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