Transcript Multinational Business Finance Professor M. Vaziri
Multinational Business Finance Professor M. Vaziri
Importance of Multi-National Corporations (MNCs) :
• Technology Transfer • Global Trade
Global Integration of Money & Capital.
Law of Comparative & Absolute Advantage MNC & Risk Management Types of MNC :
• Labor, Capital, Technology
Seekers, Cost Minimizer. MNC & Host Countries.
New World Order
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International Monetary System IMS Structure of IMS
: Framework within which the foreign Exchange rates are determined, capital flows & international trade are accommodated & Balance of Payments Adjustments are made
History of IMS
: The Gold Standard (1876-1913):
Gold as a medium of exchange- Pharaohs (3000 PC)
The Greeks, Romans & Persians Used gold coins & passed through the mercantile era to the 19th century
No multinational agreement, but each country declared a par value for its currency in terms of gold based on rule of games or "Gold Standard"
International Monetary System
IMS-cont..
Mercantilism of 19th Century
: Need for IMS:
Europe adapted the IMS in 1870 & the U.S.. in 1879
$20.67/Ounce of Gold, £4.274/Ounce:
$20.67/£4.2474=£4.8665/$
Limitation of gold reserve & supply of money
Limit the flow of goods and gold & suspension of GS
Inter War Years: 1914-1944:
Free Fluctuating of Exchange Rates with consideration of the gold and par value of other currencies.
Short sell of week currencies, re-evaluation of £, the collapse of the Austrian banking system-total abandonment of GS
International Monetary System IMS-cont..
The Bretton Wood Agreement : (1944)
Dollar based Monetary System (par value based on $)
Fixed value in term of $, but not required to convert
Only $ remained convertible to gold: $35/Ounce
Only 1% of par allowed for fluctuation
Devaluation was not allowed for purpose of high export
10% devaluation for week currency or approval of IMF
IMF & World Bank were created
Former Soviet Union did participate at Bretton Wood but chose not to join IMF or World Bank
International Monetary System IMS-cont..
International Monetary Fund IMF :
Mission:Rendering temporary assistance to currencies with cyclical, seasonal or random fluctuation.
Help countries with a structural trade problem
IMF is funded based on quota of expected post WWII trade
The Original quota were 25% in gold or $ ( Gold tranche ), & 75% local currency.
A member country can borrow up to its original 25% in gold or convertible currencies in any 12 month plus 100% of its total quota. A member country can also borrow up to 120% of its quota in convertible currency or gold, even through it only paid 25% in convertible currency or gold.
International Monetary System
IMS-cont..
International Monetary Fund
IMF Cont..
:
At the present time, each of the 151 member can borrow up to 150% annually of its quota or up to 450% during a three years period
Cumulative access could be up to 600% of members quota
Distribution of the quota is prelude to distribution of vote
U.S. Vote:19.1%, UK:6.6%,Germany:5.8%, France:4.8%,Japan:4.5%,Canada:3.2%
General Agreement to Borrow: IMF ability to borrow from member countries, currently more than $180 billion.
Special Drawing Rights (SDR): created according to Rio de Janeiro agreement (1967) to help increase the global trade between nations
SDR is distributed based on members quota and valued based on 16 then 5 currency
First $/SDR determined then value of other currencies are measured
International Monetary System
IMS-cont..
Monetary Development: (1944-1971)
EFTA (1957) & EEC (1959), rapid increase in world trade
U.S.. deficit of 1959 & International Monetary Reserve dilemma: BOP deficit to create more reserve for LDCs
Doubt of convertibility of major reserve currencies
"Interest Equalization Tax"on foreign borrowing & creation of Euro-bond
Mandatory control of direct foreign investment ,control of foreign lending by U.S banks,& high U.S deficit
official Currency Swaps: Group of Ten Industrialized Nations as a interest credit between central banks
International Monetary System IMS-cont..
Floating Exchange Rate-Crises of 1971:
U.S. BOT had reached to all-time high in 1971
U.S lost one-third of her official gold & president Nixon suspended convertibility of $ to gold
U.S.imposed 10%surcharge on imports & freezed P&W
Most European currencies gained against $
Smithsonian agreement : December of 1971
Group ten Industrialized Nations signed on Dec, 17 1971
$ devaluated to $38/Ounce, Yen evaluated against $ :16.9%,Canada 7.4%
Floatation of 2.25% (Max 4.5%) is allowed
$ lost its value sharply: $42.22 in free market, $70 in official London market
International Monetary System IMS-cont..
