Bài giảng Financial Management - Chapter 24: International Financial Management

Chapter 24International Financial ManagementAfter Studying Chapter 24, you should be able to:Explain why many firms invest in foreign operations.Explain why foreign investment is different from domestic investment. Describe how capital budgeting, in an international environment, is similar to or dissimilar from that in a domestic environment. Understand the types of exchange-rate exposure and how to manage exchange-rate risk exposure. Compute domestic equivalents of foreign currencies given the spot or forward exchange rates. Understand and illustrate the purchasing-power parity (PPP) and interest-rate parity.Describe the specific instruments and documents used in structuring international trade transactions.Distinguish among countertrade, export factoring, and forfaiting.International Financial ManagementSome BackgroundTypes of Exchange-Rate Risk ExposureManagement of Exchange-Rate Risk ExposureStructuring International Trade TransactionsSome BackgroundFill product gaps in foreign markets where excess returns can be earned.To produce products in foreign markets more efficiently than domestically.To secure the necessary raw materials required for product production.What is a company’s motivation to invest capital abroad?International Capital Budgeting1. Estimate expected cash flows in the foreign currency.2. Compute their US-dollar equivalents at the expected exchange rate.3. Determine the NPV of the project using the US required rate of return, with the rate adjusted upward or downward for any risk premium effect associated with the foreign investment.How does a firm make an international capital budgeting decision?International Capital BudgetingOnly consider those cash flows that can be “repatriated” (returned) to the home-country parent.The exchange rate is the number of units of one currency that may be purchased with one unit of another currency.For example, the current exchange rate might be 2.50 Freedonian marks per one US dollar.International Capital Budgeting ExampleA firm is considering an investment in Freedonia, and the initial cash outlay is 1.5 million marks.The project has 4-year project life with cash flows given on the next slide.The appropriate required return for repatriated US dollars is 18%.The appropriate expected exchange rates are given on the next slide.International project details:International Capital Budgeting Example0 –1,500,000 2.50 –600,000 –600,0001 500,000 2.54 196,850 166,8222 800,000 2.59 308,880 221,8333 700,000 2.65 264,151 160,7704 600,000 2.72 220,588 113,777 Net Present Value = 63,202EndofYearExpectedCash Flow(marks)ExpectedCash Flow(US dollars)Present Valueof Cash Flowsat 18%ExchangeRate (marksto US dollar)International Capital BudgetingInternational diversification and risk reductionUS Government taxationTaxable income derived from non-domestic operations through a branch or division is taxed under US code.Foreign subsidiaries are taxed under foreign tax codes until dividends are received by the US parent from the foreign subsidiary.Related issues of concern:International Capital BudgetingTax codes and policies differ from country to country, but all countries impose income taxes on foreign companies.The US government provides a tax credit to companies to avoid the double taxation problem.A credit is provided up to the amount of the foreign tax, but not to exceed the same proportion of taxable earnings from the foreign country.Excess tax credits can be carried forward. Foreign TaxationInternational Capital BudgetingExpropriation is the ultimate political risk.Developing countries may provide financial incentives to enhance foreign investment.Bottom line: Forecasting political instability.Protect the firm by hiring local nationals, acting responsibly in the eyes of the host government, entering joint ventures, making the subsidiary reliant on the parent company, and/or purchasing political risk insurance. Political RiskImportant Exchange-Rate TermsCurrency risk can be thought of as the volatility of the exchange rate of one currency for another (say British pounds per US dollar).Spot Exchange Rate – The rate today for exchanging one currency for another for immediate delivery.Forward Exchange Rate – The rate today for exchanging one currency for another at a specific future date.Types of Exchange-Rate Risk ExposureTranslation Exposure – Relates to the change in accounting income and balance sheet statements caused by changes in exchange rates. Transactions Exposure – Relates to settling a particular transaction at one exchange rate when the obligation was originally recorded at another. Economic Exposure – Involves changes in expected future cash flows, and hence economic value, caused by a change in exchange rates.Management of Exchange-Rate Risk ExposureNatural hedgesCash managementAdjusting of intracompany accountsInternational financing hedgesCurrency market hedgesNatural HedgesBoth scenarios are natural hedges as any gain (loss) from exchange rate fluctuations in pricing is reduced by an offsetting loss (gain) in costs in similar global markets. Globally Domestically Determined DeterminedScenario 1Pricing XCost XScenario 2Pricing XCost XNatural Hedges – “Not!”Both of these scenarios are not natural hedges and thus create a possible firm exposure to events that impact one market and not the other market. Globally Domestically Determined DeterminedScenario 3Pricing XCost XScenario 4Pricing XCost XCash ManagementExchange cash for real assets (inventories) whose value is in their use rather than tied to a currency.Reduce or avoid the amount of trade credit that will be extended as the dollar value that the firm will receive is reduced and reduce any cash that does arrive as quickly as possible.Obtain trade credit or borrow in the local currency so that the money is repaid with fewer dollars.What should a firm do if it knew that a local foreign currency