International Business Exam 2

International Financial Management Tasks

1. Choose a capital structure: determine the ideal long-term mix of debt versus equity financing 2. Raise funds for the firm: Acquire equity, debt, or intracorporate financing for funding activities and investments. 3. Working capital and cash flow management: Manage funds passing in and out of the firm's value-adding activities. 4. Capital budgeting-Assess financial attractiveness of major investment projects 5. Managing currency risk- 6. Manage the diversity of international accounting and tax practices- Learn to operate in a global environment with diverse accounting practices and international tax regimes.

Advantages of the Global Capital Markets for the firms

1.Compared to being restricted to financial markets in the home country, the global market provides a broader base from which the firm can draw funds. 2.Greater breadth of financing sources means firms can often access funds at substantially lower cost. 3.The market provides a variety of investment opportunities for MNEs, professional investment firms, and individuals.

Causes of Rapid Rise in Global Capital Markets

1.Governments' deregulation of financial markets made capital easier to move across national borders. 3.Innovation in information and communication technologies accelerated the ease and pace of global financial transactions. 3.Globalization pressured firms to seek new and lower cost ways to finance global operations and to manage global financial management activities. 4.Widespread securitization led to conversion of illiquid financial instruments, such as bank loans, into tradable securities, such as bonds.

Forward contract

A financial instrument to buy or sell a currency at an agreed-upon exchange rate at the initiation of the contract for future delivery.

International Monetary Fund (IMF)

Agency that promotes exchange rate stability, monitors exchange systems, provides funding to developing countries.

World Bank

Agency that provides loans and technical assistance to combat global poverty around the world.

Current rate method

All foreign currency balance-sheet and income statement items are translated at the current exchange rate- the spot exchange rate in the effect on the day (in the case of balance sheets), or for the period (in the case of income statements), the statements are prepared. This is typically used when translating records or foreign subsidiaries that are considered separate entities, rather than part of the parent firm's operations.

Foreign Exchange

All forms of internationally-traded money including foreign currencies, bank deposits, checks, and electronic transfers.

Futures contract

An agreement to buy or sell a currency in exchange for another at a pre-specified price and on a pre-specified date.

Bretton Woods

At war's end, seeking stability in the international monetary and financial system, 44 countries signed the ________________. This established a fixed exchange rate system in which the U.S. dollar was pegged to a set value for gold ($35 per ounce), and other major currencies were pegged to the dollar.

Transparency

Degree to which firms regularly and comprehensively reveal substantial information about their financial condition and accounting practices.

Learning

Develop the firm's products, technologies, capabilities, and skills by internalizing knowledge gained from international ventures.

Forward rate

Exchange rate applicable to the collection or delivery of foreign currencies at some future date but specified at time of the transaction

Spot rate

Exchange rate based on the current rate of exchange

Trade surplus

Exports exceed imports; may result when the exporter's currency is undervalued, as in China's official policy regarding its currency

National Stock Exchanges and Bond Markets

Facilities for trading securities and bonds

Global capital market

Financial markets where firms and governments raise intermediate-term and long-term financing. )Participating in the global capital market allow firms to access funds from a larger pool of capital at competitive interest rates)

Global money market

Financial markets where firms and governments raise short-term financing. It is the meeting point of those who want to invest money and those who want to raise funds.

foreign bond markets, stock exchanges, banks, venture capital firms, and intra-corporate financing

Firms access funds from a variety of sources: (based on wherever in the world capital is cheapest)

Why firms use transfer pricing

Firms can use transfer pricing to shift profits out of high-tax countries into low-tax countries; minimize foreign exchange risks, for example, by moving funds out of countries where a currency devaluation is forecast; and optimize the management of internal cash flows.

Currency option

Gives the purchaser the right, but not the obligation, to buy a certain amount of foreign currency at a set exchange rate within a specified amount of time

Government Action

Governments intervene to influence the value of their own currencies, e.g., the Chinese government regularly intervenes in the foreign exchange market to keep the renminbi undervalued, to help ensure exports.