Jamaican Agreement: January 1976
Floating Rate has been established ( has continued today)
Gold was demonetarized as a reserved asset
IMF agreed to sell $25 million ounces of gold to its members and used the proceeds to help the poor nations
IMF quota increased to $41 and then to $180 billion
10% of the voting power given to OPEC members
Non-oil producing countries have more access to IMF
Floating Exchange Rate System has officially adopted & continued until present time
International Monetary System IMS-cont..
•
Plaza Agreement
•
Louvre Agreement http://www.econ.iastate.edu/classes/econ355/choi/cur.htm
Balance of Payments (BOP)
Definition of BOP : Record of transactions between residents of one country & rest of the world
Functions of BOP:
•
Helps force market potential of a country
• • •
Helps to understand the currency fluctuation of a country It is a poor description of National Economy Useful in measuring economic performance if there is FER $ was indexed at 100 at 1970: If index is greater than 100,$ gain Vs other countries currencies.
Accounts of BOP:
• •
Trade Balance : Net balance in merchandise traded Current Account: Trade account+earning & expe on services
• •
Performed service: travel, shipping, banking, insurance, etc Debt service: interest, dividend received or paid abroad.
Gravurev.ppt
Balance of Payments (BOP) Con..
•
Basic Balance: Current account+long term capital (such as direct investment)
• •
Overall Balance: basic Balance+short term capital +Error & Omission Unilateral Transfer: no corresponding flow of G&S-non military goods, grants, foreign aids, donation, inheritance
•
Capital account: record of investment & payments
Macro Modeling of BOP:
Aggregates Income : Y=C+S, Where, C=Agg Consumption & S=Agg Saving Aggregate Expenditure: E=C+Id, where Id=Domestic investment Y-E=S-Id If Y is greater than E, S is greater than Id Gravurev.ppt
Balance of Payments (BOP) Con..
Coping with Current account deficit (CAD):
Relationship between CAD & currency depreciation
According to General Equilibrium View : not a simple one
1976-1980: $ depreciate, CAD decreased
1980-1985 $ appreciate, CAD increased
Impose high tariffs & quotas:
Since S-Id=X-M, (unless S & Id changes), if M decline, X must decline : less import means less demand for foreign currency, less supply of domestic currency, and an increase in value of domestic goods, which mean less export.
End Foreign ownership of domestic assets
No capital account surplus means interest rate will increase & investment & income will decline
Stimulate savings: Current Account.
If S is greater than Id, we will have capital outflow, causing deficit to decrease in both Government budget & Gravurev.ppt
FF
Foreign Exchange Market(FEM)
The Functions of FEM
1.
Transfer of Purchasing Power.
2.
International Credit such as L.C.
3.
Minimize Exposure to Foreign Exchange Risk
4 5
Market for Hedging & Arbitrageur Market for currency Swaps, futures & forward/Spot Transactions
Participants in FEM
1. Banks & Non-banks 2. FEM Dealers- benefited from bid-ask spread 3. Market Makers-Position on certain Currencies 4. FEM Brokers (56%) 5. Exporter, Importer, Tourists MNCs, Portfolio Managers 6. Speculators & Arbitrageur 7. Central Banks
Types of FEM Transactions
Spot Transactions: one day settlement (63% of market)
Forward Transactions: one, two, six & 12 month (6%)
Swaps Transactions: Simultaneous purchase or sale of FE, with two value dates: spot-forward, forward-forward Example: sell £20 mil forward for $ deliver in two months at $1.4870/£ & simultaneously buy back £20 mil forward for delivery in three month at $1.4820/£.
Swaps Transactions Forward Transactions Spot Transactions
Types of Quotations
Direct Quotation :
Home currency in terms of foreign currency.
$/ff=$.1265/ff: American Way
Indirect Quotation:
Foreign currency in terms of home currency
ff/$=ff7.9045/$.
Bid & ask spread:
buy(bid) at ff7.9030/$ & ask(offer) at ff7.9070/$
Difference between bid-ask is dealer premium=transaction cost
Cross Rates:
Dutch Guilder/$ over Danish Koran DF3.0245/DK9.7215=DG.3111/Korana
Point Quotation:
Difference between forward rate & spot rate (swap rate).
