Financial Management and Accounting McGraw-Hill/Irwin International Business, 11/e Copyright © 2008 The McGraw-Hill Companies, Inc. All rights reserved. chapter twenty-one

21-3 Learning Objectives  Explain capital structure choices and their impact on the MNC  Describe the process of multilateral netting and its contribution to cash flow management  Describe the importance of leading and lagging in cash flow management  Categorize foreign exchange risks into transaction exposure, translation exposure, and economic exposure  Describe the basic idea of a swap transaction and its applications

21-4 Learning Objectives  Explain a currency swap contract and its usefulness to the financial manager  Recognize the usefulness and dangers of derivatives  Explain the role of and approaches to sales without money  Identify the major challenges faced in international accounting  Describe the international accounting standards’ convergence process and its importance

21-5 Capital Structure of the Firm Retained earnings Debt –Offshore financial center specializes in financing nonresidents, low taxes and few banking regulations Equity –American depository receipts (ADRs): foreign shares held by a custodian in the issuer’s home market and traded in dollars on the U.S. exchange

21-6 Financial Management Decisions In what currency should capital be raised? How structured: equity, debt? What sources of capital? If capital market, which ones? Are other sources of money available? How much and for how long?

21-7 Cash Flow Management Multilateral Netting –Subsidiaries transfer net intracompany cash flows through a centralized clearing center

21-8 Cash Flow Management Leading and Lagging –Timing payments early (lead) or late (lag), depending on anticipated currency movements, so they have the most favorable impact

21-9 Foreign Exchange Risk Management Transaction exposure –Change in the value of financial position created by foreign currency changes between establishment and settlement of contract Translation exposure –Potential change in value of a company’s financial position due to exposure created during consolidation process Economic exposure –Potential for value of future cash flows to be affected by unanticipated exchange rate movements

21-10 Transaction Exposure: Hedging Hedging –process to reduce or eliminate financial risk Forward market hedge –Foreign currency contract sold or bought forward in order to protect against foreign currency movement Currency option hedge –Option to buy or sell specific amount of foreign currency at specific time to protect against foreign currency risk Money market hedge –Method to hedge foreign currency exposure by borrowing and lending in domestic and foreign money markets

21-11 Transaction Exposure: Swaps Swap contract –Spot sale/purchase of asset against future purchase/sale of equal amount in order to hedge financial position Bank Swap –Swap made between banks to acquire temporary foreign currencies Currency Swap –Exchange of debt service of loan or bond in one currency for debt service of loan or bond in another currency

21-12 Transaction Exposure: Swaps cont’d. Interest Rate Swap –Exchange of interest rate flows to manage interest rate exposure Spot and forward market swaps –Use spot and forward markets to hedge foreign currency exposure Parallel Loans –Matched loans across currencies made to cover risk

21-13 Translation Approaches –Current rate method Current assets and liabilities are valued at current spot rates and noncurrent assets and liabilities are translated at historic exchange rates –Temporal method Monetary accounts are valued at spot rate and accounts carried at historical cost are translated at historic exchange rates

21-14 Hedges and Swaps as “Derivatives” Contract whose value is tied to the performance of a financial instrument or commodity

21-15 Sales Without Money Countertrade –The trade of goods or services for other goods or services (6 varieties) Counterpurchase –Goods supplied do not rely on the goods imported Compensation –Developing country makes payment in products produced by use of developed country equipment Barter –Direct exchange of goods or services for goods or services

21-16 Sales Without Money, cont’d. Switch Trading –Use of third party to market products received in countertrade Offset –Trade arrangement that requires portion of the inputs be supplied by receiving country Clearing account arrangements –Process to settle trading account within specified time

21-17 Industrial Cooperation An exporter’s commitment to a longer- term relationship than that in a simple export sale, in which some of the production occurs in the receiving country (five methods) –Joint Venture –Coproduction and specialization –Subcontracting –Licensing –Turnkey plants

21-18 Taxation and Transfer Pricing Transfer Price –The cost of intracompany sale of goods or services