20

Financial ManagementFinancial Management

International Businessby Ball, McCulloch, Frantz,

Geringer, and Minor McGraw-Hill/Irwin Copyright © 2006 The McGraw-Hill Companies, Inc. All rights reserved.

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

Chapter ObjectivesChapter 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 centers20-2

Fluctuating CurrencyFluctuating Currency Exchange Rates 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 Engage in hedging or

accelerate or delay payments

20-3

Transaction RisksTransaction 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 RisksTransaction Risks

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

20-5

Transaction RisksTransaction Risks

Acceleration or Delay of PaymentIf an importer expects the currency in

its country to depreciate in terms of the currency of its foreign supplierIt 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 RisksTransaction 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 RisksTransaction Risks

Objectives of Intra-international Company PaymentsWithin 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 RisksTransaction Risks

Objectives of Intra-international Company PaymentsKeep as much money as is reasonably

possible in countries with high interest ratesKeep as much money as is reasonably

possible in countries where credit is difficult to obtain

Maximize holdings of hard, strong currenciesMinimize holding of currencies that are

subject to currency controls

20-9

Transaction RisksTransaction Risks

Exposure Netting Taking open positions

in two currencies that are expected to balance each other

Two ways to accomplish exposure nettingCurrency groupsA 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 RisksTransaction Risks

Exposure NettingAdvantages

Avoids the costs of hedgingHowever, is also more risky

Price 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

20-11

Translation RisksTranslation Risks

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

20-12

Translation RisksTranslation Risks

Realistic InformationManagement must base important

decisions on the updating of all asset and earnings values

Management FearsManagers fear that shareholders and

analysts will regard translated and reported foreign exchange losses as speculation or bad management

Neutralizing the Balance SheetHaving monetary assets in amounts

approximately equal to monetary liabilities20-13

SwapsSwaps

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

SwapsSwaps 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 InvestingCapital 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 InvestingCapital Raising and Investing

Equity Capital Capital raised by

selling common stock representing ownership of the company

Debt Capital Capital raised by

selling bonds representing debt of the company

20-17

Advantages toAdvantages toInterest Rate SwapsInterest Rate Swaps

Swaps give the corporation the flexibility to transform floating-rate debt to fixed-rate

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 SwapsCurrency 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

DerivativesDerivatives

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 MoneySales 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

CountertradeCountertrade

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 Counterpurchase Compensation Barter Switch Offset Clearing account arrangements

20-22

CountertradeCountertrade

CounterpurchaseGoods supplied by the

developing country are not produced by or out of goods or products imported from the developed country

CompensationCall for payment by

the developing country in products produced by developed country equipment

20-23

BarterAn 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

CountertradeCountertrade

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

CountertradeCountertrade

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 CooperationIndustrial Cooperation

Industrial CooperationLong-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 ventureCoproduction and specializationSubcontracting Licensing Turnkey plants

20-26

International Finance CenterInternational 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 CenterInternational Finance Center

Additional functions Handle internal

and external invoicing

Help weak currency affiliates

Strengthen affiliate evaluation and reporting systems

20-28