1 chapter 13 global financial management. 2 key issues in global finance currency exchange...
TRANSCRIPT
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Chapter 13 Global Financial Management
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Key issues in global finance
Currency exchange variations
• Strategic exposure (long -term )• Transaction exposure (short-term)• Translation exposure (book valuation effect)
Investment• Project valuation
Financing
• Equity financing and cross-listing• Debt financing• Trade financing• Project finance
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Currency exchange variations
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Strategic effects of forex variations
Domestic Domestic
DomesticDomestic
Global
GlobalGlobal
Global
Effects of a ‘domestic’devaluation
Effects of a ‘domestic’revaluation
Increasescompetitivenessagainst imports
Decreasescompetitivenessof products withhigh global content
Increasescompetitivenessof domesticalyproduced products
No effects
Decreasescompetitiveness
Increasecompetitiveness
Decreasescompetitiveness
No effects
Markets Markets
Firms Firms
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Strategic effects: what to do?
• Move production: to low cost countries to countries with weak currencies?
• Differentiate to make products less price-sensitive
• Balance production-sales by currency zones
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Transaction exposure
• Hedging techniques:
• Forward contracts• Money markets contracts• Future contracts• Options• Swap• Netting• Leading and lagging
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Hedging with forward contract
Example: a US machinery company sells to a paper machine to a Finnish company for 10 million Euros payable in one year
US interest rate: 1%Euro interest rate: 2%Spot exchange rate: 1.30 $/€Forward rate (1 Year): 1.287$/£
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Example: The paper machinery transaction
Forward hedge Spot rate at
Maturity Unhedged receipt US$
Forward hedge US$
Gain losses from
hedging
1,20 12,00 12,87 0,871,25 12,50 12,87 0,371,29 12,87 12,87 0,001,30 13,00 12,87 -0,131,35 13,5 12,87 -0,631,40 14,00 12,87 -1,13
Money market hedge US Company borrows 10€ at 2% rate and gets 9,80 € €Uses borrowing to buy US$ at spot rate =9.8/1.3 12745 US$Invest 12,745 US$ at 1% 12872 US$At maturity gets 80 m€ used to repay loan
Both hedging technics brings the same results 12872 US$ US$representing a cost of hedging of 13000-12872 128 US$
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NettingExample: Cash receipts and disbursements matrix for Teltrex ($000)
Payments
Receipts US (US$) Germany (€)Australia
(AUD) UK (£) ExternalTotal inter
SubsidiariesTotal
ReceiptsUS - 40 30 60 120 130 250Germany 50 - 45 80 90 175 265Australia 25 10 - 35 60 70 130UK 30 40 20 - 80 90 170External 100 120 150 80 - 450
Total inter Subsidiaries 105 90 95 175 465Total payments 205 210 245 255 350 1265
Teltrex’s interaffiliates foreign exchange transactions without netting (000 $)
US
AUS
GER
UK
+40
+60
+30
+35
US
AUS
GER
UK
+10
+10
+20
+15
+10
+25
+30
+20
+10
+25
+30+10
+20
+40
Bilateral netting of Teltrex’s interaffiliates foreign exchange transactions (000 $)
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Netting cont.Example
Payments
Receipts US (US$) Germany (€)Australia
(AUD) UK (£) ExternalTotal inter
subsidiaries Total receiptsUS - 40 30 60 120 130 250Germany 50 - 45 80 90 175 265Australia 25 10 - 35 60 70 130UK 30 40 20 - 80 90 170External 100 120 150 80 - 450
Total inter subsidiaries 105 90 95 175 465Total payments 205 210 245 255 350 1265
Intersubsidiaries netting
US
AUS
GER
UK
+10
+40+30
+35
+15
+5
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Global financing
Cross-listing
If cost of capital is different (fragmented) across countries there is a potential advantage of arbitrage (assuming similar risks).
But also:• Higher liquidity • Larger investor base• Higher visibility• Less vulnerable to hostile take-over
However:• Costs of compliance• Higher dependance on volatility of international markets
Source: Eun and Resnick: International Financial Management, 2001
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Global financing cont.
Source : NYSE Factbook, 1999.
