International Business CH14

Financing International Trade and Investment

- International banking - International bond markets - International stock markets - Government financing

bonds are categorized three way

- domestic - foreign - eurobond

Parent Firm Capital Budgeting

A holding company is a conglomerate firm that is common in MNCs. When evaluating the profitability of capital investments in subsidiaries, the parent firm needs to take the perspective of the consolidated holding company, including both the parent firm and its subsidiary. The first step is to calculate the net present value of capital investments in the foreign subsidiary.

Futures Contracts

Contracts can be purchased for a small commitment fee known as a margin. This low cost of futures contracts makes them very affordable to use as a way to manage exchange rate and other market risks.

options contracts

Currency option contracts give an investor the right, but not the obligation, to buy (call option) or sell (put options) a specified amount of currency at a date in the future at a pre-determined price

Cash Flow Sensitivity to Exchange Rate Risk

Firms can experience fluctuations in cash flows due to currency movements. Exchange rate risk can dramatically affect the cash flows of firms.

Foreign Forward Contracts

Foreign currency contracts are one of the most popular forward futures. However, they are available only for major currencies.

Currency Risk and Stock Valuation

Foreign sales of firms will decline due to local currency appreciation. Import costs can rise when local currency depreciates. Suppliers and buyers that are affected by exchange rate risk can affect domestic firms with no export or import business.

Bank of International Cooperation (JBIC)

Japanese bank that supports exporters around the world that have at least 30 percent Japanese content

government financing

Loan programs that are either insured or guaranteed by the federal government - IMF - World Bank _ Export-Import Bank in the US - The US Small Business Administration

Hedging Foreign Exchange Futures Example

Man is expected to be paid 10m Euro in two months by European company. Man wants to lock in exchange rate of 1:1 Euro do US$ Man is hoping for a foreign exchange rate decline for US$ at the end of the 2 months. Man must sell Euros for future contract. Contract cost 125k Euros, so sell 80. (80 * 125,000 = 10m). Man gest the 10 m euro and exchanges them at the spot market price rate which has dropped from 1:1 to 1:0.96 in 2 months. So trade 10m Euro for $9.6m

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

Multinational Capital Budgeting

Multinational firms with operations in different countries make profits over time in different currencies. Earnings on investment over time should be converted to their present values. Earnings in different currencies need to be also converted to the home currency in order to compute their present values. Fluctuations in currency values can affect the profitability of foreign subsidiaries of MNCs

Speculation

Speculation is the opposite of hedging. Speculators attempt to earn profits from trading in currencies or currency derivatives

International Stock Markets

Stock markets enable firms to issue new equity and raise long-term capital. They allow investors around the world to invest in firms on a global basis. Stock investing is popular due to the fact that stocks have outpaced other types of financial instruments in terms of returns. There is the possibility that stock prices can fall dramatically

Stock Values and Foreign Exchange Movements

Stock returns are a convenient way to measure long-run exchange rate risk for a firm. Exchange rate risk affects only about 10-20% of stocks. Given that exchange rates are approximately ten times more volatile than inflation, and the most stocks are affected by changes in the level of inflation, this small percentage of stocks exposed to exchange rate risk is disappointing.

Export-Import Bank

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

Special Drawing Right (SDR)

a basket of currencies consisting of dollars, euros, pounds, and yen created by the International Monetary Fund (IMF) for use as a benchmark to value the currencies of different countries

syndicate

a group of banks that collectively make a loan to a firm

beta risk

a measurement of the general market risk of a stock in the Capital Asset Pricing Model (CAPM)

open account

a simple agreement wherein the exporter sends an invoice with the goods and the exporter pays upon the receipt

exchange rate sensitivity

a stock value measured with the coefficient obtained by regressing the stock's return on a currency's return over time

currency swaps

allow firms to exchange currencies at a previously agreed exchange rate as a way to hedge exchange rate movements; Currency swaps can be established over a period of up to ten years. Some exchanges offer currency swaps, which lower counterparty risk due to guaranteed performance by the exchange

