2. 20 Financial Management International Business by 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

3. Chapter 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 centers 20-2

4. Fluctuating Currency 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

5. Transaction 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

6. Transaction 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

7. Transaction Risks  Acceleration or Delay of Payment  If an importer expects the currency in its country to depreciate in terms of the currency of its foreign supplier  It 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

8. Transaction 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

9. Transaction Risks  Objectives of Intra- international Company Payments  Within 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

10. Transaction Risks  Objectives of Intra-international Company Payments  Keep as much money as is reasonably possible in countries with high interest rates  Keep as much money as is reasonably possible in countries where credit is difficult to obtain  Maximize holdings of hard, strong currencies  Minimize holding of currencies that are subject to currency controls 20-9

11. Transaction Risks  Exposure Netting  Taking open positions in two currencies that are expected to balance each other  Two ways to accomplish exposure netting  Currency groups  A 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

12. Transaction Risks  Exposure Netting  Advantages  Avoids the costs of hedging  However, 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

13. Translation 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

14. Translation Risks  Realistic Information  Management must base important decisions on the updating of all asset and earnings values  Management Fears  Managers fear that shareholders and analysts will regard translated and reported foreign exchange losses as speculation or bad management  Neutralizing the Balance Sheet  Having monetary assets in amounts approximately equal to monetary liabilities 20-13

15. Swaps 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

16. Swaps 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

17. Capital 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

18. Capital 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

19. Advantages to Interest Rate Swaps Advantages to Interest 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

20. Currency 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

21. Derivatives  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

22. Sales 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

23. Countertrade 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

24. Countertrade  Counterpurchase  Goods supplied by the developing country are not produced by or out of goods or products imported from the developed country  Compensation  Call for payment by the developing country in products produced by developed country equipment 20-23  Barter  An 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

25. Countertrade  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

26. Countertrade 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

27. Industrial Cooperation  Industrial Cooperation  Long-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 venture  Coproduction and specialization  Subcontracting  Licensing  Turnkey plants 20-26

28. International 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

29. International Finance Center Additional functions Handle internal and external invoicing Help weak currency affiliates Strengthen affiliate evaluation and reporting systems 20-28