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Project finance
‘Financing of a particular economic unit in which the providersof funds look primarily to the cash flow from the project as the source of funds to service their loans or provide a return on equityand to the assets of the economic unit as collateral for the loans.’*
*Nevitt & Fabozzi (2000) and Finnerty (1996)
Involves:
• Private sponsors• Multinational development agencies (IFC, ADB, EBRD, AFDB..)• Bilateral development agencies (CDC, AFD, Finnfunds, OECF..)• Commercial banks• Export credit agencies (Coface, Hermes, ECGD…)
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Objectives
To look at the costs and benefits of a project from the point of view:
• of the fund providers (financial risks and return)
• of the stakeholders (economic and social risks and return)
This applies to:
• Infrastructure projects
• Industrial projects
I.R.R
E.R.R
Project valuation
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The points of view of the providers of funds
• Project sponsor• Other equity providers• Loan providers
Project cash flow based evaluation:• NPV• IRR• Pay back
Issues:
• Evaluation of the risks for the funds providers
• How to incorporate risks into the calculation
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Risks in project evaluationConstruction risks
Operating risks Sovereign risksTechnology
Timing
Supporting industries
Logistics and red tape
Complexity or untestedtechnology may lead tocost overruns orconstruction delays.
Failure to complete on time may induce penalties and jeopardize cash flows
Absence of qualified contractors and supporting services
Difficulties in custom clearancetransport of materials andpersonnel
Supply
Market
Quantity and quality ofresources
Price and quantity of output
Throughput
Efficiency of process
Operating Costs
Staibilty of cost factors
Force majeure ‘Acts of god’EnvironmentalWars, terrorism
Disruption Strikes
Expropriation
Legal
Direct Creeping
Lack of law enforcement
Inflation
Foreign exchange
Convertibilty and transferability
Price control
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Mitigating risks in projects
Construction risks Operating risks Sovereign risks
Technology
Timing
Supporting industries
Logistics and red tape
Proven technologyAppropriate technologyExperience in projectsProject management
Project management
Suppliers trainingPiggy backing
Local knowledge
Supply
Market
Supplier trainingInternational suppliersIntegrated projects (power,water, etc.)
Take-off contractsExportsThroughput Proven processExperienceManagementOperating costs Quality of managementLong-term contractsForce majeure InsuranceDisruption FairnessHuman resource management
Expropriation
Legal
Multilateral agency as shareholderHost country assets in home country
Lobbying
Inflation
Foreign exchange
Convertibilty and transferability
Price controlLobbying
Output priced in hard currency
Pricing
Offshore proceeds account
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Accounting for risks in projects evaluation
Adjusting the cost of equity with a ‘risk’ premium
Adjusting the cash flows
Adjust each element of cash flow according to expected occurrence of adverse events
Country βeta (Lessard): CoE= Risk free rate + country risk premium + asset βeta *market equity premium*
Country βeta
Risk premium :a) based on bond spread
= (yield on host country bonds - yield on home country bonds)
b) Export credits agency credit risk premium
2 methods:
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1. Calculate the risk premium due to market risk (offshore project βeta) to be included in the cost of equity
Offshore project βeta = βeta of comparable project in home country * country βetaWhere country βeta = volatility of the host country stock market (correlation of changes with
home country) (or GDP)/ to the home country
2. Add a political risk premiumBond risk premium
3. Adjust WACC accordingly
4. Cost of equity in a foreign investment:
= Risk-free home country + country risk (bond risk premium) + market risk premium*(company βeta * country market βeta)
Adjusting the cost of equity (Donald Lessard - MIT)
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Adjusting the cost of equity (Donald Lessard - MIT) cont.
Example:Investment of Australian Mining Co. (AMC) in Brazil, entirely financed with equityCash flow in Brazilian Real (BRL):
Year 0 1 2 3 4 5Cash flow -175 40 45 50 55 145
(1 AUS$ = 1.9 BRL)
(AMC cost of equity: 12% (5% risk free + 5% market risk + 2% company risk)
10 year government bond rates: Australia = 5.5%; Brazil= 12.4%) GDP variation βeta BRZ/AUS= 1.04
NPV without risks (cost of equity: 12%) =IRR =
NPV with risks (cost of equity: 12% + (12.4% - 5.5%) + (5%*1.04) =IRR =
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1. Identify the elements of cash flow subject to country risk variation (revenues, costs)
2. Assign a probability of occurrence to those elements
3. Take the expected value [likely cash flow * (1-probability of adverse event)]
4. Possibility to run a Monte Carlo simulation if various probabilities affect various elements
5. Calculate NPV with global cost of capital
Adjusting the cash flows (Hawawini & Viallet - INSEAD)
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Trade finance