Transcript Slide 1
20
Financial Management
This chapter covers:
•Currency values
affect on international
business
•The importance of
financial management
•Financial
management tools
•Derivatives as
hedging devices
•Financial executives
networking and
cooperation
•Payments other than
money
•Hard vs. soft
currencies
•International finance
centers
International Business
by Ball, McCulloch, Frantz,
Geringer, and Minor
McGraw-Hill/Irwin
Copyright © 2006 The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
Realize that the currencies of countries change in value in terms of
each other
Understand how currency value changes affect international business
transactions
Recognize the importance of financial management to an IC
Know about financial management tools
Understand the growing use of derivatives as hedging devices
Explain how financial executives network and cooperate
Understand why exporters sometimes accept payment in forms other
than money
Differentiate between hard, convertible currencies and soft,
nonconvertible ones
Explain the importance of international finance centers
20-2
Fluctuating Currency
Exchange Rates
Transaction risks
Usually involve a
receivable or a payable
denominated in a foreign
currency
Result from a purchase
from a foreign supplier or
a sale to a foreign
customer
Methods of protection
20-3
Engage in hedging or
accelerate or delay
payments
Transaction Risks
Forward Hedge
The international
company contracts with
another party to deliver to
that party at an agreed
future date a fixed
amount of one currency
in return for a fixed
amount of another
currency
Majority of forward
hedge contracts are with
the company’s bank or
banks
20-4
Currency Option Hedges
A covered position
Financial manager has
funds when entering the
contract or they are due
from another business
transaction on or before
the due date
An Uncovered Position
Financial manager uses
the foreign exchange
market to take advantage
of an expected rise or fall
in the relative value of a
currency
Transaction Risks
20-5
Credit or Money Market
Hedge
Company desiring hedge
is borrower
Exporter can
Lend the money
Put it in a CD
Use it in a swap
Use it as operating
capital
Must compare interest
rates between countries
Transaction Risks
Acceleration or Delay of Payment
If an importer expects the currency in its country
to depreciate in terms of the currency of its
foreign supplier
It will be motivated to buy the necessary
foreign currency as soon as it can
This assumes the importer must pay in the
currency of the exporter
Payment accelerations or delays are frequently
called leads or lags
20-6
Transaction Risks
Acceleration or Delay
of Payment
Leads
Immediate purchases
of a foreign currency
to satisfy a future need
because the buyer
believes it will
strength vis-à-vis the
home currency
20-7
Acceleration or Delay
of Payment
Lags
Delayed purchases of
a foreign currency to
satisfy a future need
because the buyer
believes it will
weaken vis-à-vis the
home currency
Transaction Risks
Objectives of Intra-
international Company
Payments
Within the strictures of
applicable laws and the
minimum working
capital requirements of
the parent and affiliates
ICs can maximize their
currency strength and
minimize their
currency weaknesses
20-8
Transaction Risks
Objectives of Intra-international Company
Payments
Keep as much money as is reasonably possible in
countries with high interest rates
Keep as much money as is reasonably possible in
countries where credit is difficult to obtain
Maximize holdings of hard, strong currencies
Minimize holding of currencies that are subject
to currency controls
20-9
Transaction Risks
Exposure Netting
Taking open positions in
two currencies that are
expected to balance each
other
Two ways to accomplish
exposure netting
Currency groups
A combination of a
strong currency and a
weak currency
20-10
Currency Groups
Some groups of
currencies tend to move
in close conjunction with
one another even during
floating rate periods
A Strong Currency and a
Weak Currency
Involves two payables (or
two receivables), one in a
currently strong currency
and the other in a weaker
one
Transaction Risks
Exposure Netting
Advantages
Avoids the costs of hedging
However, is also more risky
Price
20-11
Adjustments
Sales management often desires to make sales in a country
whose currency is expected to be devalued
In such a situation, financial management finds that
neither hedging nor exposure netting is possible or
economical
Translation Risks
20-12
The losses or gains that
can result form
restating the values of
the asset and liabilities
arising from
investments abroad
from one currency to
another
Translation Risks
Realistic Information
Management must base important decisions on
the updating of all asset and earnings values
Management Fears
Managers fear that shareholders and analysts will
regard translated and reported foreign exchange
losses as speculation or bad management
Neutralizing the Balance Sheet
Having monetary assets in amounts
approximately equal to monetary liabilities
20-13
Swaps
Trades of assets and
