FIN 4604 FINAL

Eurobond

A bond originally offered outside the country in whose currency it is denominated. For example, a dollar-denominated bond originally offered for sale to investors outside the United States.

CAPM

A theoretical model that relates the return on an asset to its risk, where risk is the contribution of the asset to the volatility of a portfolio. Risk and return are presumed to be determined in competitive and efficient financial markets.

subpart F income

A type of foreign income, as defined in the U.S. tax code, which under certain conditions is taxed immediately in the United States even though it has not been repatriated to the United States. It is income of a type that is otherwise easily shifted offshore to avoid current taxation.

value added tax

A type of national sales tax collected at each stage of production or sale of consumption goods, and levied in proportion to the value added during that stage.

seasoned offering

Additional offerings of equity shares post-IPO.

Adverse Regulatory changes

Although expropriation has historically been the most "feared" of political risks, it is still relatively infrequent. The more common form today is the creeping expropriation,

Investment Agreement

An agreement that spells out specific rights and responsibilities of both the investing foreign firm and the host government.

OLI paradigm

An attempt to create an overall framework to explain why MNEs choose foreign direct investment rather than serve foreign markets through alternative modes such as licensing, joint ventures, strategic alliances, management contracts, and exporting.

Qualified Institutional Buyer (QIB)

An entity (except a bank or a savings and loan) that owns and invests on a discretionary basis a minimum of $100 million in securities of non-affiliates.

Greenfield Investment

An initial investment in a new foreign subsidiary with no predecessor operation in that location. This is in contrast to a new subsidiary created by the purchase of an already existing operation.

Letters of Credit

An instrument issued by a bank, in which the bank promises to pay a beneficiary upon presentation of documents specified in the letter.

Tenor

An international trade term. A bill of exchange drawn directly upon and accepted by an importer or purchaser, rather than a bank, and due at a specified future time

Directed Public Share

An issue that is targeted at investors in a single country and underwritten in whole or in part by investment institutions from that country.

Banker's Acceptance

An unconditional promise by a bank to make payment on a draft when it matures. This comes in the form of the bank's endorsement (acceptance) of a draft drawn against that bank in accordance with the terms of a letter of credit issued by the bank.

Bank's draft

An unconditional written order requesting one party (such as an importer) to pay a specified amount of money at a specified time to the order of the writer of this item. One example is personal checks.

Foreign Credit Insurance Association (FCIA)

An unincorporated association of private commercial insurance companies, in cooperation with the Export-Import Bank of the United States, that provides export credit insurance to U.S. firms.

Sight Draft

A U.S. government agency created to finance and otherwise facilitate imports and exports.

Parties of Letters of Credit

A beneficiary (exporter) and an applicant (importer) agree on a transaction and the importer then applies to its local bank for the issuance of an L/C. The importer's bank issues an L/C and cuts a sales contract based on its assessment of the importer's creditworthiness, or the bank might require a cash deposit or other collateral from the importer in advance. These participants are all

Trade Acceptance

A bill of exchange (B/E) that is due on demand; i.e., when presented to the bank.

Foreign bond

A bond issued by a foreign corporation or government for sale in the domestic capital market of another country, and denominated in the currency of that country

American Depository Receipts (ADRs)

A certificate of ownership, issued by a U.S. bank, representing a claim on underlying foreign securities.

Draft or bill exchange

A check for payment drawing upon a bank's own account; a check whose payment is guaranteed by a bank.

Can arise when the exporter is unsure of the financial standing of the foreign bank

A confirmed L/C is issued by one bank and can be confirmed by another bank, in which case the confirming bank can honor drafts drawn in compliance with the L/C. An unconfirmed L/C is the obligation only of the issuing bank. An exporter is likely to want a foreign bank's L/C confirmed by a domestic bank when the exporter has doubts about the foreign bank's ability to pay. Such doubts

Time Draft

A draft that allows a delay in payment. It is presented to the drawee, who accepts it by writing a notice of acceptance on its face. Once accepted, the time draft becomes a promise to pay by the accepting party.

commercial paper

A firm can issue unsecured promissory notes to fund its short-term financing needs, including both domestic and export receivables. However, it is only the large well-known firms with favorable credit ratings that have access to this funding.

the firm being able to raise more capital at a lower marginal cost

A firm is able to increase its market liquidity by raising debt in the euromarket and by tapping local capital markets through foreign subsidiaries. Increased market liquidity causes the marginal cost of capital line to flatten out on the right. This results in

Controlled Foreign Corporation (CFC)

A foreign corporation in which U.S. shareholders own more than 50% of the combined voting power or total value. Under U.S. tax law, U.S. shareholders may be liable for taxes on undistributed earnings of the controlled foreign corporation.

strategic alliance

A formal relationship, short of a merger or acquisition, between two companies, formed for the purpose of gaining synergies because in some aspect the two companies complement each other.

syndicated loan

A large loan made by a group of banks to a large multinational firm or government. These loans allow the participating banks to maintain diversification by not lending too much to a single borrower.