TRIANGULAR ARBITRAGEUR
Buying & selling of one currency for another & returning to the original one.
U.S $ UK £ DM $ 1 S($/£)=1.8930 S($/DM)=0.453 £ S(£/$)=0.526 1 0.239 DM 2.205 4.190 1
If S(DM/$)*S(£/DM)*S($/£) is greater than one, successful arbitrageur.
(2.205*0.239*1.893)=$0.9979, not successful arbitrageur
The Interest Rate Parity Theory
DEF: Except for transaction costs, national interest rate, the differences in for security of similar risk & maturity should be equal but opposite in sign, to forward exchange rate discount or premium for foreign currency.
It links National Monetary Market Rate to Foreign Exchange Rate.
Forward Exchange Rate Discount & Premium: (Forward Rate Spot Rate ) /(Spot Rate)*12/n*100 ( Spot Rate Forward Rate )/(Forward Rate)*12/n*100 DM2.5885-2.5639/2.5639*12/3*100=+3.8379 per year: It means DM is in 3.8379%, 3-month forward premium or the U.S. $ is in 3.8379%, 3-month forward discount .
The operation of Covered Interest Arbitrageur
Test for Parity
–
UK 3-Month Interest Rate=12% per year
– –
U.S. 3-month Interest Rate=7% per year Transaction Cost=.15% should be calculated at the beginning of transaction
–
Size of Transaction=$2,800,000.00
Covered Interest Arbitrageur actions:
–
Step 1. Borrow $2.8mil at 7%/year for 3-month
– – –
Step 2. Exchange $2.8 mil for £ at spot rate of $1.4000/£ & receive £2mil.
Step 3. Invest £2mil for 3-month in UK at 12%/year or 3%/Quarter.
Step 4. Sell £2.06mil forward at 3-month forward rate of $1.3860/£: which include £2mil principal & £60,000 interest for the 3-month (3%*2mil=$60mil
–
Step 5. Pay transaction cost of $4,200 ($2.8*.15)
The operation of Covered Interest Arbitrageur-Con...
Covered Interest Arbitrageur actions con..:
– –
Step 6. Three month after, redeem UK investment of £2,06mil Step 7. Fulfill forward contract by selling £2060mil at $1.3860/£ forward rate & receive $2.855160.
–
Step 8. Repay loan of $2.8mil plus 3-month interest at 1.75%/Quarter ($2.8*1.75%=$49000).
Profit Calculation:
– – – –
Proceed from investment in UK=$2,855,160.
Principal+interest from borrowing=$2,849,000 Transaction cost=$4200 Net profit =$2,855160-2,849000-4200= $1,950.00
Speculation in FEM Spot Market Speculation:
• Spot rate:DG2.9000/$,Forward Rate=DG2.8000/$ • 6-month expected spot rate=DG2.700/$ • With $40,000, buy:$40,000*DG2.9=DG116000 • Sell at DG2.7/$ for $42965 (116000/2.7) • Make profit of 2965 or14.82%/Year
Forward Market Speculation
B uy $40,000*DG2.8=DG112000
B uy back $ at DG2.7=$41,481
Profit=$1,481
1.
Factors to be considered in forecasting the ER
Expected changes in spot rate, 2.
3.
Inflation rate differential, Interest rate differential, 4.
BOP problems, 5. Growth of Money supply 6.
Business Cycle, 7. 8.
Change in International Monetary Reserve, Increase in official-nonofficial rate spread 9.
FE policies such as , FE. control, ceilings on interest rate, high import duties, export subsidies, excess G-Spending, 10. Elasticity of demand for exchange rate, Forward rate discount or premium
Foreign Change Market Cont..
Purchasing power Parity (PPP)Theory :
Def: If the spot rate exchange rate. between two countries starts in equilibrium, any change in the difference of rate of inflation between them tends to be offset over the long run by equal, but opposite change in spot
If inflation rate in China increases by 4%, Chin's Ys deprecate by 4%
Current Account Balances are very sensitive to change in inflation Rate
International Fisher Effect (Fisher Open):
Difference in interest rate between two countries is equal, but opposite in sign to the spot exchange rate of foreign currency to home currency
Fisher Effect (Irving Fisher):
Differences in inflation rate rate between countries is equal to the differential between them.
interest
Foreign Change Market Cont..