liabilities in different
currencies or interest rate
structures to lessen risks or
lower costs
There are several types of
swaps
Spot and forward
market swaps
Parallel loans
Bank swaps
20-14
Swaps
Spot and Forward Market
Swaps
Parent buys foreign
currency in the spot
market and lends to
subsidiary
Parent shorts the same
amount of foreign
currency for period of
loan
Cost depends on discount
rate in forward market
compared to spot market
20-15
Parallel Loans
Each parent company
lends to its subsidiary in
the subsidiary’s currency
Each loan is made and
repaid in one currency
avoiding exchange risk
Bank Swaps
Historically swaps
between banks of two or
more countries to acquire
temporarily needed
foreign currency
Capital Raising and Investing
When a company wishes to raise capital, its financial
management must make a number of decisions
The currency in which the capital will be raised
Long-term estimate of the strength or weakness of that
currency
How much of the money raised should be equity capital
and how much should be debt capital
Where the money should be borrowed from
Which capital market will be lowest cost
How much money and for how long
Whether other sources of money are available
20-16
Capital Raising and Investing
Equity Capital
Debt Capital
20-17
Capital raised by selling
common stock
representing ownership
of the company
Capital raised by selling
bonds representing debt
of the company
Advantages to
Interest Rate Swaps
Swaps give the corporation
the flexibility to transform
floating-rate debt to fixedrate
There are potential rate
savings
Swaps may be based on
outstanding debt and may
thus avoid increasing
liabilities
Swaps provide alternative
sources of financing
20-18
Swaps are private
transactions
There are no SEC reporting
or registration requirements
The contract is simple and
straightforward
Rating agencies take a
neutral to positive position
Tax treatment is
uncomplicated
Currency Swaps
Companies use currency
swap markets
when they need to raise
money in a currency
issued by a country in
which they are not well
known
Would therefore pay a
higher interest rate
than available to a
local or better-known
borrower
20-19
Derivatives
Financial instruments such as futures, options and
swaps, the values of which are tied to price
movements of the underlying commodities or other
instruments
Are derivatives safe?
Proper management of derivatives s a tricky, three-stage
process.
Identify where the risks lie
Design an appropriate strategy for managing these risks
Select the right tools to execute the strategy
20-20
Sales Without Money
A number of countries
desire goods and products
for which they do not have
the convertible currency to
pay
There are two
nonmonetary trade
themes
Countertrade
Industrial cooperation
20-21
Countertrade
International trade in which at least part of the
payment is in some form other than hard,
convertible currency
There are six varieties of countertrade
20-22
Counterpurchase
Compensation
Barter
Switch
Offset
Clearing account arrangements
Countertrade
Counterpurchase
Goods supplied by the
developing country are
not produced by or out of
goods or products
imported from the
developed country
Compensation
Call for payment by the
developing country in
products produced by
developed country
equipment
20-23
Barter
An ancient form of
commerce and the
simplest sort of
countertrade
The developing
country sends
products to the
developed country that
are equal in value to
the products delivered
by the developed
country to the
developing country
Countertrade
Switch
Frequently, the goods
delivered by the
developing country are
not easily usable or
salable
A third party in
brought in to dispose
of them. This process
is called switch
trading
20-24
Offset
Occurs when the
importing nation requires
a portion of the materials,
components, or
subasemblies of a
product to be procured in
the local market
The exporter may set up
or cooperate in setting up
a parts manufacturing
and assembly facility in
the importing country
Countertrade
Clearing Account
Arrangement
Used to facilitate the
exchange of products
over a specific time
period
When the period ends,
any balance
outstanding must be
cleared by the
purchase of additional
goods or settled by a
cash payment
20-25
Industrial Cooperation
Industrial Cooperation
Long-term relationships between developed
country companies and developing country
plants in which some or all production is done in
the developing country plant
Five methods
Joint venture
Coproduction and specialization
Subcontracting
Licensing
Turnkey plants
20-26
International Finance Center
New developments in international financial
management
Floating exchange rates
Growth in the number of capital exchange markets
Different and changing inflation rates among
countries
Advances in electronic cash management systems
The explosive growth of the use of derivatives to
protect against risks
20-27
International Finance Center
20-28
Additional functions
Handle internal and
external invoicing
Help weak currency
affiliates
Strengthen affiliate
evaluation and
reporting systems