A Feasibility Discussion For Local Currency Pricing Of Overseas Education For Chinese Students Using Financial Derivatives

As the Chinese economy fast develops, the overseas education for Chinese students is seeing a trend from being regarded as a luxury to a common service. In the past, when Chinese students are choosing their overseas education destinations, the main factors for considerations were the rankings of universities, the quality of education experience and the advantages of the major, etc. Since overseas education was treated as a luxury, students are insensitive to its price, not to mention the fluctuation of exchange rates. However, as overseas education makes its way to the lives of common people, it is becoming a choice of life instead of luxury consumption. Students are paying much more attention to price than they were in the past. Other conditions being equal, a comparison of price between universities is now a key process in the decision making of more and more Chinese students who are planning their overseas education. Even though some Chinese students use bank services to hedge the exchange rate risk, the majority of them are fully exposed to exchange rate fluctuations. What’s more, if we look at the issue from the perspective of the cost of exchange rate risk hedging, it will cost more for students to hedge individually, let alone the lack of professional expertise, the difficulty to enter financial markets and the time and energy devoted to all these. The problem is, that the universities, even though they receive tuition fee in their own currency, are exposed to an embedded foreign exchange rate risk in the quality-adjusted student intakes. This is because of the fact that exchange rate fluctuations might reduce the number and quality of Chinese student applicants. As the success of university is closely linked with the performance of students and the level of academic research, the quality of students is as important as the amount of tuition fees received.The author of this dissertation suggests that overseas education for Chinese students can be priced in local currency, that is, Renminbi (RMB). This is because of the fact that education industry in western countries depend more and more on Chinese student intakes. This means that overseas education market is transforming from a seller’s market to a buyer’s market and that in a buyer’s market sellers have to cater to the needs of the buyers. This LCP (local currency pricing) design transfers the exchange rate risk from the students to the universities. Since the total amount of tuition fees received is relatively large, and could be estimated, universities enjoy economics of scale when hedging exchange rate risks. With the assistance of professional financial institutions in quantitative analysis and with the use of financial derivatives, we can achieve the hedging, thus reducing the relevance between exchange rate risk and student quality.Considering the money-laundry risk accompanied with transactions of bulk amount of currency, the author of this dissertation refers to related literatures concerning anti-money-laundry and suggests that the LCP design can be limited to only implement within the frame of regulators and that we have legal compliance arrangement together with bank, thus avoiding the risk in the cross border transaction of RMB.In order for the local currency pricing design to work in reality, detailed plan and timetable involving the university, the banks and students are introduced. To simplify the analysis, the author of this dissertation limits the analysis down to one of the leading foreign education destinations, the UK and its currency Great Britain Pound (GBP).3 month and 9 month GBPCNY forward exchange rate contracts are the primary financial hedging used. The historical data can be easily accessed for analytical and back-test purposes. By quantifying the return and volatility of the design, an optimal hedging ratio is calculated for the LCP to work. GARCH models have been used to model conditional variances and covariance of exchange rate, in order to generate a forward-looking optimal hedging ratio. Back and scenario tests have shown that the local currency pricing arrangement can work if applied in 2014/15 academic year and can effectively hedge away volatilities.Through the analysis of this dissertation, the author concludes that the LCP of overseas education is feasible and has a multi-win outcome. Chinese students can hedge away their exposure to exchange rate risk. Western universities, while undertaking the exchange rate risk, can quantify and hedge away the risk and enhance its reputation among students. Banks can increase revenue by selling more exchange rate derivatives. The author of this dissertation suggests that the LCP design is more applicable to middle ranking and reputation universities. The education service of these universities have the characteristics of consuming goods and buyer’s market. They can significantly enhance their reputation by the distinct introduction of LCP. Top brand universities, in comparison, will benefit less in the enhancement of reputation, so that they have little motivation to adopt LCP.