Interest rates

High inflation and _________ are positively related. It forces banks to pay high ______________. Ex: If inflation is 10%, banks must pay more than 10% to attract deposits.

Trade deficit

Imports exceed exports; the government may devaluethe nation's currency to correct a trade deficit.

supply and demand:

In a free market, the "price" of any currency (the exchange rate) is determined by

The firm

International transactions require firms to deal with huge sums of foreign exchange.

Global Financial Crisis

It initially arose in the U.S., when investors lost confidence in the value of securitized home mortgages. -Banks lenders and insurance companies became volatile, and stock markets crashed. -A key factor was the availability of "easy money" from the U.S. Federal Reserve Bank. -Many bad mortgages were "securitized"-bundled into investment assets and sold in global financial markets. -Overtime, investors realized many loans were high-risk, which led to capital flight. *The crisis highlights the importance of strong regulation, transparency, and supervision of institutions in the global financial system.

International Financial Management

It is the acquisition and use of funds for cross-border trade, investment, and other commercial activities.

Commercial Banks

Lend money to finance business activity, play a key role in nations' money supplies, and exchange foreign currencies.

Multilateral netting

Strategic reduction of cash transfers within the MNE family through the elimination of offsetting cash flows. This involves three or more subsidiaries that hold accounts payable or accounts receivable with one other. MNEs with numerous subsidiaries usually establish a netting center that headquarters supervises.

Bank for International Settlements

Supervises Central Bank monetary policy and other activities.

European firms pay more for inputs from the U.S. Higher costs reduce profitability; require higher prices. European firms can increase their exports to the U.S. European firms can raise their prices to the U.S. Increased exports to the U.S. lead to higher revenues.

Suppose, last year, the exchange rate was 1 = $1. Now, suppose the rate has gone to: 1.50E = $1. What is the effect of this change on Europeans?

Flexibility

The agility to manage diverse country-specific risks and opportunities by tapping resources in indiv countries and exploiting local opportunities

Temporal method

The choice of the exchange rate depends on the underlying method of valuation. Assets and liabilities normally valued at historical cost are translated at historical rates, that is, the rates in effect when the assets were acquired. Assets and liabilities normally valued at market cost are translated at the current exchange rate. Thus, monetary items such as cash, receivables, and payables are translated at the current exchange rate. Non-monetary items such as inventory and property, plant and equipment are translated at historical rates.

Global financial system

The collection of financial institutions that facilitate and regulate the flows of investment and capital funds worldwide. It includes the national and international banking systems, the international bond market, and national stock markets.

Balance of trade

The difference between the value of a nation's exports and its imports.

Debt Financing

The firm borrows money from a creditor in exchange for repayment of principal and interest. The main advantage over equity financing is the firm does not sacrifice any ownership interests. It obtained from two sources: loans (usually from banks) and the sale of bonds. The firm may borrow money from banks in its home market or in foreign markets. Borrowing internationally is complicated by differences in banking laws and infrastructure, lack of loanable funds, and fluctuating exchange rates.

Equity financing

The firms obtain this by selling stock to investors or by retaining earnings, which is profit reinvested in the firm rather than paid to investors.

Foreign exchange market

The global marketplace for buying and selling national currencies.

higher lower

The greater the demand for a currency, the _______ its price The lower the demand for a currency, the ___________ its price.

lower higher

The greater the supply of a currency, the ________ its price. The lower the supply of a currency, the ________ its price.

International monetary system

The institutional framework, rules, and procedures by which national currencies are exchanged for one another.

Net working capital

is the difference between current assets and current liabilities.

Economic growth

is the increase in value of the goods and services produced by an economy

Balance of Payments

is the nation's balance sheet of trade, investment, and transfer payments with the rest of the world. It reflects the difference between the total amount of money coming into and going out of a country

Direct quote

is the number of units of the domestic currency needed to acquire one unit of the foreign currency.

Indirect quote

is the number of units of the foreign currency obtained for one unit of the domestic currency

Capital Flight

is the rapid sell-off by residents or foreigners of their holdings in a nation's currency or other assets, usually in response to a domestic crisis that causes them to lose confidence in the country's economy. The investors exchange their holdings in the weakening currency for those of another, often a hard currency. This from a country diminishes its ability to service debt and pay for imports.

