Finance Exam 2

How to find ROE

1. Find the net income 2. Find total equity 3. Find ROE

Cash Cycle

Amount of time we finance our inventory; difference between when we receive cash from the sale and when we have to pay for the inventory; = inventory period + A/R Period - A/P Period

Home currency approach

Estimate cash flows in foreign currency, estimate future exchange rates using IRP or Relative PPP, convert future cash flows to dollars (home currency), discount using domestic required return (compute NPV using Home Country Discount rate)

Foreign Currency Approach

Estimate cash flows in foreign currency, use the IFE to convert domestic required return to foreign required return, discount using foreign required return, convert NPV to dollars using current spot rate

Spot trade

Exchange currency immediately; exchange right now, ON THE SPOT

Total asset turnover

How many dollars of sales are generated from $1 total assets

ROE

Net Income/Total Assets (total assets should equal 1)

Short-Run Exposure

Risk from day-to-day fluctuations in exchange rates and the fact that companies have contracts to buy and sell goods in the short-run at fixed prices.

Spot trade

Settled in 2 days

The day to day fluctuations in exchange rates create

Short term exchange rate risk exposure

How do you define a forward rate

Talk to a company or bank and LOCK in that forward rate, agreeing on an exchange rate in the future

International Fisher Effect

Tells us that the real rate of return must be constant across countries. If it is not, investors will move their money to the country with the higher real rate of return

Spot rate

The exchange rate for an immediate trade

Forward trade

Agree today to exchange currency at some future date and some specified price

External uses for financial statements

Creditors, suppliers, customers, stockholders

Political Risk

Changes in value due to political actions in the foreign country, investment in countries that have unstable governments should require higher returns, the extent of political risk depends on the nature of the business

Peer Group Analysis

Compare to similar companies, SIC and NAICS codes

Multinationals

Corporations with significant foreign operations are often called multinationals

Interest Rate Parity

Defines what that forward rate should be

Covered Interest Arbitrage

If relative PPP does not hold and forward rate differ from what the expected future spot will be, there may be an opportunity for this. To see if this condition exists, examine the relationship between spot rates, forward rates, and nominal rates between countries.

Compensating balance

If someone borrows money from a bank with a low interest bearing account; purpose of compensating balance is used as collateral, it's like putting a deposit down for an apartment, condition of loan agreement

Translation Exposure

Income from foreign operations must be translated back to U.S. dollars for accounting purposes, even if foreign currency is not actually converted back to dollars; if gains and losses from this translation flowed through directly to the income statement, there would be significant volatility in EPS.

Long-Run Exposure

Long-run fluctuations come from unanticipated changes in relative economic conditions, could be due to changes in labor markets or governments, more difficult to hedge

Internal uses for financial statements

Performance evaluation- compensation and comparison, planning for the future

Absolute Purchasing Power of Parity (PPP)

Price of an item should be the same in real terms, regardless of the currency used to purchase it. Requirements: - Transaction costs are zero - No barriers to trade - No difference in the commodity between locations - For most goods, absolute PPP rarely holds in practice - Doesn't ever really hold up

Net Income

Profit Margin*Sales

Relative PPP

Provides information about what causes changes in exchange rates. Exchange rates depend on relative inflation between countries

Triangular Arbitrage

The act of exchanging through three currencies to exploit a mispriced trio of currency quotes *In the exam, if I lose money, go the other way.

Exchange rate risk

The natural consequences of international operations in a world where relative currency values move up and down

Operating cycle

Time between purchasing the inventory and collecting the cash from sale of the inventory; = inventory period + A/R period

Inventory Period

Time required to purchase and sell the inventory

Time trend analysis

Used to see how the firm's performance is changing through time, internal and external uses

Cross-rate

Using two different exchange rates to derive the relationship between currencies.

Common size

When using percentages instead of dollars, can use this when comparing mom and pop stores with big companies like Walmart