Foreign Exchange Markets: Is it worth the risk?

The volatility in the foreign currency market over the last 15 years has highlighted the fact that we all need to look more carefully at the associated risks when dealing with the international markets. Something that is worth £1 one day could be worth 80p the next day. Credit terms agreed in America dollars, six months later could be valued at a different price depending on the market. Overseas investment projects, which are creating investment opportunities need to be aware of currency change, as trading in the wrong currency could mean the end for your business. ‘Fluctuating exchange rates create risk, and badly managed risk can lead to loss of shareholder wealth’ (Arnold, 2008)

The foreign exchange market has grown spectacularly, figures show in 1973 the equivalent of US$10bn was traded, compared with figures in 2007 which was estimated at a massive US$3,210bn. London is one of the largest currency trading centres in the world, with a 34% share.  There is a variety of people trading they include exporters/importers, tourists, fund managers, governments and central banks. The larger players are commercial banks and speculators which include hedge funds. Banks try to speculate on future movements carrying out proprietary transactions.

The global currency exchange centres are open 24hours and the vast amount of money that is traded leaves them exposed to currency risk. There are three types of risk, transaction, translation and economic risk which operate in the international market. I am going to look at translation risk, which arises because financial data denominated in one currency are then expressed in terms of another currency. Also between two accounting dates the exchange range movement can be greatly distorted.

This was the case for GlaxoSmithKline (GSK) and how the currency rate affected the profit and loss account in 2007. As the weak dollar reduced cash sales, it overall had seen sales increase by 3% in the US market. The company that was 60% UK-based had no desire to move to the US market as their share volume increased. Even with the filing of the HPV vaccine which was associated with the cervical cancer developments and the sale of Alli, an over the counter weight loss medicine which was due to go on sale. Share prices fell in the company by 7p to £14.64 a share. This is an example of how the currency change can have an adverse effect on the group profits because of the translation of the foreign subsidiaries profits. This can still occur even when the managers are performing well and increasing profits in the currency market they operate.

Sources: (Arnold, G. 2008, Financial Times, The Guardian)

Raising company finance – Facebook’s IPO

For many companies the need to raise additional cash to increase company wealth is an issue that they will come across. There are two types of Finance, which are Debt and Equity capital. Debt capital finance; are available in the form of bonds, bank loans, Trust deeds, covenants and syndicated loans. The debt is usually repaid with regular interest and spread over a period or given in a lump sum. Debt is less expensive than equity finance, due to the lower rate of return required by finance providers. The rate of return is lower because investors recognise that investing in a firm through debt finance is less risky than through shares.

Debt is very different from equity finance as the lender has no official control, they cannot vote, choose directors or interfere with company strategy. But they can set rules regarding liquidity and solvency ratio levels; if a debt is unpaid they may also take charge of an asset.

The other form of capital is through equity financing, this is in the form of ordinary shares, and if a company is not already listed it would need to go through the process of gaining a quotation on the Main market of the London Stock Exchange (LSE) or other international exchanges. There is also the option of listing on the Alternative Investment Market (AIM) where the process is less costly and the regulations are less strict. Another option of raising finance is to make additional share rights issue. Ordinary shares issued have the right to exercise control, discuss strategy and are entitled to dividends being paid out by the company in regular payments.

A company which has been in the news for raising company wealth through equity finance, Facebook the social networking site has launched the process for its stock market debut – through which anyone will be able to buy shares in the company on an open stock exchange. It has filed papers for a $5bn initial public interest that will turn key shareholders into Billionaires including Mark Zuckerberg, whom still owns a 28.4% stake. The Initial public offering (IPO) that is likely to drarf Googles entrance to the IPO market in 2004.

But is this any good for the consumers and what will this mean? In the future the need to increase shareholder wealth maximisation, talked about in my first blog. Could we see the effects of money influences taking control? Will this in theory be the end of the fun Facebook we know and love and just another branding and marketing campaign that Mark Zuckerberg did not want. Can a multimillion pound company still have the same goal as when it started eight years ago in his dorm room or is its only goal a cash agenda.

Sources: (Arnald, G. 2008. Financial Times, CNN, Bloomberg)

Stock Market Efficiency: Trinity Mirror share price over reaction, after the closure of News of the World

The stock market is an area that is highly unpredictable; the market can be affected by news and like all news the outcome is unknown until it arrives and lands on the stock market. Each share price fluctuation is independent from the one before. News can have a positive effect on share price but sometimes this can be an overreaction, and then followed by a deflation as the hype begins to diminish. There are three types of efficient market hypothesise (EMH), they are operational, allocational and pricing. I am going to look at the case of Trinity Mirror and how their share prices jumped when News of the World (NoW) closed at the beginning of July 2011.

Trinity Mirror who own national newspapers Daily Mirror, Sunday Mirror, The People magazine and the Sunday Mail had already experienced share prices plummet as reports of a ‘slow and volatile’ recovery as inflation costs, investments and surging newsprint prices would outweigh their savings planned for the year. (The Guardian) Share prices dropped by 20% to 66p a share and in the following months dropped a further 37% to 41p a share.  The publically listed company found advertising losses were a huge part to play in cost cutting as 19 categories of advertiser spending less years on year and government advertising budget over £1m had been chopped to £100k, since the economic decline in 2008.

