Kinnaird College for Women Lahore

International Finance

Pre-mid assignment: MNC’s

Submitted to: Ma’am Farah Amir

Submitted by: Noor Amjad

Major: Accounting & Finance

Semester: 8

Date: 11 Feb, 2019

Question: 1 Explain why unfavorable economic or political conditions affect the MNC’s
cash flows, required rate of return, and valuation. Identify the more obvious risks faced by
MNCs that expand internationally in the selected emerging economy assigned to each
student.

Answer: To know about why unfavorable economic and political conditions affect MNC’s
cash flows, required rate of return, and valuation, we should first know what actually MNC’s
means and its goals.

Introduction:

MNCs are defined as firms that engage in some form of international business. Their managers
conduct international financial management, which involves international investing and
financing decisions that are intended to maximize the value of the MNC. The goal of these
managers is to maximize their firm’s value, which is the same goal pursued by managers
employed by strictly domestic companies.

Reasons:

Poor economic conditions or unstable political conditions in a foreign country can reduce cash
flows received by the MNC, or they can result in a higher required rate of return for the MNC.
Either of these effects results in a lower valuation of the MNC.

Risks faced by MNCs in UAE:

Following are the risk faced by MNC’s.

 Poor Economic Conditions

First, there is the risk of poor economic conditions but this risk is comparatively less than the
second risk. Second, there is country risk, which reflects the risk of changing government or
public attitudes toward the MNC. Third, there is exchange rate risk, which can affect the
performance of the MNC in UAE.
For the UAE, we will discuss the following types of risk:

1. Sovereign risk
2. Currency risk
3. Financial Risk
4. Banking sector risk
5. Political risk
6. Economic structure risk

1. Sovereign risk is that risk when the foreign country of investment changes its foreign
exchange regulations. This could lead to reduce the value of foreign investment contracts or even
nulling them. In the UAE, sovereign risk is rated as “Stable”. It was previously rated as
“Positive”, but the rating was decreased because of the impact of the Dubai World crisis.
Nevertheless, the UAE as a whole is trusted to meet its debts & obligations, thanks to its high oil
reserves in Abu Dhabi.

2. Currency risk arises from changing the price of one currency against another currency.
Currency risk is usually not compensated with higher rate of return. In the UAE, currency risk is
rated as “Stable”. This rating was based on the authority’s commitment to maintain the UAE’s
currency price & stability, even though they will not participate in the GCC’s proposed single
currency.

3. Financial risk happens when a corporation or government defaults on its bonds, causing its
bondholders to lose money. It also means when a company does not have sufficient cash flow to
cover its debts, which could lead for the shareholders to lose their money. Many kinds of risk
ratios are used to assess the financial risk on an investment, such as: The debt-to-capital ratio: the
higher its value, the more risk is involved. The capital expenditure ratio: it demonstrates how
much cash left for running the business after paying its debts. For the UAE, the financial risk is
rated as “Moderate”. This rating was based on the fact that DUBAI (which now has more risk
than other emirates) has the Dubai International Financial Center (DIFC), which is a free trade
financial zone, & this center is regulated by the Dubai Financial Services Authority, a recognized
entity by the federal UAE government. So, government regulations keep risk level moderate.
4. Banking sector risk: The Dubai World debt caused banks to be hesitant to lend until they
will fully recover from this, where UAE banks still need to book these non-performing loans.
New regulations from the Central Bank led to increase lending by 35.5% in 2011. In general, the
banking sector risk in UAE is rated as “Stable”.

5. Political risk: Each emirate is ruled by its own emir (sheikh), & all UAE emirates are known
for its political stability. So it is obvious to rate the political risk in the UAE as “Stable”.

6. Economic risk: Oil sector is the dominant one in the UAE, especially in Abu Dhabi that
accounts for 90% of the total UAE’s oil reserve. So high oil prices is a very huge supporter for
UAE’s economy. Non oil sector, such as trade, finance & real estate, especially in Dubai that
accounts for 70% of the total UAE’s percentage, is showing a start for stability. Still, the
construction sector is depressed. Overall, the Economic risk of the UAE is rated as “low to
moderate”.

Question: 2 Explain the exchange rate risk and government regulations due to regime
followed in that country.