Foreign Currency Option (FCO) :
Def : FCO is a contract that gives buyers the amount of foreign exchange at a fixed price per unit for a specific period of time.. right to buy or sell a given (exercise price or strike price)
Types of FCO : American Option: Right to exercise on any day before the expiration date, European Option: only on the expiration date.
In-the Money Option: When you make profit, At-the-money option: profit is zero, and Out of-the money option: when you have a loss when
FCP is a flexible transaction of over 1 mil in major trading currencies for any time period up to one year, tailored to the customer's need.
This is a good alternative to the forward market.
FCP Premium: A percentage of transaction:
paid advance & according to following factors
1. Strike price relative to spot rate
2. Supply & demand for option
3. Relative interest rate between countries
4. Relative currency risk, and
5. Maturity of the option.
Foreign Exchange Market Cont..
Maturity dates & size of FCO:
Saturday proceeding the third Wednesday of expiration Month June, September, and December.
March ,
Contract size: Cited as fixed contract per unit, such as DM62,500/per unit of option: with one mil$ one can buy:$ one mil/ ¨DM62,500=16 FCP contract Price of FCP: No of cents per unit: £12,500*.02=$250.
An Exercise on FCP:
March $1.45 call option payees $.02 per £ ( purchase £12,500 at $1.45 option with expiration date of March.
If price of £ increase to $1.5100, buy £ at £1.4500 & sell £ 1.5000 & make $1.5100 1.4500=.06 per £ or 12500*.06=$750.
Subtract transaction cost of 250, & make a net profit of $750-250=$500.
Currency Future Market (CFM):
Def of CFM: CF are contract between the future dealers & client.
It does not involve commercial banks & traders
Difference between CFM & Forward Exchange Market, as inflation, contract is drawn up between banks & client;
Major Participants in CFM are: Importer & Exporter, Speculators & Arbitrageur, and those who invest abroad.
Multinational Capital Budgeting
DEF: Selecting multinational assets & allocating the required funds with consideration of the following:
• • •
Cheap loan from foreign government Foreign Exchange rate risk.
Multiple ties of taxation of different countries
•
Restrictions on repatriation of income.
NPV=-CO+CFl (1+t)/(1+i)*t, where:
• • • • • •
NPV=Net Present Value Co=cost of project E=Market value of equity CFl=Before tax expected cash flow t=tax rate I=WACC=interest rate
Multinational Capital Budgeting cont..
Factors Affecting Inventories Cash Flow:
•
Blocked Funds: Limitation of transfer of foreign exchange for trade or currency non-convertibility, if used for financing of the project, it alters the cost of capital for the firm.
• • •
Remittance restriction: only remitted cash flow is relevant.
Differences in tax structure.
Concessionary loan.
•
Effect on the sales of other divisions
NPV=-CO+CFl (1+t)/(1+i)*t, where:
• • • • • •
NPV=Net Present Value Co=cost of project E=Market value of equity CFl=Before tax expected cash flow t=tax rate I=WACC=interest rate
Multinational Capital Budgeting cont..
Calculation of Incremental Cash Flow:
• •
Cash Flow associated with the project Cost of Capital
•
Cash flow during the life of the project B
Incremental Cash flow is different from total cash flow:
• • • • • •
Cannibalization: new product taking sales away from existing product Sales creation-opposite of cannibalization Opportunity cost_windfall profit tax Sunk cost Transfer pricing National inflation difference, unexpected exchange rate, interest rate difference, political & economical environment, and
•
Difficulty in estimating terminal value.
Financing the International Trade Export-Import Financing
Functions of Financing the trade:
Managing the risk of completion of the transaction.
Protection against foreign exchange rate risk.
A measure of financing the transaction.
Solve the dilemma of seller maintaining the legal right to title until paid & buyer reluctant to pay until receiving the merchandise .
Financing the International Trade Export-Import Financing (con...)
Types and Mechanisms of Financing:
Letter of Credit (L/C): Issued by a importer bank at the request of an importer . Importer bank promises to pay the
exporter
upon receiving of required document specified in L/C.
Types of L/C:
Irrevocable (can not be canceled without consent of all parties) v.s. Revocable (can be canceled or amended before payment).
Export-Import Financing (con...)
Confirmed
(both banks of importer and exporter have obligated to pay) v.s. Unconfirmed (only obligation of issuing banks).
