debts are issued to investors with a significant rate of interest at which organisation is liable to pay interest even after having losses. Debt funding remain risky in term of exploring the business at large level because the interest is required to pay in both loss or profit situation.
Advantages: The ownership remain stable in the hand of business owners. the rate of interest also remains lenient comparatively to other commercial loans and advances (Lagerwaard, 2015). Consideration of debt is paid in the form of interest which is deductible form revenues before payment of taxes and dividends. There is no excessive burden remain on business to repay the bonds or debentures. The interest rates also remain stable as decided in contract before issuing debenture.
Disadvantages: The option of debt financing remain costly for business because the principle and interest eventually paid to debenture holders. The payment also reduces the possibility of having less reserves and surplus (Dymski and Kaltenbrunner, 2016). Excessive debts enhance the financial leverage that remain risky for business to stabilize financial performance of business. The impact of working capital also enhance the maturity of debt financing.
From the above description of source of alternatives, it is examined that equity and debt financing are considered adequate source of funding. Creditors and shareholders generally prefer low expenses-to-equity levels because, throughout the case of a business loss, their assets are better protected. As the CFO of Diageo is seeking to raise fund of £50 million. The debt and equity financing ratio must be between 1 to 1.5. If the proportion rises, creditors fund the company rather than from its own funding assets, which can be a bad trend.
Use of derivatives to hedge foreign exchange risk
In present time, there are number of risk and other contingencies related with expansion of business for a company, that are needed to be determined and resolved with the best derivation so that productivity and profitability keeps of increasing. When business expand to different part of world, the major problem or any risk faced by companies are related with receiving or making payment (Puetter, 2016). Therefore, manager focuses to implement and include various meaningful derivations such as forwards, futures, options and swaps that are beneficial to determine and reduce the risk factor or circumstance in context to payment dealing at international boundaries. As Diageo, conduct business abroad, it might just face exchange rate risk: the currency rate may adjust as foreign money is converted back into national currency. There are major four types of derivation that are as follows:
Forward: The basic form of derivatives currently available in market are forward transactions. These are considered to be most advanced form of derivatives that mainly deal of developing an agreement to sell anything in nearby time. The parties involved in forward contract makes a decision that is to fix the price of transactions on the same date when it actually take place. Moreover, forwarded contracts are even more versatile as when the partners can determine the specific product and the product volume and the settlement date. These kind of contract mainly takes places among two counter parties which defines that exchange is not negotiator in the context of forward transactions due to which there are more chance of counterparty credit issues to the respective firm. It is also stated that this agreement helps to the both parties to fix the exchange currency rate at the same time of contract which is beneficial to buy or sell the respective currency on a predetermined future date.
Future: This kind of derivation are totally different form the forward contract such as the future transactions are mainly traded on central exchange rate in fact of over then counter market that results to effective and faithful determination of prices. It is related with more standardized instrument that mainly specify the delivery of right quantity of particular goods on appropriate time and place on decided date (Storm, 2018). Business deals on futures exchange and is liable to regular transaction. Future contracts have developed from forward contracts which have many of the same functionality as it deals in structured markets. This business transaction are different from forward contract as they are related with process of regular settlement which helps in easy business of Diageo in particular time frame. Future contracts, furthermore, are mentioned on the exchange list stating that such it acts like as an n intermediary agreement. Such agreements are therefore prepared of generic form and there is no way to change these types of business transaction. Another crucial note to be added in term of futures contract is that the sellers and buyers are not part of any kind of agreement as they are needed to enter into a trade deal.
Option: The third derivative type is known as option which differs significantly from other mention above derivation (Boako and Alagidede, 2016). Both parties are obligated by the agreement to perform a certain obligation at a certain date in forward and future business contract. But on the other side Option agreements are deemed to be asymmetrical, in which binding on one partner is important and requiring the another party to determine the appropriate future date for making a contract that must be before the expiry of that agreement. Therefore, at future date, another party seems to have the obligation to sell and buy while the other party have a option to make specific decision. This option contract has two type call and put option which means that Call option offers company the option but never the responsibility to purchase anything at a particular price on the future date. On the other side put option offer the right and determine that it is not necessary to trade anything on predetermined rate at a specific time period.