The United Arab Emirates will keep its currency peg to the U.S. dollar. Since 1997, the AED has
been pegged to the U.S. dollar at a fixed rate of 3.6725 dirhams to 1 USD. That means the
AED/AUD exchange rate will move in tandem with USD fluctuations.

There are no currency restrictions in the U.A.E. as residents and non-residents are entitled to
hold fully convertible off shore or on shore bank accounts in the U.A.E. or overseas in dirhams
or in foreign currency.

Currently, UAE has adjusted itself to shifts in international financial turmoil, and it keeps its
currency steady against the dollar. This state of affairs should continue for a few more years,
even though increasing diversification of its economy, especially towards financial business, will
increasingly warrant a switch to flexible exchange rates. It is also important that as the bulk of
UAE`s export income is so typically concentrated in a single area, managing a floating-currency
regime would be pretty awkward. The authorities responsible for distributing the oil income
earned in dollars would clearly have to transfer part of this revenue to residents so that they
could pay for their imports, otherwise the value of the national currency would plummet. As
things stand, this proportion is fixed automatically, albeit indirectly, by the need to keep the
exchange rate stable, but no objective criterion exists to do this if the currency is floating. The
authorities would either have to establish one, but they would soon run into the same sort of
problems as with a fixed exchange-rate regime without the benefits of the stability afforded by
the latter, or they would not publicly reveal what it was, thus fuelling speculation, which would
further heighten the currency‘s volatility. All this would seem to justify sticking with the current
exchange-rate regime, with the fight against inflation being waged via curbs on lending or tighter
fiscal policy.

The UAE economy continues to cope with consequences of the 2014 oil shock with a GDP
growth expected to have reached 1.3% in 2017 (as opposed to 3% in 2016). Economic
performance remained subdued in 2017, partly due to cuts in oil output as part of OPEC
agreements. GDP is expected to grow considerably in 2018 (3.4% according to IMF, 3.9%
according to UAE Ministry of Finance) as both oil and non-oil outputs are projected to grow
more than by 3% in 2018 in Abu Dhabi, the largest and wealthiest emirate in the country. Over
the medium term, the country's economy is expected to receive a boost from its hosting of the
World Expo 2020.

The UAE is considered as a “safe haven” for investments in the region and the economy was not
significantly affected by the boycott imposed on Qatar in June 2017.The country, which is a
constitutional federation, is governed by the Federal Supreme Council. It consists of the leaders
of the seven emirates. The Federal National Council, which is the consultative council, has 40
members, of which half is elected and the rest is appointed by the rulers of the seven emirates.
The latest election was held in 2015 and the next one is due in 2019, where no substantial
changes are expected. The country is expected to remain politically stable, and should therefore
continue to attract foreign investments.

Since 2015, the UAE has faced a significant deficit due to the decline in oil revenues. After
further deepening in 2016, trade deficit has moderated somewhat in the first half of 2017. Many
public infrastructure projects, which were postponed, are poised to continue in 2018 and a new
master plan for the upcoming two decades is being prepared by the Ministry of Infrastructure.
Current account surplus, which used to be equivalent to over 10% of GDP before the oil shock,
fell to 2.4% in 2016, but is thought to have reached 2.6% of GDP in 2017 (IMF). The surplus is
expected to rise to 2.8% in 2018 with the recovery in oil prices and production. The recently
introduced 5%-VAT should also help the government generate AED 12 billion worth of revenue
within its first year of implementation. Inflation, which had reached 6.5% in 2015 and 5.8% in
2016, fell to 1.97% in 2017, and is expected to remain contained in 2018.

Conclusion:

Although the economy remains relatively sensitive to oil market fluctuations, prospects appear
promising this year. A strong dose of fiscal stimulus and the ongoing infrastructure investment
push related to the preparation of Expo 2020 which will notably buttress the construction sector
should drive momentum. The recent landmark investment law, relaxation of visa rules and other
business-friendly reforms also all appear poised to both attract qualified foreign workers and to
significantly boost FDI inflows. Nevertheless, slower global growth, trade protectionism and
financial volatility constitute important downside risks. Focus Economics panelists expect GDP
to increase 3.0% in 2019, which is down 0.1 percentage points from last month’s forecast, and
3.4% in 2020.