Back-to-back loan

A loan in which two companies in separate countries borrow each other's currency for a specific period of time and repay the other's currency at an agreed maturity. Sometimes the two loans are channeled through an intermediate bank.

earnings stripping

A multinational firm may allocate debt differently across its various foreign subsidiaries to reduce tax liabilities in high tax environments. Units in high tax environments may be assigned very high debt obligations in an attempt to maximize the interest deductibility provisions offered in that country. This is termed

Tax Treaties

A network of bilateral treaties that provide a means of reducing double taxation

Euroequity

A new equity issue that is underwritten and distributed in multiple foreign equity markets, sometimes simultaneously with distribution in the domestic market.

Fronting Loan

A parent-to-subsidiary loan that is channeled through a financial intermediary such as a large international bank in order to reduce political risk. Presumably government authorities are less likely to prevent a foreign subsidiary repaying an established bank than repaying the subsidiary's corporate parent

Order Bill of Lading

A shipping document through which possession and title to the shipment reside with the owner of the bill.

Turnover Tax

A tax based sales, and is similar in structure to a VAT, in which taxes may be assessed on intermediate stages of a good's production.

Direct Tax

A tax paid directly to the government by the person on whom it is imposed.

Forfeiting

A technique for arranging nonrecourse medium-term export financing, used most frequently to finance imports into Eastern Europe. A third party, usually a specialized financial institution, guaranteeing the financing

Private Equity

Asset ownership in a business that is not publicly traded. These investments are typically made by private equity firms or private equity funds.

5.2

Assume a before tax cost of debt of 8% and a tax rate of 35% then the after tax cost of debt is:

10

Assume a risk-free rate of interest of 4%, an expected rate of return on the market portfolio of 9% and a beta of 1.2 then the traditional domestic CAPM results in a cost of equity of:

Bulldog

British pound-denominated bond issued within the United Kingdom by a foreign borrower.

Repositioning of funds

The movement of funds from one currency or country to another. An MNE faces a variety of political, tax, foreign exchange, and liquidity constraints that limit its ability to move funds easily and without cost.

Yankee Bond

Dollar-denominated bond issued within the United States by a foreign borrower

Thin Capitalization Rules

Earnings stripping is typically limited by host government requirements for minimum equity capitalizations or interest deductibility limits. The U.S. defines it as anything above a 3:1 debt-to-equity ratio, with net interest exceeding 50% of adjusted taxable income (taxable income plus interest plus depreciation). Interest expenses that exceed 50% paid to a related corporation are not deductible toward U.S. taxes. These rules are known as

Eurocurrency market is a major source of short term bank loans

Eurocurrency markets serve two valuable purposes: (1) eurocurrency deposits are an efficient and convenient money market device for holding excess corporate liquidity, and (2)

lower cost of capital and greater ability to raise capital

Firms having access to markets with high liquidity and a low level of segmentation should have a

Tax Deferral

Foreign subsidiaries of MNEs pay host country corporate income taxes, but many parent countries, including the United States, defer claiming additional taxes on that foreign source income until it is remitted to the parent firm.

a lower marginal cost of capital, improved liquidity for its shares, and a larger capital budget

If a firm is resident in a segmented capital market, it can still escape from this market by sourcing its debt and equity abroad. The result should be

Foreign exchange risk and political risk

If all capital markets are fully integrated, securities of comparable expected return and risk should have the same required rate of return in each national market after adjusting for

kd (1-t)

If the before-tax cost of debt is kd, and the corporate income tax is t, the after-tax cost of debt is:

Country Risk

In banking, the likelihood that unexpected events within a host country will influence a client's or a government's ability to repay a loan. This risk is often divided into sovereign (political) risk and foreign exchange (currency) risk.

Tax Neutrality

In domestic tax, the requirement that the burden of taxation on earnings in home country operations by an MNE be equal to the burden of taxation on each currency equivalent of profit earned by the same firm in its foreign operations. Abroad this requires that the tax burden on each foreign subsidiary of the firm be equal to the tax burden on its competitors in the same country.