was going to fall in value (e.g., drop from $.70 per peso to $.60 per peso)?Cash ManagementGenerally, one cannot predict the future exchange rates, and the best policy would be to balance monetary assets against monetary liabilities to neutralize the effect of exchange-rate fluctuations.A reinvoicing center is a company-owned financial subsidiary that purchases exported goods from company affiliates and resells (reinvoices) them to other affiliates or independent customers.Cash ManagementGenerally, the reinvoicing center is billed in the selling unit’s home currency and bills the purchasing unit in that unit’s home currency.Allows better management of intracompany transactions.Netting – A system in which cross-border purchases among participating subsidiaries of the same company are netted so that each participant pays or receives only the net amount of its intracompany purchases and sales.International Financing Hedges Foreign commercial banks perform essentially the same financing functions as domestic banks except:They allow longer term loans.Loans are generally made on an overdraft basis.Nearly all major commercial cities have US bank branches or offices available for customers.The use of “discounting” trade bills is widely utilized in Europe versus minimal usage in the United States.1. Commercial Bank Loans and Trade BillsInternational Financing Hedges Eurodollars are bank deposits denominated in US dollars but not subject to US banking regulations.This market is unregulated. Therefore, the differential between the rate paid on deposits and that charged on loans varies according to the risk of the borrower and current supply and demand forces.Rates are typically quoted in terms of the LIBOR.It is a major source of short-term financing for the working capital requirements of the multinational company.2. Eurodollar FinancingInternational Financing Hedges A Eurobond is a bond issued internationally outside of the country in whose currency the bond is denominated. The Eurobond is issued in a single currency, but is placed in multiple countries.A foreign bond is issued by a foreign government or corporation in a local market. For example, Yankee bonds, Samurai bonds, and Rembrandt bonds.Many international debt issues are floating rate notes that carry a variable interest rate.3. International Bond FinancingInternational Financing Hedges Currency-option bonds provide the holder with the option to choose the currency in which payment is received. For example, a bond might allow you to choose between yen and US dollars.Currency cocktail bonds provide a degree of exchange-rate stability by having principal and interest payments being a weighted average of a “basket” of currencies.Dual-currency bonds have their purchase price and coupon payments denominated in one currency, while a different currency is used to make principal payments.4. Currency-Option and Multiple-Currency bondsCurrencies and the EuroEach country has a representative currency like the $ (dollar) in the United States or the ₤ (pound) in Britain.On January 1, 1999, the “euro” started trading.European Union (EU) currently includes Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovenia and Spain.Euro – The name given to the single European currency. Symbol is € (much like the dollar, $).Currency Market Hedges A forward contract is a contract for the delivery of a commodity, foreign currency, or financial instrument at a price specified now, with delivery and settlement at a specified future date. Spot rate $.168 per EFr 90-day forward rate .166 per EFrAs shown, the Elbonian franc (EFr) is said to sell at a forward discount as the forward price is less than the spot rate.If the forward rate is $.171, the EFr is said to sell at a forward premium.1. Forward Exchange MarketCurrency Market Hedges The firm has the option of selling 1 million Elbonian francs forward 90 days. The firm will receive $166,000 in 90 days (1 million Elbonian francs x $.166).Therefore, if the actual spot price in 90 days is less than .166, the firm benefited from entering into this transaction. If the rate is greater than .166, the firm would have benefited from not entering into the transaction.Fillups Electronics has just sold equipment worth 1 million Elbonian francs with credit terms of “net 90.” How can the firm hedge the currency risk?Currency Market Hedges Typical discount or premium ranges for stable currencies are from 0 to 8%, but may be as high as 20% for unstable currencies.How much does this “insurance” cost?Annualized cost of protection = ($0.002)/( $.168) × (365 days / 90 days) = 0.011905 × 4.0556 = 0.0483 or 4.83%Currency Market Hedges A futures contract is a contract for the delivery of a commodity, foreign currency, or financial instrument at a specified price on a stipulated future date.A currency futures market exists for the major currencies of the world.Futures contracts are traded on organized exchanges.The clearinghouse of the exchange interposes itself between the buyer and the seller. Therefore, transactions are not made directly between two parties.Very few contracts involve actual delivery at expiration.2. Currency FuturesCurrency Market Hedges Sellers (buyers) cancel a contract by purchasing (selling) another contract. This is an offsetting position that closes out the original contract with the clearinghouse.Futures contracts are marked-to-market daily. This is different than forward contracts that are settled only at maturity.Contracts come in only standard-size contracts(e.g., 12.5 million yen per contract).2. Currency Futures (continued)Currency Market Hedges A currency option is a contract that gives the holder the right to buy (call) or sell (put) a specific amount of a foreign currency at some specified price until a certain (expiration) date.Currency options hedge only adverse currency movements (“one-sided” risk). For example, a put option can hedge only downside movements in the currency exchange rate.Options