18-1 International Financial Management

18-2 Chapter Objectives_1 Analyze the advantages and disadvantages of the major forms of payment in international trade Identify the primary types of foreign-exchange risk faced by international businesses Describe the techniques used by firms to manage their working capital

18-3 Chapter Objectives_2 Evaluate the various capital budgeting techniques used for international investments Discuss the primary sources of investment capital available to international businesses

18-4 Financial Issues in International Trade Which currency to use for the transaction When and how to check credit Which form of payment to use How to arrange financing

18-5 Method of Payment Payment in advance Open account Documentary collection Letters of credit Credit cards Countertrade

18-6 Forms of Drafts Sight draft: requires payment upon transfer of title to the goods from the exporter to the importer Time draft: extends credit to the importer by requiring payment at some specified time Date draft: specifies particular date

18-7 Figure18.1 Using a Sight Draft

18-8 Documentation for Letters of Credit Export licenses Certificates of product origin Inspection certificates

18-9 Types of Letters of Credit Advised letter of credit Confirmed letter of credit Irrevocable letter of credit Revocable letter of credit

18-10 Figure 18.2 Using a Letter of Credit

18-11 Countertrade Occurs when a firm accepts something other than money as payment for its goods or services Forms Barter Counterpurchase (parallel barter) Buy-back Offset purchase

18-12 Map 18.1 Countertrade by Marc Rich

18-13 Table 18.1 Payment Methods for International Trade MethodTiming -PaymentTiming - DeliveryRisks - Exporter Risks - Importer Availability of Financing Conditions for Use Payment in advance Prior to deliveryAfter paymentNoneExporter may fail to deliver N/AExporter has strong bargaining Open accountAccording to credit terms When goods arrive in importer’s country Importer may fail to pay NoneYesExporter has complete trust in importer Documentary collection At delivery (sight draft); at later time (time draft) Upon payment (sight draft); upon acceptance (time draft) Importer may default or fail to accept draft NoneYesRisk of default is low Letter of creditAfter terms of letter are fulfilled According to terms Issuing bank may default, incorrect documents Exporter honors terms of letter but not contract YesExporter lacks knowledge; Importer has good credit Credit cardAccording to normal procedures When goods arrive in importer’s country NoneExporter fails to deliver N/ATransaction size is small CountertradeWhen exporter sells countertraded goods When goods arrive in importer’s country Exporter may not be able to sell NoneNoImporter lacks convertible currency

18-14 The Itaipu Dam the Parana River between Brazil an Paraguay

18-15 Foreign-Exchange Exposure Transaction exposure Translation exposure Economic exposure

18-16 Transaction Exposure Financial benefits and costs of an international transaction can be affected by exchange rate movements that occur after the firm is legally obligated to complete the transaction Transactions Purchase of goods, services, or assets Sales of goods, services, or assets Extension of credit Borrowing of money

18-17 Options for Responding to Transaction Exposure Go naked Buy forward currency Buy currency future Buy currency option Acquire an offsetting asset

18-18 Political uncertainty can affect transaction exposure

18-19 Go Naked Benefits No capital outlay Potential for capital gain if home currency rises in value Costs Potential for capital loss if home currency falls in value

18-20 Buy Forward Currency Benefits Elimination of transaction exposure Flexibility in size and timing of contract Costs Fees to banks Lost opportunity for capital gain if home currency rises in value

18-21 Buy Currency Future Benefits Elimination of transaction exposure Ease and relative inexpensiveness of futures contracts Costs Small brokerage free Inflexibility in size and timing of contract Lost opportunity for capital gain if home currency rises in value

18-22 Buy Currency Option Benefits Elimination of transaction exposure Potential for capital gain if home currency rises in value Costs Premium paid up front for option because of its “heads I win; tail I don’t lose” nature Inflexibility in size and timing of option

18-23 Acquire Offsetting Asset Benefits Elimination of transaction exposure Costs Effort or expense of arranging offsetting transaction Lost opportunity for capital gain if home currency rises in value

18-24 Translation Exposure Impact on the firm’s consolidated financial statements of fluctuations in exchange rates that change the value of foreign subsidiaries as measured in the parent’s currency Reduce translation exposure through the use of a balance sheet hedge

18-25 Economic Exposure Impact on the value of a firm’s operations of unanticipated exchange rate changes Affects all areas of operations Management of economic exposure involves analyzing likely changes in exchange rates

18-26 Map 18.3 Changes in Currency Values Relative to the U.S. $, July 2003

18-27 Management of Working Capital Corporate Financial Goals Minimizing working-capital balances Minimizing currency conversion costs Minimizing foreign-exchange risk

18-28 Figure 18.3 Payment Flows Without Netting

18-29 Evaluating Investment Projects Net Present Value Internal Rate of Return Payback period

18-30 Net Present Value Approach A dollar today is worth more than a dollar in the future Estimate the cash flows the project will generate and then discount them back to the present

18-31 Other Factors to Consider When Using Net Present Value Approach Risk Adjustment Choice of Currency Whose Perspective: Parent’s or Project’s?

18-32 Before investing $500 million in this Chilean copper mine, Placer Dome carefully analyzed the risks

18-33 Figure 18.4 Internal Sources of Capital for International Businesses