Background: One Of The Best Ways To Learn Broad Concepts

Backgroundone Of The Best Ways To Learn The Broad Concepts Presented I

Background one of the best ways to learn the broad concepts presented in this course is to put yourself in the position of an MNC manager or board member and apply the concepts to financial decisions. Although board members typically do not make these managerial decisions, they need to have the conceptual skills to monitor policies implemented by the MNC’s managers. This requires considering what actions they might take if they were in managerial roles or setting corporate policies.

Imagine a business that teaches English to individuals in a non-Australian country—specifically, a language school called Bell Beijing in Beijing, China. You establish this business by investing A$60,000 from Australia, setting up a small subsidiary with an office and classroom leased locally. Local employees who speak English are hired to teach students, with courses including a one-month structured program and a one-week intensive program for individuals planning to visit Australia. Both courses are advertised locally, and all revenues and expenses are in Chinese yuan. The subsidiary transfers most profits to Australia monthly, but revenue varies with customer enrollment.

Paper For Above instruction

This paper explores the critical financial management issues faced when operating an international language school in China as a subsidiary of an Australian investor, focusing particularly on exchange rate systems, profit repatriation, crisis responses, and funding strategies. The broad concepts of foreign exchange markets, risk management, and international finance are central to understanding the operational and strategic decisions in such an international context.

1. Exchange rate systems in Australia and China: advantages and disadvantages

Australia employs a floating exchange rate system where the value of the Australian dollar (AUD) is determined primarily by market forces, such as supply and demand, with minimal direct government intervention (Hall, 2019). The advantage of this system includes flexibility, allowing the currency to adjust to economic conditions, thereby providing a buffer against external shocks. However, the volatility associated with floating rates can create uncertainty for businesses engaging in international transactions, such as the language school in China. Fluctuations in the AUD can impact the cost of repaying Australian loans and influence profitability.

China operates a managed or pegged exchange rate system, historically pegged to the US dollar, with the People’s Bank of China (PBoC) controlling daily trading ranges (Ma, 2020). This system provides stability, which benefits international trade and investment by reducing currency risk. On the downside, managed regimes can result in misalignments, that is, over- or under-valuation, leading to distortions in trade and investment decisions. For example, if the Chinese yuan (CNY) is artificially maintained at a lower level, it can boost exports but hurt importers and investors expecting currency appreciation.

For your business, the Chinese exchange rate system impacts operational costs, profit repatriation, and competitiveness. Fluctuations in the CNY affect the yuan value of repatriated profits and influence pricing strategies and course fees for local clients. If the yuan depreciates due to market pressures, the value of your converted profits diminishes when transferred back to Australia, affecting your overall returns.

2. Repatriation of profits and tax implications in China and Australia

Repatriating profits from China involves converting yuan into Australian dollars and transferring funds to Australia. The process benefits from the flexible exchange rate system, but currency fluctuations can affect the amount received. To hedge against this risk, firms might use forward contracts or options to lock in exchange rates beforehand (Madura & Fox, 2019).

Tax implications in both jurisdictions influence profit repatriation strategies. In China, profits are subject to corporate income tax, which generally is about 25%, with additional rules on withholding tax on dividends sent abroad—typically capped at 10% due to tax treaties (Lardy, 2018). Repatriating profits may involve withholding taxes unless exemptions apply. Meanwhile, Australian residents are taxed on worldwide income, including foreign dividends, where credit for foreign taxes paid can be claimed to avoid double taxation (ATO, 2020). Proper planning ensures tax-efficient repatriation, minimizing tax liabilities and maximizing returns.

3. Impact of a currency crisis: the 1997 Asian Financial Crisis scenario

A. Effect on the Chinese yuan and the PBoC’s response

During the Asian Financial Crisis, many Asian currencies depreciated sharply. Given China’s managed exchange rate system, the PBoC would likely intervene to stabilize the yuan in times of crisis by purchasing foreign reserves to support the currency or adjusting the band in which it trades (Yu and Chen, 2000). Such interventions aim to prevent excessive depreciation that could trigger capital flight or destabilize the economy. If the PBoC maintains a tight peg during a crisis, the yuan’s value may temporarily hold steady but at the expense of accumulating reserves or risking increased economic disruption if pressures mount.