ICAPM

an asset pricing model that includes both domestic and global market factors to estimate the cost of equity of required rate of return on stocks

Sensitivity Analysis

an examination of optimistic, expected, and pessimistic scenarios to give a more complete picture of the risks and returns of investments abroad; a good way to assess risky 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

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 in a currency futures contract and profiting on an increase in the value of the currency over time (Gain on long position if prices of underlying assets rise) /

Diversification

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

domestic bonds

debt contracts sold by firms domiciled in a country in the home currency

over-the-counter market

derivatives market run by large banks

Currency forward contracts

futures contracts available in currencies of emerging-market countries by large banks in the OTC market

marked-to-market

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

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 of goods and services. It affects both exporters and importers. If the dollar decreased in value relative to the euro, the U.S. exporter would gain profits, and the U.S. importer would lose profits

Hedging

intends to reduce potential transaction, translation, and economic risks of currency movements that could lead to volatile cash flows and losses

home bias

investing most of retirement and other savings in one's home country, which reduces diversification; nt reducing risks as much as possible

International Bond Markets

involve unregistered bonds that are internationally syndicated, offered simultaneously to investors in several countries, and issued outside of the jurisdiction of any single country

translation risk

is associated with the short-term effects of currency movements on the consolidated accounting statements of a firm. Converting the subsidiary's financial statements from their operating currency to the MNC's home country reporting currency is necessary for reporting in financial statements the financial performance of all subsidiaries abroad to the home country tax authorities. Changes in currency values over time will affect accounting values. Currency denomination of accounting statements can affect their interpretation. Translation risk can affect firms reporting accounting information with operations abroad.

money center banks

large global banks; dominate international banking

margin call

losses that are incurred and that cause the participant's balance to fall below the maintenance margin at the end of the trading day

CHIPS (Clearing House Interbank Payments System)

organization in New York City that provides large, wholesale dollar payments services for businesses, banks, and governments

SWIFT (Society of Worldwide Interbank Financial Telecommunications)

organization that provides secure communications for contracts, invoices, and other trade documents that normally accompany cash payments

commercial letter of credit (LC)

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

short position

selling a currency in a currency futures contract and profiting on a decrease in the value of the currency over time (Gain on short position if prices of underlying assets fall) \

margin

small commitment fee needed to purchase a futures contract

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

net present value

the difference between present value of futures profits on an investment project minus the initial investment cost; if npv is positive, capital investment should be approved

Exchange Rate Risk

the impact of random change in the value of one currency with respect to other currencies

consolidated accounting statements

the income statements and balance sheets of multinational corporations and of all subsidiaries abroad due to home country tax requirements

premium

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

cost of equity

the required rate of return by stockholders in a firm and is estimated by means of the Capital Asset Pricing Model (CAPM)

cost of capital

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

payment in advance

the safest method available to an exporter, but that which exposes the importer to some risk related to delivery of goods

exchange risk beta

the sensitivity of a stock to market risk affected by currency movements

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

Organized Exchanges

the trading of futures contracts in major currencies and offering price transparency and efficiency in addition to elimination of counterparty risk due to guaranteed payments on contacts

country risk

the uncertainty in predicting how a variety of different factors will affect an investment in a country, including political risk, economic risk, inflation risk, tax risk, etc

economic risk

the ways in which long-term exchange rate movements affect firms; Protracted swings in exchange rates over a period of time can affect a firm's long-run cash flows and thereby alter the firm's value.

cost of debt

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

Measuring Foreign Exchange Exposure

two kinds of short-term effects of currency movements are transactions risk and translation risk. The long-term effects of currency movements are associated with economic risk.

convenient way to measure a currency's value in world markets

use a basket of currencies

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

value factor

whether a firm has growth or value and how this firm characteristic provides an estimate of the cost of equity

size factor

whether a firm is small or large and how this size provides an estimate of the cost of equity