Fotogrametría

The BRIC countries, as per Goldman Sachs study, are expected to be dominant

economies in the world in the next 25 years and are projected to challenge the existing world economic order. What are the economicl and financial implications of this for U.S.

financial managers with respect to the following:

A. International Trade Transactions B. International Securities Transactions C. Central Bank Reserves

What exciting opportunities and critical challenges such a development pose for multinational corporations and U.S. citizens?  How do we benefit from it?

BRICs Growth  Trade Implications

GLOBAL TRADE: The BRIC countries are likely to become dominant players in the global economy over the next 25 years. In 2005, BRICs contributed 28% of global economic growth.

In addition, in 2005 four BRIC countries had 15% share of global trade, held 30% of global reserves of gold and foreign currency, and got 15% of global foreign direct investment and took in 3% of FDI outflows. Therefore, U.S. financial managers must take into account the impact of BRICs in Global Trade.

Intra-Trade: There are several economic reasons for these countries to engage in intra-trading. The BRICs have the potential to form a powerful economic and trading bloc to the exclusion of the modern-day trading blocs [such as G7]. This would not be in the interest of the U.S. as it would probably have to pay more to receive these goods and in turn makes higher costs. World trade markets will also be greatly affected by dominance of BRICs as multinational corporations attempt to take advantage of the enormous potential offered by BRICs.

Terms-of-Trade: [Higher or Lower prices?] Due to specialization, Brazil and Russia will become the dominant suppliers of raw materials and China and India are likely to become the dominant global suppliers of manufactured goods and services [like OPEC]. For example, far cheaper automobiles affordable to the consumers within the BRICs may be produced in lieu of the luxury models that U.S. automobile manufacturers sell. If this happens, the enhanced competition would imply a better price for the global consumers but lead to a decline in U.S. manufacturing. But, as BRIC continues to grow increasing demand for resources, will increase prices upward. For the U.S. , this means higher prices all around as well as more competition for U.S. products both internationally and domestically.

Financial Centers and Markets: Historically, New York and London have maintained the pivotal leadership in capital markets, with their tradition of stability and financial innovations. In 1990s, Tokyo, Hong Kong and Singapore financial markets have gained ground as financial centers to the global economy, attracting great amounts of investors and money. As BRICs countries gain more global clout, new financial centers of power and influence will reshape the landscape. However, New York and London will remain the global players in this field with diminished importance.

Central Bank Reserves and Global Currency: Since world war II, the U.S. dollar has been the dominant global reserve currency. But after the 2009 global financial crisis, ideas of creation of a new supranational currency to handle mutual and regional transactions are increasing.

The move calls into question the role of dollar as the world’s top reserve currency. The BRIC nations and China have been promoting the need for a new global reserve currency that is 'diversified, stable and predictable' as they push for a bigger role in world affairs. This is a direct attack on the perceived 'dominance' of the US Dollar. In earlier years, Russia, Europe and Japan have raised this issue. Dollar has a dual role. The Central Bank Reserves of most nations are backed with U.S. dollars or gold. U.S. is the preferred investment destination for Central Banks of the world, and investors. An alternative, such as EURO, SDR, Gold or Basket of currencies would not be in the long term interest of the United States and lead to a diminished role of the U.S. dollar in world affairs. Creation of a new reserve currency and substitution of the dollar would lead to a fall in the value of the dollar against major currencies. A strong BRIC could minimize the importance of the US dollar globally.

Products: Gains of Trade:  Economics & Efficiency  Cheaper Prices  Better Products

 Higher standard of Life.

Investment opportunities: The rising status of BRICs as economic powers poses a great deal of opportunities for multinational corporations to grow profit, grow and consolidate in global market share. These companies must learn to penetrate these diverse markets and

understand their consumers. In Brazil, US corporations have performed joint ventures in the import export business due to its vast natural resources. In India, many US corporations have outsourced and off-shored customer service departments and the business continue

growing. In China, where labor costs are one of the lowest in the world, US corporations have built factories that produce goods that are imported from China. However, US financial managers must address the challenges this global trade represents. In Brazil and Russia, for example, corruption; In Russia, corporate governance and employment stability; In India, multinational corporations still have to cope with a very heavy bureaucracy, and in China, there is a intense business competition with Chinese national companies and foreign

companies. On the other hand, United States citizens and residents as consumers can benefit from this phenomenon by getting much cheaper products and services with a great deal of variety. However, by off-shoring and outsourcing of many jobs in the current decade, U.S.

manufacturing and employment has been impacted. U.S. corporations need dynamic strategies at the work place to train employees in other industries and professions.