exist in both the spot and futures markets.The value depends on exchange rate volatility.3. Currency OptionsCurrency Market Hedges In a currency swap two parties exchange debt obligations denominated in different currencies. Each party agrees to pay the other’s interest obligation. At maturity, principal amounts are exchanged, usually at a rate of exchange agreed to in advance.The exchange is notional – only the cash flow difference is paid.Swaps are typically arranged through a financial intermediary, such as a commercial bank.A variety of (complex) arrangements are available.4. Currency SwapsMacro Factors Governing Exchange-Rate BehaviorThe idea that a basket of goods should sell for the same price in two countries, after exchange rates are taken into account.For example, the price of wheat in Canadian and US markets should trade at the same price (after adjusting for the exchange rate). If the price of wheat is lower in Canada, then purchasers will buy wheat in Canada as long as the price is cheaper (after accounting for transportation costs). Purchasing-Power Parity (PPP)Macro Factors Governing Exchange-Rate BehaviorThus, demand will fall in the US and increase in Canada to bring prices back into equilibrium.The price elasticity of exports and imports influences the relationship between a country’s exchange rate and its purchasing-power parity.Commodity items and products in mature industries are more likely to conform to PPP.Frictions such as government intervention and trade barriers cause PPP not to hold.Purchasing-Power Parity (PPP continued)Macro Factors Governing Exchange-Rate BehaviorIt suggests that if interest rates are higher in one country than they are in another, the former’s currency will sell at a discount in the forward market.Remember that the Fisher effect implies that the nominal rate of interest equals the real rate of interest plus the expected rate of inflation.The international Fisher effect suggests that differences in interest rates between two countries serve as a proxy for differences in expected inflation.Interest-Rate ParityMacro Factors Governing Exchange-Rate BehaviorF = current forward exchange-rate in foreign currency per dollar.S = current spot exchange-rate in foreign currency per dollar.rforeign = foreign interbank Euromarket interest raterdollar = US interbank Euromarket interest rateInterest-Rate Parity (continued) The international Fisher effect suggests:FS=1 + rforeign1 + rdollarInterest-Rate Parity ExampleThe current German 90-day interest rate is 4%.The current US 90-day interest rate is 2%.The current spot rate is .706 Freedonian marks per US dollar ($1.416 per mark).What is the implied 90-day forward rate? Interest-Rate Parity ExampleF = (1.04) x (0.706) / (1.02) = 0.720Thus, the implied 90-day forward rate is 0.720 marks per dollar.The implied 90-day forward rate is:F0.706=1 + 0.041 + 0.02Structuring International Trade TransactionsIn international trade, sellers often have difficulty obtaining thorough and accurate credit information on potential buyers.Channels for legal settlement in cases of default are more complicated and costly to pursue.Key documents are (1) an order to pay (international trade draft), (2) a bill of lading, and (3) a letter of credit.International Trade DraftThe international trade draft (bill of exchange) is a written statement by the exporter ordering the importer to pay a specific amount of money at a specified time.Sight draft is payable on presentation to the party (drawee) to whom the draft is addressed.Time draft is payable at a specified future date after sight to the party (drawee) to whom the draft is addressed.Time Draft FeaturesAn unconditional order in writing signed by the drawer, the exporter.It specifies an exact amount of money that the drawee, the importer, must pay.It specifies the future date when this amount must be paid.Upon presentation to the drawee, it is accepted.Time Draft FeaturesThe acceptance can be by either the drawee or a bank.If the drawee accepts the draft, it is acknowledged in writing on the back of the draft the obligation to pay the amount so many specified days hence.It is then known as a trade draft (banker’s acceptance if a bank accepts the draft).Bill of LadingIt serves as a receipt from the transportation company to the exporter, showing that specified goods have been received.It serves as a contract between the transportation company and the exporter to ship goods and deliver them to a specific party at a specific destination.It serves as a document of title.Bill of Lading – A shipping document indicating the details of the shipment and delivery of goods and their ownership.Letter of CreditA letter of credit is issued by a bank on behalf of the importer.The bank agrees to honor a draft drawn on the importer, provided the bill of lading and other details are in order.The bank is essentially substituting its credit for that of the importer.Letter of Credit - A promise from a third party (usually a bank) for payment in the event that certain conditions are met. It is frequently used to guarantee payment of an obligation.CountertradeUsed effectively when exchange restrictions exist or other difficulties prevent payment in hard currencies.Quality, standardization of goods, and resale of goods that are delivered are risks that arise with countertrade.Countertrade – Generic term for barter and other forms of trade that involve the international sale of goods or services that are paid for – in whole or in part – by the transfer of goods or services from a foreign country.ForfaitingThe forfaiter assumes the credit risk and collects the amount owed from the importer.Most useful when the importer is in a less-developed country or in an Eastern European nation.Forfaiting – The selling “without recourse” of medium- to long-term export receivables to a financial institution, the forfaiter. A third party, usually a bank or governmental unit, guarantees the financing.