1、24-1 Pearson Education Limited 2004Fundamentals of Financial Management,12/e Created by:Gregory A.Kuhlemeyer,Ph.D.Carroll College,Waukesha,WI24-2uExplain why many firms invest in foreign operations.uExplain why foreign investment is different from domestic investment.uDescribe how capital budgeting,
2、in an international environment,is similar or dissimilar to that in a domestic environment.uUnderstand the types of exchange-rate exposure and how to manage exchange-rate risk exposure.uCompute domestic equivalents of foreign currencies given the spot or forward exchange rates.uUnderstand and illust
3、rate the purchasing-power parity(PPP)and interest rate parity.uDescribe the specific instruments and documents used in structuring international trade transactions.uDistinguish among countertrade,export factoring,and forfaiting.24-3uSome BackgrounduTypes of Exchange-Rate Risk ExposureuManagement of
4、Exchange-Rate Risk ExposureuStructuring International Trade Transactions24-4uFill product gaps in foreign markets where excess returns can be earned.uTo produce products in foreign markets more efficiently than domestically.uTo secure the necessary raw materials required for product production.24-51
5、.Estimate expected cash flows in the foreign currency.2.Compute their U.S.-dollar equivalents at the expected exchange rate.3.Determine the NPV of the project using the U.S.required rate of return,with the rate adjusted upward or downward for any risk premium effect associated with the foreign inves
6、tment.24-6uOnly consider those cash flows that can be“repatriated”(returned)to the home-country parent.uThe is the number of units of one currency that may be purchased with one unit of another currency.uFor example,the current exchange rate might be 2.50 Freedonian marks per one U.S.dollar.24-7uA f
7、irm is considering an investment in Freedonia,and the initial cash outlay is 1.5 million marks.uThe project has 4-year project life with cash flows given on the next slide.uThe for repatriated U.S.dollars.uThe appropriate are given on the next slide.24-80 -1 2 3 4 Net Present Value=63,202EndofYear(m
8、arks)(U.S.dollars)(marksto U.S.dollar)24-9uInternational diversification and risk reductionuU.S.Government taxationuTaxable income derived from non-domestic operations through a branch or division is taxed under U.S.code.uForeign subsidiaries are taxed under foreign tax codes until dividends are rec
9、eived by the U.S.parent from the foreign subsidiary.24-10uTax codes and policies differ from country to country,but all countries impose income taxes on foreign companies.uThe U.S.government provides a tax credit to companies to avoid the double taxation problem.uA credit is provided up to the amoun
10、t of the foreign tax,but not to exceed the same proportion of taxable earnings from the foreign country.uExcess tax credits can be carried forward.u Foreign Taxation24-11uExpropriation is the ultimate political risk.uDeveloping countries may provide financial incentives to enhance foreign investment
11、.uBottom line:.uProtect 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.u Political Risk24-12can be thought of as the volatility of the exchange rate of one currency
12、 for another(say British pounds per U.S.dollar).-The rate today for exchanging one currency for another.-The rate today for exchanging one currency for another.24-13-Relates to the change in accounting income and balance sheet statements caused by changes in exchange rates.-Relates to settling a par
13、ticular transaction at one exchange rate when the obligation was originally recorded at another.Involves changes in expected future cash flows,and hence economic value,caused by a change in exchange rates.24-14uNatural hedgesuCash managementuAdjusting of intracompany accountsuInternational financing
14、 hedgesuCurrency market hedges24-15uBoth 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 DeterminedPricing XCost XPricingXCostX24-16uBoth of these scenar
15、ios 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 DeterminedPricing XCostXPricing XCost X24-17uExchange cash for real assets(inventories)whose value is in their use rather than tied to a curr
16、ency.uReduce 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.uObtain trade credit or borrow in the local currency so that the money is repaid with fewer dollars.24-18uGener
17、ally,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.uA is a company-owned financial subsidiary that purchases exported goods from company affiliates and resells(r
18、einvoices)them to other affiliates or independent customers.24-19uGenerally,the reinvoicing center is billed in the selling units home currency and bills the purchasing unit in that units home currency.uAllows better management of intracompany transactions.-A system in which cross-border purchases a
19、mong 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.24-20uForeign commercial banks perform essentially the same financing functions as domestic banks except:uThey allow longer term loans.