Individual firms in markets

International portfolio theory typically concludes that adding international securities to a domestic portfolio will reduce the portfolio's risk. Although this idea is fundamental to much of international financial theory, it still depends on

International Offshore Financial Centers

Many MNEs have foreign subsidiaries that act as tax havens for corporate funds awaiting reinvestment or repatriation. These tax-haven subsidiaries, which are partially a result of tax-deferral features on earned foreign income allowed by some of the parent countries are known as

7.6

Now assume a risk-free rate of interest of 4%, an expected rate of return on the global market portfolio of 8% and a global beta of 0.90 then the ICAPM results in a cost of equity of:

Exproporiation

Official government seizure of private property, recognized by international law as the right of any sovereign state provided affected owners are given prompt compensation and fair market value in convertible currencies.

Firm-specific or country specific

Political risk is the possibility that political events in a particular country will influence the economic well-being of a firm operating in that country. Multinational firms need to anticipate and manage political risk. In order to do that, the firm must understand the differing types of risks and their likelihood of occurrence. The political risks facing a multinational firm can be categorized as

Export Credit Insurance

Provides assurance to the exporter or the exporter's bank that, should the foreign customer default on payment, the insurance company will pay for a major portion of the loss

Floating Rate Note

Short- to medium-term debt instruments sold in the eurocurrency market.

Eurocommerical Paper

Short-term notes (30, 60, 90, 120, 180, 270, and 360 days) sold in international money markets.

Global Depository Receipt (GDR)

Similar to American Depositary Receipts (ADRs), it is a bank certificate issued in multiple countries for shares in a foreign company. Actual company shares are held by a foreign branch of an international bank. The shares are traded as domestic shares, but are offered for sale globally by sponsoring banks.

Global Registered Shares

Similar to ordinary shares, these shares have the added benefit of being tradable on equity exchanges around the globe in a variety of currencies.

Direct and Indirect Taxes

Some taxes are applied directly to income while other types of taxes are based on some other measurable performance characteristic of the firm.

Territorial Approach (To taxes)

Taxation of income earned by firms within the legal jurisdiction of the host country, not on the country of the firm's incorporation.

Ownership advantages

The OLI Paradigm states that a firm must first have some competitive advantage in its home market that can be transferred abroad if the firm is to be successful in foreign direct investment. The letter "O" here stands for

Norway, Denmark, Finland, Germany

The Swedish School has rather successfully explained not just the initial decision to invest abroad but also later decisions to reinvest elsewhere and to change the structure of a firm's international involvement over time. Based on the internationalization process of a sample of Swedish MNEs, economists observed that these firms tended to invest first in countries that were not too far distant in psychic terms. Countries having close psychic distance were defined as those with a cultural, legal, and institutional environment similar to Sweden's, such as

Foreign Tax Credit

The amount by which a domestic firm may reduce (credit) domestic income taxes for income tax payments to a foreign government.

Equity Risk Premium

The average annual return of the market expected by investors over and above riskless debt.

Swedish school of economists

The behavioral approach to analyzing the FDI decision is typified by the so-called

tax morality

The consideration of conduct by an MNE to decide whether to follow a practice of full disclosure to local tax authorities or adopt the philosophy, "When in Rome, do as the Romans do."

Market Liquidity

The degree to which a firm can issue a new security without depressing the existing market price, as well as the degree to which a change in price of its securities elicits a substantial order flow.

Export-Import Bank

The length of time of a contract or debt obligation; loan repayment period

Residential approach

The levy of taxes against the worldwide income earned by a business by home country tax authorities regardless of where or in which country the income was earned.

Cross-Listing

The listing of shares of common stock on two or more stock exchanges.

ke = krf + Bj (km-krf)

The most widely accepted and used method of calculating the cost of equity for a firm today is the capital asset pricing model (CAPM). CAPM defines the cost of equity to be the sum of a risk-free interest component and a firm-specific spread, over and above that risk-free component, as seen in the following formula:

Political risk

The possibility that political events in a particular country will influence the economic well-being of firms in that country.

transfer pricing

The pricing of goods, services, and technology transferred to a foreign subsidiary from an affiliated company is the first and foremost method of transferring funds out of a foreign subsidiary.

Worldwide Approach

The principle that taxes are levied on the income earned by firms that are incorporated in a host country, regardless of where the income was earned.