Revolving (valid for more than one transaction) v.s. non revolving (only good for one transaction).
Cumulative revolving (amount that is not used can be added together) v.s. non-cumulative (amount which is not used can not add together).
Issuers of L/C: L/Cs can be issued by foreign bank and confirmed by local bank or confirmed by third party.
Export-Import Financing (con...)
It can be issued only by local bank or issued by foreign bank with no confirmation from domestic bank.
Draft: Bill of Exchange (B/E):
Order written by an exporter to be paid a specific amount of money by the importer or importer bank at a specific period of time.
Party who initiates the draft is called Drawer or Originator (Usually exporter).
Party the draft being written for is
Drawee
(usually importer). If drawee is buyer, draft is called trade draft, if it is bank, it is called bank draft.
Export-Import Financing (con...)
Conditions for Draft:
It must be in writing and signed by a drawer.
It must contain an unconditional promise to pay a definite sum of money to drawer at a specific time.
It could be written to order or bearer with receiving bank or person being a holder in due course.
Types of draft: Sight Draft ,
Time Draft
, Clean Draft, Documentary Draft
Bill of Lading (B/L):
Composed of merchandise receipt
,
contract (obligation of career)
,
documents of title
Export-Import Financing (con...)
Types of B/L:
Straight B/L : Carrier delivers the merchandise to the designated person when paid in advance or
Order B/L
; grant the title to the specified person.
Clean B/L: Merchandise received by the carrier must be in a good condition v.s Foul B/L merchandise could have a margin of damage.
Other Financing related Documents:
Commercial Invoice: Price , financial terms, shipping condition such as FOB, FAS, C&F and CIF.
Export-Import Financing (con...)
Public and Private Financing agencies:
Export Credit Insurance : Credit for export and insurance for default importer.
Foreign Credit Insurance Association (FCIA)
Export Import Bank
Private Export Funding Corporation (PEFCO)
Overseas Private Insurance Corporation. (OPIC)
www.freetradeat10.com
www.mexonline.com/nafta.htm
http://www.usmcoc.org/naftafor.html
Def:
The Fundamentals of Counter Trading
Financing the international trade with exchange of goods and credit Types of Counter trading Barter Trading : Goods for Goods - Pepsi for Vodka Counter purchase : Partial payment in cash and merchandise. German Car to Iran for Oil and Cash.
Compensation arrangement or Buyback:: Buyback the output of capital invested: Russia buys gas from a gas pipeline built for Iran.
Switch Trading: Exchange the blocked currency for hard currency by switching the trade: Blocked funds of Canada can be traded at a discount for other currency for trading with Romania.
www.countrywatch.com
Working Capital Management
Def: Managing of Current Assets & Liabilities : Flow Prospective: Managing the location of liquid funds to find both the currency in which liquid funds are held and country where such funds are placed
Tax Structure
Exchange Rate
Liquidity consideration
Import Restrictions
Political and social consideration
Rate of return for excess cash investment
Inconvertibility of the fund
Exchange control
Conversion Blockage
Heavy withholding TAX ON FOREIGN INCOME, DIVIDEND,ROYALTY, AND OTHER RESTRICTION FOR REMITTANCE OF THE FUND.
International Fund Transfer
Recovering funds from affiliate without piquing host country’s sensitivity with a large Dividend drain
Allocation of a large overhead from parent to an affiliate
Facilitate the entry of local capital to
joint venture
FUND TRANSFER STRATEGIES:
If foreign exchange losses are expected, speed up the transfer
Consideration for the age and size of the affiliate
Availability of the fund to the affiliate
Availability of the joint venture
Transferability of royalty fees and other foreign income
Consideration for transaction, speculative and precautionary balances
Managing International Receivables & Inventory
Receivable: Lead and Lag Techniques:
Provide funds to affiliate in exchange for equities
Sell in and provide credit in long run from one affiliate to others
Re-invoicing centers: separate subsidies to manage intercompany transactions when the title passes to re invoice center but goods are directed to the affiliate.
Inventory:
Taking advantage of free trade zone
Consideration for inflation rate
Consideration for currency devaluation, price freeze, import restrictions etc..
MNC’s Strategy & Direct Investment
1. Theory of MNC
• • •
Most MNC’s are oligopolies .
They operate in product and factor market imperfection.