20、uLoans are generally made on an.uNearly all major commercial cities have U.S.bank branches or offices available for customers.uThe use of“discounting”trade bills is widely utilized in Europe versus minimal usage in the United States.24-21uEurodollars are bank deposits denominated in U.S.dollars but
21、not subject to U.S.banking regulations.uThis 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.uRates are typically quoted in terms of the LIBOR.uIt is a major
22、 source of short-term financing for the working capital requirements of the multinational company.24-22uAis a bond issued internationally outside of the country in whose currency the bond is denominated.uThe Eurobond is issued in a single currency,but is placed in multiple countries.uA is issued by
23、a foreign government or corporation in a local market.For example,Yankee bonds,and Samurai bonds.uMany international debt issues are that carry a variable interest rate.24-23uCurrency-option bonds provide the holder with the option to choose the currency in which payment is received.For example,a bo
24、nd might allow you to choose between yen and U.S.dollars.uCurrency cocktail bonds provide a degree of exchange-rate stability by having principal and interest payments being a weighted average of a“basket”of currencies.uDual-currency bonds have their purchase price and coupon payments denominated in
25、 one currency,while a different currency is used to make principal payments.24-24uEach country has a representative currency like the$(dollar)in the United States or the (pound)in Britain.uOn January 1,1999,the“euro”started trading.uThe euro is the common currency of the European Monetary Union(EMU)
26、,which currently includes the following 12 European Union(EU)countries:uAustria,Belgium,Finland,France,Germany,Greece,Ireland,Italy,Luxembourg,the Netherlands,Portugal,and Spain.The name given to the single European currency.Symbol is (much like the dollar,$).24-25uA is a contract for the delivery o
27、f a commodity,foreign currency,or financial instrument at a price specified now,with delivery and settlement at a specified future date.Spot rate$.168 per EFr 90-day forward rate .166 per EFruAs shown,the Elbonian franc(EFr)is said to sell at a as the forward price is less than the spot rate.uIf the
28、 forward rate is$.171,the EFr is said to sell at a.24-26uThe 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).uTherefore,if the actual spot price in 90 days is less than.166,the firm benefited from ent
29、ering into this transaction.uIf 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.”24-27uTypical discount or premium ranges for stable currencies ar
30、e from 0 to 8%,but may be as high as 20%for unstable currencies.=($.002)/($.168)X(365 days/90 days)=.011905 X 4.0556=.0483 or 24-28uA is a contract for the delivery of a commodity,foreign currency,or financial instrument at a specified price on a stipulated future date.uA currency futures market exi
31、sts for the major currencies of the world.uFutures contracts are traded on organized exchanges.uThe clearinghouse of the exchange interposes itself between the buyer and the seller.Therefore,transactions are not made directly between two parties.uVery few contracts involve actual delivery at expirat
32、ion.24-29uSellers(buyers)cancel a contract by purchasing(selling)another contract.This is an offsetting position that closes out the original contract with the clearinghouse.uFutures contracts are marked-to-market daily.This is different than forward contracts that are settled only at maturity.uCont
33、racts come in only standard-size contracts(e.g.,12.5 million yen per contract).24-30uA 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.uCurrency options hedge only adverse currency m
34、ovements(“one-sided”risk).For example,a put option can hedge only downside movements in the currency exchange rate.uOptions exist in both the spot and futures markets.uThe value depends on exchange rate volatility.24-31uIn a two parties exchange debt obligations denominated in different currencies.E
35、ach party agrees to pay the others interest obligation.At maturity,principal amounts are exchanged,usually at a rate of exchange agreed to in advance.uThe exchange is notional-only the cash flow difference is paid.uSwaps are typically arranged through a financial intermediary,such as a commercial ba
36、nk.uA variety of(complex)arrangements are available.24-32uThe idea that a basket of goods should sell for the same price in two countries,after exchange rates are taken into account.uFor example,the price of wheat in Canadian and U.S.markets should trade at the same price(after adjusting for the exc
37、hange 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).24-33uThus,demand will fall in the U.S.and increase in Canada to bring prices back into equilibrium.uThe price elasticity of export
38、s and imports influences the relationship between a countrys exchange rate and its purchasing-power parity.uCommodity items and products in mature industries are more likely to conform to PPP.uFrictions such as government intervention and trade barriers cause PPP not to hold.24-34uIt suggests that i
39、f interest rates are higher in one country than they are in another,the formers currency will sell at a discount in the forward market.uRemember that the Fisher effect implies that the nominal rate of interest equals the real rate of interest plus the expected rate of inflation.uThe international Fi
40、sher effect suggests that differences in interest rates between two countries serve as a proxy for differences in expected inflation.24-35F=current forward exchange-rate in foreign currency per dollar.S=current spot exchange-rate in foreign currency per dollar.rforeign=foreign interbank Euromarket i
41、nterest raterdollar=U.S.interbank Euromarket interest rateThe international Fisher effect suggests:FS=1+rforeign1+rdollar24-36uThe current German 90-day interest rate is 4%.uThe current U.S.90-day interest rate is 2%.uThe current spot rate is.706 Freedonian marks per U.S.dollar($1.416 per mark).24-3
42、7F=(1.04)x()/(1.02)=Thus,the is.The is:F=1+.041+.0224-38uIn international trade,sellers often have difficulty obtaining thorough and accurate credit information on potential buyers.uChannels for legal settlement in cases of default are more complicated and costly to pursue.uKey documents are(1)an or
43、der to pay(international trade draft),(2)a bill of lading,and(3)a letter of credit.24-39uThe is a written statement by the exporter ordering the importer to pay a specific amount of money at a specified time.is payable on presentation to the party(drawee)to whom the draft is addressed.is payable at
44、a specified future date after sight to the party(drawee)to whom the draft is addressed.24-40uAn unconditional order in writing signed by the drawer,the exporter.uIt specifies an exact amount of money that the drawee,the importer,must pay.uIt specifies the future date when this amount must be paid.uU
45、pon presentation to the drawee,it is.24-41uThe acceptance can be by either the or a.uIf 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.uIt is then known as a(if a bank accepts the draft).24-42uIt serve
46、s as a receipt from the transportation company to the exporter,showing that specified goods have been received.uIt 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.uIt serves as a document of title.-
47、A shipping document indicating the details of the shipment and delivery of goods and their ownership.24-43uA letter of credit is issued by a bank on behalf of the importer.uThe bank agrees to honor a draft drawn on the importer,provided the bill of lading and other details are in order.uThe bank is
48、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.24-44uUsed effectively when exchange restrictions exist or ot
49、her difficulties prevent payment in hard currencies.uQuality,standardization of goods,and resale of goods that are delivered are risks that arise with 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
50、 in part-by the transfer of goods or services from a foreign country.24-45uThe forfaiter assumes the credit risk and collects the amount owed from the importer.uMost useful when the importer is in a less-developed country or in an Eastern European nation.-The selling“without recourse”of medium-to lo