Securitization

The replacement of nonmarketable loans (such as direct bank loans) with negotiable securities (such as publicly traded marketable notes and bonds), so that the risk can be spread widely among many investors, each of whom can add or subtract the amount of risk carried by buying or selling the marketable security.

private placement

The sale of a security issue to a small set of qualified institutional buyers.

Beta

The second letter of the Greek alphabet, used as a statistical measure of risk in the Capital Asset Pricing Model. It is the covariance between returns on a given asset and returns on the market portfolio, divided by the variance of returns on the market portfolio.

Weighted Average Cost of Capital (WACC)

The sum of the proportionally weighted costs of different sources of capital, used as the minimum acceptable target return on new investments.

territorial tax system

The vast majority of the countries within the Organization for Economic Cooperation and Development (OECD) currently utilize a

Consumption Taxes

These are indirect taxes charged to individuals when they spend money on goods and services. Like GST it is a tax imposed at the point in time when money is spent rather than earned. Sales taxes in the United States are a form of this tax. They are usually charged as a percentage of the sale price.

Excise Taxes

These are indirect taxes levied on individual items—targeted items—and are often charged as a set money amount on the individual item. Often referred to as "user fees," taxes on gasoline, cigarettes, trucking, airline travel, are quite common internationally. They may be charged to generate funds to support the underlying activity such as airport operations or highway maintenance. They are also often charged to act as a deterrent to use as taxes imposed on cigarettes and alcohol.

country specific risks

These are risks that affect the MNE at the project or corporate level but originate at the country level. They can be further sub-divided into government risks and instability risks. The most frequently seen government risks are expropriation (nationalization when experienced on a country level), regulatory changes, and fund transfer restrictions (blocked funds). Instability risks on a country level include mass labor movements or strikes, civil unrest, and near war-like conditions.

Global specific risks

These are risks that affect the multinational at the project or corporate level. They can be further sub-divided into those risks arising from the national government and its possible intervention in legal contracts, government risks, and the possible impacts of other external interests like sabotage or boycotts, instability risks. The most frequently experienced government risks breach of contract, regulatory changes, and expropriation.

Global specific risks

These are risks that can impact both domestic and multinational enterprises at the project or corporate level but originate at the global level. Examples are terrorism, the anti-globalization movement, environmental concerns, poverty, and cyber attacks.

Factors

These are specialized firms that purchase receivables at a discount on either a non-recourse or recourse basis

Capital market segmentation

This is a financial market imperfection caused mainly by government constraints, institutional practices, and investor perceptions. The most significant imperfections include asymmetric information between domestic and foreign investors, lack of transparency, high transaction costs, foreign exchange risks, political risks, corporate governance differences, and a variety of regulatory barriers.

Withholding Taxes

This is a form of direct taxes that applies to passive income (such as dividends, interest, and royalties) earned by a resident of one country within the tax jurisdiction of a second country, that are normally subject to a tax in the second country. The reason for the institution of this type of taxes is actually quite simple: governments recognize that most international investors will not file a tax return in each country in which they earn income. The government, therefore, wishes to ensure that a minimum tax payment is received. Therefore, taxes are kept by the corporation from the payment made to the investor, and those taxes are then turned over to tax authorities. They are the subject of most bilateral tax treaties and generally range between 0% and 25%.

tax avoidance

This is a term that describes extremely aggressive strategies and structures used by business to reduce taxes far below what most governments expect. This latter category would include the use of offshore tax havens.

Goods and Services Tax (GST)

This is a value-added tax applied to the sales of most goods and services. In Australia for example this tax is levied on transactions in the production process, but then refunded to all parties in the chain of production other than the final consumer.

Breach of contract

This term refers to changes in host country regulations that alter operating conditions of investments. The focus here is the negative impact of those changes, as few multinationals enjoy changes that reduce cost or operating requirements once the investment has been made and the investor has lost much of its negotiating strength.

Revocable L/C

This type of L/C can be canceled or amended at any time before payment; it is intended to serve as a means of arranging payment but not as a guarantee of payment.

Irrevocable L/C

This type of L/C obligates the issuing bank to honor drafts drawn in compliance with the credit and can be neither canceled nor modified without the consent of all parties, including in particular the beneficiary (exporter).

their optimal financial structures, systematic risk, availability of capital, and optimal capital budget

Whether or not MNEs have a lower cost of capital than their domestic counterparts depends on

Samurai Bond

Yen-denominated bond issued within Japan by a foreign borrower.