This stabilization policy impacts your business by maintaining the yuan’s value, thereby reducing unforeseen fluctuations in profits and costs. However, prolonged intervention could lead to currency misalignment, affecting competitiveness and export pricing.

B. Australian RBA’s likely reactions and effects on profits

If the yuan depreciates significantly, Australian importers, including the RBA, would observe increased Australian dollar prices for Chinese imports, possibly fueling inflation (Reserve Bank of Australia, 2022). To counteract inflationary pressures and contain capital outflows, the RBA might respond by lowering interest rates or intervening in financial markets. For your business, a depreciating yuan could lead to higher costs for converting Chinese revenue into AUD, squeezing profit margins unless you effectively hedge the currency risk.

4. Financing growth through financial markets

To expand your language school network across Beijing and other cities, you could tap into financial markets for capital. The most accessible instruments include foreign exchange forward contracts, commercial loans, and bonds. Using local or international bonds can provide substantial funding, especially if you issue debt in currencies aligned with your revenue streams or expenses (Brealey, Myers, & Allen, 2019). Alternatively, banks offer foreign currency loans, which can be customized with hedging clauses to mitigate exchange rate risks, supporting growth plans effectively.

5. Currency selection for raising funds: advantages and disadvantages

Raising funds in Australian dollars offers advantages such as familiarity with the currency, straightforward repaying of AUD-denominated debt, and the ability to match Australian expenses. However, disadvantages include exposure to fluctuations in the Chinese currency if revenues are in yuan, increasing the risk of profit erosion (Madura & Fox, 2019). Conversely, raising funds directly in Chinese yuan avoids currency mismatch but might involve higher costs and regulatory hurdles.

6. Hedging mechanisms against currency risk with banks

If you select an AUD loan, to hedge against yuan depreciation, you can enter into forward contracts or currency options. A forward contract locks in a specific exchange rate for future conversion, providing certainty in repayment amounts. Currency options grant the right, but not the obligation, to exchange at a predetermined rate, offering flexibility if market conditions move favorably (Levy, 2019). These instruments mitigate the risk of adverse currency movements impacting your debt-servicing capacity.

7. Alternative growth strategies amid capital constraints

If raising external capital proves challenging, alternative strategies include reinvesting retained earnings, forming strategic partnerships, franchising the model, or seeking government grants and subsidies for educational initiatives. Each approach has strengths and weaknesses; reinvestment maintains ownership but limits the scale of growth, partnerships can provide shared resources but may dilute control, while franchising allows rapid expansion with reduced capital but requires strong brand management (Ghemawat, 2020). Choosing the right strategy depends on your risk appetite, control preferences, and available internal resources.

References

• Australian Taxation Office (ATO). (2020). Foreign income and credits. Australian Taxation Office.
• Brealey, R. A., Myers, S. C., & Allen, F. (2019). Principles of Corporate Finance (13th ed.). McGraw-Hill Education.
• Ghemawat, P. (2020). Redefining Global Strategy: Crossing Borders in a World Where Differences Still Matter. Harvard Business Review Press.
• Hall, B. (2019). The Australian dollar: An overview. Reserve Bank of Australia Bulletin, 83(1), 23-34.
• Lardy, N. R. (2018). Chinese Economic Reform: Progress Continues. Peterson Institute for International Economics.
• Levy, H. (2019). Currency Risk Management: Hedging Strategies and Instruments. Journal of Financial Markets, 45, 65-82.
• Ma, G. (2020). China's Exchange Rate Policy: Managing Currency Stability. Asia & Pacific Policy Studies, 7(2), 150-164.
• Madura, J., & Fox, R. (2019). International Financial Management (13th ed.). Pearson Education.
• Reserve Bank of Australia. (2022). Monetary Policy Decisions and Economic Outlook. RBA Bulletin, 86(2), 5-16.
• Yu, Z., & Chen, W. (2000). China's Exchange Rate Policy and Its Implications. Journal of Asian Economics, 11(4), 565-583.