They have intangible capital in the form of trade markets, patents, general marketing skills, organizational abilities to raise the market and introduce new products, quality control, advertising, distribution, after-the-sale service and ability to forecast exchange markets.
2. Investment Strategy
• • •
Vertical Integration - diversification across the industry.
Horizontal Integration - investment within the industry.
Trade innovation and barriers prohibit market entry by continuous introduction of new products, different services and product differentiation.
3. Follow-the-Lead Behavior
•
Cost reduction and economy of scale; low cost production site with low price -- oligopoly price leadership and cost minimizer.
MNC’s Strategy & Direct Investment (con...)
4. Joint Venture 5. Pricing Conversion
High prices in home country to compensate for low prices overseas.
6. Investing in Each Other’s Market
•
“if you undercut me in my home market, I will do the same thing in your market.”
Process Material Savings Labor Savings Capital Savings Multiple Factors
Process Classification
U.S.
E.C.
19% 61% 19% 1% 54% 18% 24% 4% Japan 48% 16% 28% 8%
• •
Swaps - A Brief Overview
Interest Rate Swaps:
– –
No Principal ever changes hands.
Maturity varies from under one year to over 15 years.
–
Types:
»
Coupon Rate Swap float rate.
-- fixed rate to
»
Basis Swap -- float rate to float rate.
Currency Swaps:
–
to receive one currency for another currency at a fixed or flexible rate.
International Financial Market
• •
Sources of Capital International Market: business operation External Market:
– – – –
A. Domestic Market: domestic funds for domestic use.
B. International Market: domestic funds for foreign use.
C. International Market: foreign funds for domestic use.
D. Offshore Market: foreign funds for foreign use ie. London, N.Y., Tokyo, Zurich, Singapore, Bahrain, Bahamas.
•
Eurodollar vs Eurocurrencies Market
U.S. Dollar time deposits in a bank outside the U.S.A.
•
Bank may be foreign bank or overseas branch of a U.S. bank.
•
Deposits could be in: Call Money, Overnight Draft, 3-month CD.
Eurodollar deposits are not demand deposit and can’t be transferred by a check drawn on the bank having the deposit. It can be transferred by a wire or cable from a balance-hold in a corresponding bank located in the U.S.
Banks in which Eurodollar or Eurocurrencies are deposited are generally called Eurobanks.
Reasons for Existence of Eurodollar Market
1. Convenient money market 2. Major source of short-term bank loans 3. Arbitrage purpose 4. U.S. long-time trade deficit 5. Money regulation in the U.S.
6. Military expenses of the 1960’s and 1970’s 7. Freezing of foreign assets in the U.S. in the 1970’s and 1980’s
Size of the Market
• • •
According to the report by Bank for International Settlement , the size of the market has increased 4 times since the 1970’s to $2,056 billion.
A Majority of the dollar deposits are in Europe (60%), and the rest are in Asia -- mainly in Japan and Singapore.
The Expansion of the market is very similar to the money creation principle of a commercial bank.
Euro-capital Market
• •
Money Market (Euro-Line of Credit, Revolving Credit, Syndicated Short-term and Medium-term loans) Euro-CD, such as Spot Rate CD, Roll-over Credit where the interest is paid in floating rate and TAPS, CD’s for less than a year with min $25,000 denomination which could be in a series of identical CD’s (Tranche) or single issue, and Five currency CD (denominated in a basket of five different currencies).
Eurobonds
1. The Euronote Market: short to medium-term debt instruments (negotiable promissory notes) sold in the Eurocurrency market.
– They are underwritten by different facilities, such as
Revolving Underwriting Facilities (RUF), Note Insurance Facilities (NIF) and Standby Note Issuance Facilities (SNIF).
2. Euro-commercial Papers (ECP) - one, three and six month maturities.
3. Euro Medium-term Notes (EMTN): bridges maturity gap between ECP and Eurobond.
4. Euro-bond Market
–
Straight Fixed Rate Issue -fixed CR, specified maturity date and full principal repayment upon final maturity.
–
Floating Rate Notes (FRN) - semiannual coupon, variable rate, fixed maturity or perpetuities.
–
Euro-Equity Convertibles - similar to straight bond with added feature to convert to a certain number of stocks prior to maturity.
Eurobonds
4. Euro-bond Market (con...)
–
Dual currency Bonds - purchase price and coupon denominated in one currency and the principal redemption value fixed in a second currency.