Swaps: Swaps are financial transactions allowing both parties to swap inflows and outflows of cash. The swaps typically involve exchanging for a variable income in relation to a set of specific company cash flow. Interest rate swaps, product and currency swaps seem to be some of common forms of swaps. Swaps allow businesses, among other risks, to reduce foreign exchange risks. On the market, swap deals are not typically traded (Visser, 2015). These are personal agreements signed by two parties. Investment bankers usually act as intermediaries for these deals. It can be understandable by the example of risk mitigating interest rate swap as it is assumed the notional principle of 1000000, apart from credit risk, fixed flows are risk free, cash flow which will remain uncertain at initiation in orange. The formation of 1-year rate happened to equal today’s forward interest rates, increasing in short duration parallel to today’s forward interest rates. Increase in short term rates will increase and V.V. as cash flow in interest rate swap for four years will remain fixed at £19925.20 and floating for 1st year £13250, 2nd year £20763.90, £23764.90 for 3rd year and 22253.30 for 4th year. The receiver of floating payer fixed protected against will enhance in short term interest rates. Gains on swap offset business losses due to rise in rates. Receiver of fixed payer of floating protected in respect of protected will fall in long term interest. Gains on swap offset business losses due to decreased in rates. As the interest rates are parity relations with currency swaps with credit exposure.
Advantages and disadvantages of forwards, future, options and swap to hedge foreign exchange risk
Advantages: These can be measured towards the coverage duration as well as the exposure's cash weight. Forwards are custom-made and it can be prepared for any length and number (Rethel, 2017). It's offering a full protection. This not only provide price protection but also remains easy to understand for users. These remain high form counter products. Transaction cost in some cases remain avoided in and there are no restrictions on less sales. The risk free rate is used for borrowing and lending. Arbitrage options are deflated whenever it arises. Price movement risk is being controlled through forwards.
Disadvantages: There is a lack of liquidity remain associated with private contract. The risk of defaulting of counterparty remain high with forward contracts. These type of contracts remain unorganised which creates complexities while framing the contracts. Once the contract is breached than entering in new contract become difficult for contractors. It is recognised that the tying up capital remain required at high level due to which liquidity get decreased and cash flow before settlement get misbalanced.
Advantages: Big volumes of securities exchanged on a daily basis, there is still a great opportunity to position trading requests very rapidly. For such a reason, jumping a jump to something like a new level is unusual for the rates, and trade in futures contracts is very active. Therefore, the profit needed to hold a futures market is low and, if he correctly predicted that buying pressure, he earns huge profits (Wolff and Zachmann, 2015). Time duration is one of the major advantage for users in case of volatile assets in most of the cases the trading cost remain fixed which mitigate the risk of changing interest rates.
Disadvantages: These are made especially useful for both the danger-tolerant small investor by their standard functionality and also very high pay-out rates. For example, future might not be the greatest way to purchase shares, but is a good way to purchase different assets like resources, currency and indices. The volatility allows these stakeholders to engage in industries they would otherwise never has had exposure to. Time period remain already set in future projects due to which certain investments remain worthless and reduce credibility for users.
Options are derivative methods that investors and traders use before paying compensation to protect the risk of price movements. The major benefits and drawback of option contract for respective company are discussed below:
Advantages: Buying and selling options gives both buyers and sellers flexibility as it could be used to earn a profit of the ever-changing market in a broad range of techniques (Bassens and Van Meeteren, 2018). With the help of this derivation investors are able to control any kind of risk associated with investment and it also support in reducing these potential risk. Option contract are treated to be less risk as compared to any other contract option or trading techniques. It is most beneficial to avoid large loss to company due to limited risky factors within option premium.
Disadvantages: The main drawback of option trading is that it gets expired on a particular time that leads to huge losses to the following party those are part of purchase option (Sassen, 2016). Option contact are more complex rather than any other trading instrument therefore it requires a closer overview and maintenance.
In present time the concepts of currency swaps are in more demand and trend because it provides extreme level of additional flexibility. In many complicated situation swaps also enables the both parties arbitrage across different matrix of currencies and various short term maturities. There are number of advantages and disadvantage of Swaps for Diageo that are discussed below:
Advantages: This mainly depends on the standard of competitive value analysis through which one lender replaces the competitive advantage they have to the other lender's supply and demand (Langley, 2018). The defined results between both parties is beneficial to arrange funds at lower cost. It is used to gain advantage of the new finance platform for both parties by disclosures of competitive advantage. It is also used by management of Diageo to hedge risk such as any down fall in the current interest rate then manager are needed to replace fixed rate obligations with floating rate. Swap contracts can solve risks due to interest rate variations and can exchange treaties could also be reached in specific time period.
Disadvantages: The main drawback of SWAP contract is that early termination of swaps even much before the time of maturity that may create the chance of breakage cost. There is more possibility of lack of liquidity.
The above report discusses about the concept of global finance in order to determine the aspects of international expansion of business with optimum source of fund. The report covers the criteria in two sections as first section is able to correlate the requirement of source of funding for global expansion. Critical evaluation and description of source of funds provides an idea that which source of funding is beneficial for company to maintain the financial leverage in adequate level. Considering the cases in the given report, equity and debentures are best option for source of funding. Second part of report is able to critically compare different derivative alternatives to hedge foreign exchange. It is evaluated that each derivative has its own advantages and disadvantage that mitigate the risk in different scenarios.
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