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International Finance Exercises


Purchasing power parity dictates competitive advantages within international finance. According to the theory of purchasing power parity, "the exchange rate between currencies of two countries should be equal to the ratio of the countries' price levels" (Eun & Resnick, 2012)

International Finance Exercises


One of the most notable examples of this phenomenon is the case of China. The country purposely tries to keep the value of its currency to as little as possible because that ultimately provides it a much stronger competitive advantage in foreign markets (Hamlin, 2014)

International Finance Exercises


In this case, if a currency of a country depreciates more than what is justified through the purchasing power parity principle, that country will gain stronger competitiveness. On the other hand, if a country's currency increases in value, the competitive position within international finance will ultimately suffer and weaken (Moffatt, 2013)

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This pattern of beneficial gains continues until financial year 2007, when a total of benefit of $2.4 billion was realized (Brooks, 2008)

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By hedging in these derivatives the organization has the potential to limit its exposure to movements in aviation fuel as the jewel price movements are likely to be reflected in the kerosene and heating oil market resulting from the similar characteristics of the commodities (Sadrinna, 2010). When looking at the underlying strategy of Southwest and their use of derivatives Scott Topping, the director of corporate finance states that the main motivation was based on the strict control of cost (Carter et al

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The derivative price for the commodity will reflect the market expectations of the future influences on the commodity, whereas the spot price is the current price (Sandaran, 2010). The ideal situation will see the difference in the commodity price in the derivative contract and spot price move closer to zero as the contract moves closer to maturity (Chorafas, 2008)

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To appreciate the way that derivatives have played a role in Southwest Airlines financial performance the subject may be discussed, looking at what is meant by the term derivative and the way they are used by Southwest in their hedging strategy, along with consideration of the reasons the firm may have utilized this strategy along with the results achieved by the firm. Derivatives are financial tools designed to create a price exposure based on the valuation of an underlying asset, commodity or even event and capture the market price changes or fluctuations (Dodd, 2002)

International Finance the Use of


This indicates the risk associated with hedging. However, without hedging Southwest Airlines would have faced losses at a much earlier date, in 2004 (Gimbel, 2008)

International Finance the Use of


A brief consideration of the different categories of derivatives will help one to appreciate the way in which they may be used by firms such as Southwest, usually with the aim of reducing some type of risk as part of a wider risk management strategy. A forward is one of the oldest types of derivative, with records of this type of people demonstrating its use as long ago as 2000 BCE in India (Markham, 1987)

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The price of aviation fuel in the future contract turned out to be much higher than the spot price at the time of purchase, and resulted in the airline making a loss of $992 million (Brooks, 2008). This resulted in the airline posting a loss in the third quarter of that year (Pae, 2008)

International Finance the Use of


It is argued that the strategy of undertaking hedging may help to prevent potential bankruptcy costs, as creditors may feel more confident in management of the company and their ability to recover debts (Ross, 1996). Ironically, it is companies that face the greatest financial challenges/difficulties which are least able to undertake risk management from hedging in derivatives (Rampini et al

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The recent strategy includes utilizing derivatives where the underlying commodity is heating oil and kerosene. These commodities are highly viable as they are aligned with aviation fuel, utilizing the same inputs, and Southwest Airlines may benefit from the greater degree of liquidity facilitated by the larger trading market for these commodities, both traded on the New York Mercantile Exchange (NYMEX) (Sadrinna, 2010)

International Finance the Use of


Basis risk occurs as a result of the potential difference between the contract spot price for a commodity and the agreed price for the underlying commodity in the derivative. The derivative price for the commodity will reflect the market expectations of the future influences on the commodity, whereas the spot price is the current price (Sandaran, 2010)

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Another consideration is the short-term condition of the South Korean economy. The country is facing long-run expansionary conditions, since 1997, but the current state is characterized as "fragile recovery," to the point where further stimulus, either through monetary or fiscal policy may be required (Kim, 2014)

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The rate is set by the central bank, which sets a bound in which the yuan can trade. This is roughly based on the USD, but the problem is that the lack of free float means that many observers believe not only is China manipulating the value of its currency but that such manipulations are unsustainable (Palmer, 2012)

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Many employees at Japan's Nomura (NMR) talk of a stifling, hierarchical culture that has so far led to a disproportionate number of that investment bank's biggest rainmakers seeking out jobs at higher-paying hedge funds." (Harris, 2008) I

International Finance in Japan This


automakers and sent them tumbling into a time of great financial difficult as the sales and profits of carmakers in Japan are being damaged "forcing them to review their alliances." (Nakata, 2008) the North American market is critical to Japanese automakers and because of this "

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is now about to swallow, and that Japan's painful decade-long internal restructuring might have insulated her companies from external trouble." (Schulz, 2008) Schulz states that there was a mistake made in relation to having underestimated "the extent of global integration not only in finance, but also in production and consumption that has emerged during the last decade

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Banks had been allocating more and more personnel until then with the economic expansion, but when the business cycle turned down, bank profits fell. " (Fukao, 2008) While the major banks have practically completed all of their bad loan disposals there has been slower improvement in regional banks therefore should the deterioration of the economy continue "it is possible that bad loans will begin increasing again

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[and] build an international financial architecture to address the global financial crisis, gripping the rich economies, including those of the United States, Japan, and the European Union." (Luci, 2009) at least this is the opinion of Dr