–
Currency Cocktail Bond - denominated in one of several currency baskets such as SDR or ECU; stable interest and principal payments.
–
Stripped Bond - deep discounted bond issued in bearer form in order to sell them to non-residents; Certificate of Accrual on Treasury Securities (CATS).
5. Yankee Bond - issued by non-residents in U.S. Dollars sold in the U.S.
6. Foreign Bond - issued by non-residents in non Dollars sold in the U.S.
Eurobonds
• 7. Treasury Bond - long-term obligation of federal
government (U.S.)
• 8. Corporate Bond (General, Debenture, Jr,
Subordinate) - long-term obligation of corporation.
• 9. Municipal Bond - long-term obligation of state and
local government.
• 10. Interest and Currency Swaps
Cost of Capitalization
Taking advantage of the capital market imperfection M>N>C can lower the cost of capitalization.
WACC = KeE/E+D + KdD/E+D
Cost of Equity = Ke = d/p+g
Capital Asset Pricing Model = Ke = Rf + B*(Rm-Rf)
Cost of Debt: Cy, Y-T-M, H.P.Y. W.A.Y.T.M. , ...
MNC Influences Cost of Capitalization by:
1. Availability of capital from domestic as well as from international
–
MNC have higher capacity to raise funds as extensions of the MC curve making it easier to borrow more at a lower rate.
2. Market segmentation
–
if the required rate on a security in a market is different from the required rate on a comparable security in an efficient capital market, the cost of capitalization will be lower if MNC has access to fully-integrated markets as it shifts the MC curve further down.
–
Cost of capital varies as the amount of employed TD/TA increases; an after tax cost of capital decrease reduces the overall cost of capital after a certain level of perceived risk by the investor increases the cost of capital.
Carcoulv.ppt
MNC Influences Cost of Capitalization by (con...):
3. Investor’s Premium for International Diversification
–
reduces the perceived risk by the investor and reduces the cost of capitalization.
4. Managing Foreign Exchange Rate Risk and Political Risk 5. Taking Advantage of Tax Treaties
– –
MNC could be subject to taxation both home and abroad.
Retained earnings in foreign affiliate are not subject to U.S. tax until they are reported, so it could reduce the cost of equity. Transfer pricing also affects the tax liability of MNC.
Carcoulv.ppt
MNC Influences Cost of Capitalization by (con...):
6. Disclosure of International Financial Statements
–
improved financial disclosure will tend to increase the relative weighting which investors place in favorable firm’s statistics relative to others, especially in capital formation from Eurocurrency Market.
–
Rating of foreign bonds by Moody and S&P as asked by Japanese to help reduce risk for the investor.
7. Financial Structure of Different Countries
–
country debt ratio is different for different countries.
Carcoulv.ppt
Example
When MNC issues foreign currency-dominated debt, its cost of repaying the principal and interest in terms of patent’s own currency will be affected as follows: If U.S. MNC borrows Deutschemarks for one year at 6% and the Mark increases interest of $ by 8%, the before tax cost of capital:
° °
Kc = interest on DM*additional interest to exchange rate change + additional principal due to exchange rate.
If the interest rate in Germany = [(1.06*1.08)-1]*100 = 14.48% and if the tax rate is 54%, then the after tax cost of capital = 14.48%(1-.54) = 7.82%.
After tax expected dollar cost to foreign affiliate of one year foreign currency loan = r = (1-d)(1-t)-d, where r = interest rate, d = expected foreign currency devaluation to dollar and t = local tax.
Advice on Avoidance of Excess Cost of Capitalization for MNC
Under no condition should a firm borrow long term in a foreign currency which has been eliminated.
Borrow long-term in foreign currency if you anticipate cash outflow on principal and interest is matched by anticipated operating receivable in the same currency.
Borrow for the purpose of diversifying long-term currency commitments.
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Short Term Financing
Definition: financing for less than a year.
Two sources of short-term financing:
Unsecured short-term financing
Secured short-term financing
Categories of unsecured short-term financing
Trade Credit
Line of Credit
Bank Loan
Commercial Papers
Short Term Financing (con...)