Floating exchange rate system

most advances economies use this, in which governments refrain from systematic intervention, and each nation's currency floats independently, according to market forces.

Cash Flow

needs arise from everyday business activities, such as paying for labor and materials or resources, servicing interest payments on debt, paying taxes, or paying dividends to shareholders -ensures cash is available where and when it is needed. It is generated from various sources and needs to be transferred from one part of the MNE to another.

Hedging

refers to efforts to compensate for a possible loss from a bet or investment by making offsetting bets or investments. In international business, it refers to using financial instruments and other measures to reduce or eliminate exposure to currency risk. If the hedge is perfect, the firm is protected against the risk of adverse changes in the price of the currency.

Inflation

refers to increases in the prices of goods and services; thus, money buys less than before. -High ________ erodes a currency's purchasing power

Market psychology

refers to investor behavior, such as herding behavior or momentum trading.

Working capital

refers to the current assets of a company

central bank

regulates the money supply, issues currency and manages the exchange rate, to accommodate economic growth.

Eurocurrency Market

representing money deposited in banks outside its country of origin, is a key source of loanable funds. U.S. dollars account for the largest share of such funds. -Eurodollars are U.S. dollars held in banks outside the U.S., including foreign branches of U.S. banks -Other eurocurrencies are euros, yens, and British pounds, as long as they are banked outside their home country

Currency Swap

the exchange of one currency for another currency, according to a specified schedule

Fronting loan

the parent deposits a large sum in a foreign bank, which then transfers the funds to the subsidiary in the form of a loan.. Fronting allows the parent to circumvent restrictions that foreign governments impose on direct intracorporate loans

Foreign currency translation

translating data denominated in foreign currencies into the firm's functional currency

Hedgers

typically MNEs and other international trade or investment firms, seek to minimize their risk of exchange rate fluctuations, often by entering into forward contracts or similar financial instruments. They are not necessarily interested in profiting from currency trading.

Hard currencies

universally accepted and preferred in international transactions. -Most currencies are not very convertible. ex: dollar, yen, pound, and euro

4 risks of international business

-Cross- Cultural Risk -Country (Political) Risk -Currency(Financial) Risk -Commercial Risk

Growing integration of financial and monetary global activity is due to:

-Evolution of monetary and financial regulations, worldwide. -Emergence of new technologies and payment systems in global finance, e.g., the Internet. -Increased global and regional interdependence of financial markets. -Growing role of single-currency systems, e.g., the Euro.

Equity Financing

-The firm obtains capital by selling shares of stock. -Main advantage is the firm obtains capital without incurring debt and having to repay funds to providers. -Main disadvantage is the firm's ownership is diluted. The global equity market is the worldwide market of funds for equity financing - the stock exchanges worldwide where investors and firms meet to buy and sell shares of stock.

Constantly Fluctuating Rates Require international managers to keep in mind 3 facts

-The prices the firm charges can be quoted in the firm's currency or in the currency of each foreign customer. -Because several months can pass between placement and delivery of an order, fluctuations in the exchange rate during that time can cost or earn the firm money. -The firm and its customers can use the exchange rate as it stands on the date of each transaction, or they can agree to use a specific exchange rate.

Managers develop international strategies to:

-allocate scarce resources and configure value-adding activities on a world wide scale -participate in major markets -implement valuable partnerships abroad -engage in competitive moves in response to foreign rivals

Factors that influence the supply and demand for a currency

-economic growth -measured as the annual increase in real GDP (in which the inflation rate is subtracted from growth). -The nation's central bank -market psychology -inflation or hyperinflation -interest rates -government action -balance of payments

China

______ is becoming the world's largest economy and a center of global banking -this country's big trade surplus and foreign investment inflows together have created massive reserves of foreign exchange.