But as the news came on the 8 July 2011 that the NoW had closed, share prices in Trinity Mirror increased rapidly to 56.75p a share, in early morning deals.  As the excitement of the advertising potential and NoW customers that would now buy their Newspapers. This put them in a much stronger position to increase share holder wealth maximization. But are the markets always priced rationally? As emotions are running high with the very public case of NoW, can the price of stock be inefficient.

In this case it was an overreaction as share prices fell to 37.5p in August 2011. Even though the closure of NoW did help boost sales in July, the trading environment and decline in the amount of customer who now buy Newspapers, in favour of online publications has led to a decline in profits. The EMH asserts that the financial markets are ‘informationally efficient’ and achieving above average returns on risk adjusted investments in not very likely. Trinity Mirror is an example of single market inefficiency and how quickly and rationally a share price can change.

The Hypothesise falls into ‘weak, semi strong and strong’ versions and Trinity Mirror falls into ‘Semi Strong’. All public information is made available; the share price instantly reflects the new changes in public information as it reacts quickly and rationally to change. But is investing just chance, how can you really know what is the best company to buy shares in or is it just pot luck.

(Sources: The Guardian, The Telegraph, London Stock Exchange)

Shareholder wealth maximisation V the stakeholders: How Marks & Spencer’s executive pay scheme failed to meet the vote at the annual general meeting.

Shareholder wealth is also defined as maximising purchasing power. It allows a company to pay its owners in dividends. The promise of regular cash flow payments in interim and final dividends is what lures investors to hand over their hard earned cash instead of spending it in the here and now. They hand over their savings to a team of managers (agents) and receive shares in return. Shareholders are generally interested in the return on investment over a long period of time and not necessarily in a short term return. Managers investing in the company’s future will produce a much higher dividend payment in the future. ‘Maximising shareholder wealth means maximising the flow of dividends to shareholders through time- there is a long term perspective’.(Arnald, G. 2007)

But the economic downturn, brought about partly by bad economic decisions, not only destroyed shareholder wealth value but also hurt the stakeholders. Shareholders are holding stocks for less time and demanding a more immediate return on investment. Boardroom meetings are dominated by talks of moving over seas to save money. Long term strategy conflicts with what is best for the shareholder.

Should some of the key principles of modern capitalism be questioned, such as the idea that businesses should only be run for immediate benefit of their shareholders and that there isno limits to executives pay and bonuses?

Mark and Spencer’s new chief executive Marc Bolland who replaced Sir Stuart Rose in May 2010 has been offered the ‘Richest pay deal on the high street, dwarfing rivals running bigger chains on the high street like Sainsbury’s and his previous employer Morrisons’. Reaching a pay package close to £15m in his first year including £7m compensation for losses he would have incurred, from leaving his previous employment in shares and bonuses. (The Guardian)

In March 2011, share prices dropped to £3.29 as the outlook for the high street was looking gloomy as cost of living chipped away at consumer spending. As government cutbacks, rising prices and interest rate rises took effect increasing the price of commodities. The food division in April was ahead by 3.4% shopper treat themselves to the £15 Mother’s Day deal attracting 500,000 shoppers. The shares finished up 20.4p at £3.60, a rise of 6%. See Figure I

Figure I.

Marks and Spencer’s has also opted out of passing on the full extent of its rising costs to cash –strapped shoppers. As promotion in rival supermarkets take their toll. The dent in profits can be seen below in Figure II as sales are down 8% on last year.

Figure II.

One thing Bolland noticed when he took over the company was how Marks and Spencer’s was not cashing in on it heritage as an innovator. Shoppers are looking for quality on the high street and have started purchasing the more expensive range as shoppers look for quality. This is a sign that he is looking at the long term strategy of the company and trying to build on the brand.

Marks and Spencer’s has also been looking at ways to reduce operating costs as they expect costs to rise 5% this year. Some of the ideas were to move some of its manufacturing operations out of China to lower cost locations such as India and Sri Lanka,Increasing share holder wealth.

At the prior years annual general meeting about 16% of shareholders failed to vote in favour of Mr Bollands remuneration report, after concerns over the amount offered to persuade him to join the company. A move which originally angered some of its shareholders, when he was originally offered the position.  75% was originally based on the companies profit performance. Now bonuses are based more on the individual’s performance against targets. Due to this Bollan was only given £1m of his original £2.4m bonus, as M&S missed targets.

In this instance Mr Bollan appears to have the best interest and the long term goal of the company as his main focus, unlike his predecessor Sir Rose who appeared to be more aggressive in his role, which main goal was predominantly to maximise share holder wealth. Bollan is looking beyond the short term goal, I think yes he knows it is about shareholders, but also thinks it’s about customers, colleagues and community.

References

Arnald, G. (2007) ‘Essentials of Corporate Financial Management’, Prentice Hall Financial Times, pp. 25

Articles

Gribben, K. (2010) ‘Will taking the long-term view hit shareholder value?’, Financial Times

Roberts, D. (2010) ‘Capitalismin crisis: Corporate governance: Revolution in the air – but it could help resue business from itself’, The Guardian Financial Pages; Pg 30

Finch, J. (2010) ‘Capitalism in crisis: Executive pay: Rogues gallery in defiance of mounting investor anger’, The Guardian Financial pages; Pg 31

BBC News, (2011) ‘M&S Boss Marc Bollan misses out on £1m bonus’, BBC News Business