19. Theoretical Relationship 6: Relationship between Spot and Forward Prices A. Illustrate the concept of “Spot-Forward pricing parity” relationship with a

numerical example.

B. What are the implications of this for Foreign Exchange Market?

Theoretical Relationship: Number 6.

“Spot-Forward pricing parity”  In Foreign Exchange Market First, let us explore what is the relationship between Spot and Forward prices of Commodities?

Rational Expectations theory argues Spot and Forward prices should be equal. If carrying cost exists, the forward price can not be greater than Spot price and Carrying cost.

Carrying cost could be positive or negative!!!

THEORY

Spot-forward parity is a condition that should theoretically hold, or arbitrage opportunities would exist. Spot-forward parity is an application of the Law of One Price. If one can

purchase a commodity today for price S [Spot] and conclude a contract to sell it three month from today for price F [Forward], the difference in price should be no greater than the cost of using money minus any expenses (or earnings) from holding the asset; if the difference is greater, one would have an opportunity to buy the “spot’ commodity and sell the “forward"

for a risk-free profit. If the difference is less, one can sell the “spot commodity” (by borrowing it) buy the forward and lock in a profit.

Example: What should be the Spot Price of barrel of Oil today and a year from now? Let us say, today Spot price is $80. Should we expect Forward price to be $120 a year from now, or $40 a year from now?

Answer: If cost of Oil is $80 a barrel today, and the Carrying cost is $1 per barrel per month, then the price of Oil cannot be more than $83 three months from now. If it is say

$85, then someone can buy the Oil today at $80, carry it for three months, and sell forward today and profit $2 per barrel.

The parity condition is the price of the Forward should equal the current Spot price adjusted for the cost of money, dividends, "convenience yield” " and any carrying cost including storage and financing costs.

Limitations for Spot-Forward Parity:

 Need Highly Liquid Markets

 High Transaction Costs

 National Regulations and Legal Restrictions

 Non-enforceable legal systems.

Spot-forward parity can be used for virtually any asset where a future may be purchased, but is particularly common in commodities, currencies and financial contracts.

In Simplified mathematical form:

F = S e ^{r T} , where

F, S represents the cost of the good on the forward market and the spot market.

e is the mathematical constant.

r is the applicable interest rate (for arbitrage, the cost of borrowing; carrying cost).

T is the time period applicable (fraction of a year) to delivery. This formulation assumes that transaction costs are insignificant.

Financial Contracts

If the carrying costs are negligible, or non-existent as in the case of financial contracts, then under the risk neutrality assumption:

F = S.

Example: Price of Stock Index today and a year from now.

Price of Inflation Index today and 3 months from now.

One of the major assumptions is that Risk Neutrality Assumptions exist.

Opponents argue there is no risk neutrality and Speculators need to be rewarded.

 How are speculators rewarded? Reward for Speculators:

If, Speculators are “Short” in forward contracts, then at present F < S

Forward prices at time of delivery would increase and be the reward for speculators.

If, Speculators are “Long” in forward contracts, then at present F > S

Forward prices at time of delivery would decrease and be the reward for speculators.

General Conclusion:

Theoretically:

 Rational Expectations theory holds true.

 Spot Price Good representation of Forward price.

 Forward prices are the best estimates of Future prices based on all available information and, in the absence of substantial carrying costs

Spot Prices = Forward Prices.

Empirical Results are mixed. Hence, for practical purposes we assume that, Forward Prices = Unbiased predictor of future spot prices.

If price of Oil is $80 today, we assume that the same will exist a year from now.

In the absence of data or markets, assume in your calculations Spot Foreign Exchange Rate is a good predictor of Forward Exchange Rate.