Chapter 14: Global Financial Management

Special Drawing Right (SDR)

-A basket of currencies consisting of dollars, euros, pounds, and yen created by the International Monetary Fund (IMF) -weighs on the currencies are based on world trading patterns of goods and services

Open Account

-A simple agreement wherein the exporter sends an invoice with the goods and the exporter pays upon the receipt -larger firms with good relations are more likely to use this method of payment due to low risk of default on the payment

Currency Swaps

-Allow firms to exchange currencies at a previously agreed exchange rate as a way to hedge exchange rate movements -over a period of up to 10 years

Domestic Bonds

-Debt contracts sold by firms domiciled in a country in the home currency -not part of the international bond market

Transactions Risk

-How short-term changes in exchange rates can affect operating costs and revenues of firms engaged in international business activities -arises from the import and export if goods and services

Home Bias

-Investing most of retirement and other savings in one's home country, which reduces diversification -not reducing their risk as much as possible -likely to increase investors risk

Hedging

-Is the use of currency derivatives to reduce potential transaction, translation, and economic risks of currency movements that could lead to losses for a firm or investor -similar to to insurance contracts where a premium is paid to protect against potential losses

International Monetary Fund (IMF)

-Provides "lender-of-last-resort" short-term loans to countries in financial crisis -Evaluates exchange rate policies -Gives technical assistance to countries -promote international monetary stability and international trade

World Bank

-Provides long-term loans for economic reform and infrastructure development in emerging and developing markets -promote international monetary stability and international trade -priorities are health, education, social institutions, environmental disasters, private business formation, economic reforms and poverty reductions

Currency Futures Contracts

-Standardized agreements to buy or sell a specified amount of currency at a date in the future at a pre-determined price -buyer agrees to buy or sell a specified amount of currency on a particular at in the future at a pre-determined price

Exchange Rate Risk

-The impact of random change in the value of one currency with respect to other currencies -risk associated with one currency changing in value relative to another currency

in Financial Crises what is likely to occur?

-currency values can plummer -market volatility can cause an exodus of global investors -financial institutions can fail -government scan lose political support

Speculators

-is the opposite of hedging -Trade in currencies and currency derivatives to earn profits and to help to make currency prices efficient

Bonds are categorized into three ways

1. domestic 2. foreign 3. Eurobond

two kinds of short-term effects of currency movements

1. transactions risk 2. translations risk

Export-Import (Ex-Im) Bank

A U.S. government export finance agency that supports U.S. firms competing against government-supported exports of other countries

Syndicate

A group of banks that collectively make a participation loan to a large international firm

International CAPM (ICAPM)

An asset pricing model that includes both domestic and global market factors to estimate the cost of equity or required rate of return on stocks The estimated rate of return required by stockholders as estimated by ICAPM) is:

Sensitivity Analysis

An examination of optimistic, expected, and pessimistic scenarios to give a more complete picture of the risks and returns of investments abroad

Plain Vanilla Currency Swap

An interest rate swap, often combined with a currency swap, if the interest being swapped is in different currencies

Call Option

An investor's right (but not obligation) to buy an asset (e.g., a currency) at a pre-determined (strike) price

Put Option

An investor's right (but not obligation) to sell an asset (e.g., a currency) at a pre-determined price

Currency Forward Contracts

Are contracts in the currencies of emerging-market countries offered by large banks in the OTC market Are less standardized than future contracts such that they can be customized by the seller/counterparty to meet the hedging needs of the buyer Are not marked-to-market daily- no liquidity risk

Consolidated Accounting Statements

Are the income statements and balance sheets of a multinational corporation and of its all subsidiaries abroad Are required reporting to home country tax authorities Are affected by currency translation risks

Term Financing

Bank and government loans to importers to cover the cost of major purchases

Trade Finance

Bank and government loans used by exporters to finance working capital (i.e., labor, materials, inventory, and accounts receivables)

Foreign Bonds

Bonds that are issued by foreign firms in another country in the home currency of that country

Eurobonds

Bonds that are sold in any country outside the home country, but in the home country's currency

Long Position

Buying a currency contract and profiting on the increased value of the underlying currency over time

Diversification

Buying securities in a portfolio with price patterns over time that are different from one another, which reduces the volatility of the portfolio

Cash Flow Sensitivity to Exchange Rate Risk

Firms can experience positive and negative fluctuations in cash flows and profits due to currency movements that strengthen or weaken the value of their products in overseas markets

Marked-to-Market

Futures contracts in which gains (losses) are earned (paid) in cash at the end of each trading day

Cost Of Capital

Is the required rate of return demanded by stock and bond investors Is used in net present value capital budgeting analyses as the discount rate

Bank of International Cooperation (JBIC)

Japanese bank that supports exporters around the world that have at least thirty percent Japanese content

Money Center Banks

Large global banks

Margin Call

Losses that cause the contract holder's balance to fall below the maintenance margin at the end of the trading day thus requiring additional investment in the contract to continue holding the contract

Bond Ratings

Moody's and Standard and Poor's rating services which are important in assuring foreign investors of the credit quality of bond issues

Clearing House Interbank Payments System (CHIPS)

Provides large, wholesale dollar payments services for businesses, banks, and governments

Commercial Letter Of Credit (LC)

Provides payment protection to both exporters and importers, as the importer's bank writes a guarantee of payment

Society of Worldwide Interbank Financial Telecommunications (SWIFT)

Provides secure communications for contracts, invoices, and other trade documents that accompany cash payments

Short Position

Selling a currency contract and profiting on the decreased value of the currency over time

Over-the-Counter (OTC) Market

The derivatives market run by large banks

Net Present Value (NPV)

The difference between present value of future profits on an investment project minus the initial investment cost

Premium

The price paid by the buyer to the seller for an option contract

Cost Of Equity

The rate of return on equity required by stockholders as estimated by Capital Asset Pricing Model (CAPM)

Payment In Advance

The safest method for exporters, but it exposes importers to risk related to delivery of goods

Translation Risk

The short-term effects of currency movements on the consolidated accounting statements of a firm

Margin

The small commitment fee needed to purchase a futures contract

Weighted Average Cost Of Capital

The sum of the costs of equity and debt weighted by the amount of financing from these two capital sources The weighted average cost of capital for a firm is: K=(equity/total market value) R + (debt/total market value) (1-tax rate) I

Country Risk

The uncertainty in predicting how economic, political, inflation, and tax risk factors will affect an investment in a country

Economic Risk

The ways in which long-term exchange rate movements affect firms

Cost Of Debt

The weighted average of different interest rates paid on long-term borrowings

Organized Exchanges

Trade futures contracts in major currencies and offer price transparency and efficiency Eliminate counterparty risk due to guaranteed payments on contacts

Banker's Acceptance

When a bank sells a LC into the financial marketplace as a money market instrument

Contagion

When stock markets in many countries move down in concert with one another and thereby reduce international diversification benefits

long term effects of currency movements

economic risk

Exchange rate risk can be hedged by

using derivative instruments including -futures -forward -options -swap contracts