Tax haven

a country hospitable to business and inward investment because of its low corporate income taxes

Strategy

a planned set of actions that managers take to make best use of the firm's resources and core competences, to gain a competitive advantage

Trade credit

a subsidiary defers payment for goods received from the parent firm

Transfer pricing

also known as intracorporate pricing, refers to prices that subsidiaries and affiliates charge one another as they transfer goods and services within the same MNE.

Indirect tax

applies to firms that license or franchise products and services, or who charge interest. The government withholds some percentage of royalty payments or interest charges as tax.

Tax havens

are countries hospitable to business and inward investment bc of their low corporate income taxes. Tax havens exist in part bc tax systems vary greatly worldwide. Thus, MNEs have an incentive to structure their global activities to minimize taxes. MNEs take advantage of these either by establishing operations in them or by funneling business transactions through them.

Foreign bonds

are sold outside the bond issuer's country and denominated in the currency of the country in which they are issued. For example, when Mexico's Cemex sells dollar-denominated bonds in the United States, it is issuing foreign bonds.

Eurobonds

are sold outside the bond issuer's home country and denominated in its own currency. For example, when Toyota sells yen-denominated bonds in the United States, it is issuing Eurobonds.

Debt financing

comes from either loans from banks and other financial intermediaries or money raised by selling corporate bonds to individuals or institutions.

Dividend remittances

commonly used to transfer funds from foreign subsidiaries to the parent, but vary depending on tax levels, currency risks, and other factors

Royalty payments

compensation paid to owners of intellectual property. Assuming the subsidiary has licensed technology, trademarks, or other assets from the parent or other subsidiaries, royalties can be an efficient way to transfer funds.

Currency risk

concerns exchange rate fluctuations that harm business profits.

Economic exposure

currency risk that results from exchange rate fluctuations affecting the pricing of products, the cost of inputs, and the value of foreign investments

Arbitragers

currency traders who buy and sell the same currency in two or more foreign-exchange markets to profit from differences in the currency's exchange rate, for the sake of generating profits.

Speculators

currency traders who seek profits by investing in currencies with the expectation that they will rise in value.

Net present value (NPV)

depends on the initial investment, cost of capital, and the amount of incremental cash flow or other advantages the proposed project is expected to provide over time.

Direct tax

imposed on income derived from business profits, intra-corporate transactions, capital gains, and sometimes royalties, interest and dividends

Bond

is a debt instrument that enables the issuer (borrower) to raise capital by promising to repay the principal along with the interest on a specified date (maturity).

Transaction exposure

is currency risk that firms face when outstanding accounts receivable or payable are denominated in foreign currencies.

Translation exposure

is currency risk that results when a firm translates financial statements denominated in a foreign currency into the functional currency of the parent firm

Intracorporate financing

is funds from sources inside the firm (both headquarters and subsidiaries) in the form of equity, loans, and trade credits.

Value-added tax (VAT)

is payable at each stage of processing in the value chain of a product or service -calculated as a percentage of the difference between the sale and purchase price of a good.

Efficiency

Lower the cost of the firm's operations and activities on a global scale.

Central depository

MNEs pool surplus into a __________ that functions either globally or for a region. The funds are then directed to needful subsidiaries or invested to generate income. It lets managers reduce the size of highly liquid accounts and invest the funds, generally at the higher interest rates offered for large deposits, to generate maximal returns.

Currency Risk

Manage the multiple-currency transactions of the firm and the exposure to exchange rate fluctuations

capital budgeting

Managers use __________ to decide which international projects are economically desirable.

Financial centers

New York, Lodon, Tokyo

Exchange Rate

Price of one currency in terms of another

Central Banks

Regulate money supply, issue currency, manage exchange rates, control national reserves.

Equity

Shares of stock provide investors with ownership interest in the firm

Capital structure

The mix of long-term equity and debt financing firms use to support their activities.

Fixed exchange rate system

is similar to the system used under the Bretton Woods agreement and is sometimes called a pegged exchange rate system. In it, the value of a currency is set relative to the value of another (or the value of a basket of currencies) at a specified rate. As this "reference value" rises and falls, so does the currency pegged to it. Many developing economies and some emerging markets use this system today.