Categories of Secured Short-term Financing
• • •
Pledging the Account Receivable Factoring the Account Receivable Inventory Loans:
»
1. Floating Lien (Blanket Lien)
»
2. Trust Receipt (Chattel Mortgage)
• •
Field warehousing Public warehousing (Terminal Warehouse Agreement)
International Short Term Financing
1. Intercompany financing 2. Local currency financing 3. Euronotes and Euro-commercial papers 4. Funds from parent company 5. Funds from operation 6. Loan from sister subsidiary 7. Loan from local and international banks 8. Currency swaps 9. Link financing (third strong currency company guarantees loan)
International Short Term Financing (con...)
10. Edged Act and agreement banking 11. International Banking Facilities 12. Joint Venture 13. World Bank and IMF 14. Regional Development Bank, such as Inter-American Development Bank 15. Export / Import Bank 16. Agency for International Development (AID) 17. OPIC
International Banking
Motivations: Access to dollar and Eurocurrency deposits and international saving markets.
Tasks of International Banking:
•
Financing exports and imports
• • • • • • •
Trading foreign exchange Underwriting both Euro-bonds and foreign bonds Borrowing and lending in Euro-currency market Participate and organize foreign exchange market Project financing International cash flow management & fund transfer Solicitation for local currency deposits to operate as full-service banks
•
Serve as consultant for MNC Gravurev.ppt
Risks in International Banking
1. Commercial Risk
•Facing difficulties in receiving the repayments
of principal and interest on due date.
•Lack of financial and economic information about
the clients and host countries and differences in accounting disclosure practices and legal procedures.
2. Country Risk
•Sovereign Risk: political, jurisdictional and
cultural differences.
•Exchange Rate Risk: shortage of foreign exchange
reserves; change in repayment schedules.
Advantages and Disadvantages of International Banking
Advantages
• • •
High rate of return for investment and relatively low loss ratio Ability to diversify loan portfolio.
Excess demand for international loans, especially for development programs.
•
Usually international loans are safeguarded by official and non-official insurance agencies, such as export credit insurance.
Disadvantages
•
Unfamiliar political and social environments and rapidly changing macroeconomic and financial variables.
• •
Unexpected events and regulators.
Weak demand for domestic loans has relaxed standards for international loans.
• •
Only a few credit-worthy countries are available.
External debt problems of many foreign international countries, especially Latin American countries and major international loan loss by many international banks.
Types of International Bank Offices
Correspondent Banking
Two way link between banks (home and foreign bank); services offered include, but not limited to: accepting drafts, honoring L/C, and furnishing credit information.
Representative Offices
•
Cannot accept deposits, make loans, accept L/C or cash checks; just help and advise parent bank clients when they are doing business in host country.
Agencies Relationship
•
Like branch banking without having authority to accept deposit from the public; may accept deposits from other banks; can arrange loans, L/C and trade foreign exchange.
Bank Subsidiaries and Affiliates
•
Can be a separately incorporated bank or owned and control by bank (partially-owned or entirely-owned subsidiaries).
Types of International Bank Offices (con...)
Branch Banking
Extension of parent bank; can be full-service bank.
International Banking Facilities (IBF)
•
An accounting entity as well as a legal entity of a bank to capture a segment of the Euromarket.
• • • •
They are not subject to FDIC rules or Fed’s Required Rate Ratio.
Deposits limited to non-residents only and size limitation.
They are exempt from state and local tax.
They could be U.S.-owned IBF (exempt from federal tax) or foreign-owned IBF, such as Japanese IBF and Italian IBF.
Edged Act Banks
•
Subsidiary of U.S. bank incorporated in U.S. under section 25 of federal banking law to engage in international banking functions and finance all types of the loans in the world.
•
They are physically located in states other than their own within the U.S. (inter-state banking).
•
If they are state chartered - called Agreement Corporation, if nationally chartered called Edged Act Bank.
Professor VAZIRI WISHS YOU: GOOD LUCK WITH "Final Exam"
CFP Diploma Finance Diploma
discussed in the class
Exam will cover the materials Review the notes and thebook.
Have your calculater ready
Have your formulas ready
Ask questions if you are confused.
Leave a self stamt and adressed envelope for your grade reporting.
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ISEFI IN THE MOVE TOWARD INTERNATIONAL CFP COUNCIL
Allemagne France Espagne Pays-Bas Italie Royaume Uni 0.0 0.4 0.8 1.2 1.6 2.0
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Suède Danemark Norvège Finlande Suisse Autriche 0.0 0.4 0.8 1.2 1.6 2.0