Financial Management eighteen Concept Preview After reading this chapter, you should be able to: 1. realize that the currencies of countries change value relative to each other. 2. understand how currency value changes affect international business transactions. 3. recognize the tremendous importance of financial management to an international company. 4. know about financial management tools. chapter
Financial Management eighteen Concept Preview continued After reading this chapter, you should be able to: 5. explain how financial executives meet, network, and cooperate with their counterparts in other organizations to protect and benefit their own organizations in derivatives operations. 6. understand why exporters sometimes accept payment in forms other than money. 7. differentiate between hard (convertible) and soft (non-convertible) currencies. 8. explain the growing importance on international financial centers. chapter
18-3 Fluctuating Currency Exchange Rates • Transaction risks • a receivable or payable in a foreign currency • protect by hedging • forward hedge contract • currency options • (un)covered positions • accelerate or delay payment • increase prices (within limits) • which way will the exchange rates go? • unrelated companies • within an international company • exposure netting • currency groups • a strong currency and a weak currency • government reactions to intra-enterprise price adjustments
18-4 Table 18.1 Currencies Traded on the International Monetary Market Traded Currency Ticker Code British pound BP Canadian dollar CD Deutsche mark DM Dutch guilder DG French franc FF Japanese yen JY Mexican peso MP Swiss franc SF
18-5 Fluctuating Currency Exchange Rates • Translation risk • financial statements of an international company have to be converted to a common currency • assets, liabilities, revenues and expenses in more than one currency • neutralizing the balance sheet • swaps • spot and forward market swaps • parallel loans • bank swaps
18-6 Figure 18.3 Parallel Loans by Two Parent Companieseach to the subsidiary of the other U.S. Dollar Loan Italian Lira Loan American parent company Italian parent company American subsidiary of Italian company Italian subsidiary of American company
18-7 Capital Raising and Investing Decisions 1. Currency in which the capital will be raised 2. Long-term estimate of the strength or weakness of that currency 3. How much of the money raised should be equity capital and how much should be debt capital. 4. Whether the money should be borrowed from a. commercial or ordinary bank b. a bank as part of a swap c. another company as part of a swap d. another part of an international company e. public offering in a capital market 5. If using a capital market which market can the company achieve its objective at lowest cost 6. How much money the company needs and for how long. 7. Whether other sources of capital are available.
18-8 Capital Raising and Investing • Interest rate swaps • Bank-intermediated “plain vanilla” swaps • AAA bank issues 11 percent fixed-rate debt • BBB firm taps floating-rate market at LIBOR plus 0.5 percent • BBB firm swaps its floating rate to bank at LIBOR minus 0.25 percent. • AAA banks swaps its 11 percent fixed rate to BBB firm • BBB firm saves 150 basis points and passes 75 of them on to AAA bank; the bank saves 25 points on the normal floating range.
Gives the corporation the flexibility to transform floating-rate debt to fixed-rate and vice versa. Swaps may be based on outstanding debt and may thus avoid increasing liabilities Swaps provides an alternate source of financing Swaps are private transactions There are no SEC reporting or registration requirements yet Potential rate savings The swap contract is simple and straight forward Rating agencies (Moody’s/ S&P) take a neutral to positive position on corporate swaps Tax treatment on swaps is uncomplicated—no withholding taxes levied on interest payments to overseas partners Interest expense of the fixed-rate payer is fixed rate obligation 18-9 Capital Raising and Investing Interest Rate Swaps—Advantages
18-10 Capital Raising and Investing • Currency swaps • Hedges and swaps as “derivatives” • Are derivatives safe? • identify where the risks lie • design an appropriate strategy for managing them • select the right tools to execute the strategy • Financial executives’ datebooks: networking
1995 rank 1 2 5 3 6 7 8 9 10 12 Million 50 100 150 200 250 1996 rank 1 Chicago Board of Trade 2 Chicago Mercantile Exchange 3 LIFFE London 4 BM&F Sao Paulo 5 Chicago Board Options Exchange 6 New York Mercantile Exchange 7 Marché á Terme Inter- nationale de France 8 Deutsche Borse 9 London Metal Exchange 10 Meff Renta Variable 4.63% -2.63% 27.17% -9.26% -15.76% 3.16% -3.93% 36.20% 4.63% 1995-96 growth Trading volume 0.71% 4.42% 18-11 Table 18.2 Top 10 Derivatives Exchanges Derivatives markets Source: FIA Monthly Volume Report and exchanges.
18-12 Sales Without Money— Countertrade • Involves two or more contracts • One for the purchase of developed country products or services • One or more for the purchase of less developed country products /services
Counterpurchase goods supplied by the LDC are not produced by or out of goods or products imported from the DC Compensation payment by the LDC in products produced by DC equipment Barter LDC sends products to the DC that are equal in value to the products delivered by the DC to the LDC Switch (trading) goods delivered by LDC are not easily usable or salable--third party disposes of them Offset importing nation requires a portion of the materials, components, or subassemblies of a product be procured in the local (importer’s) market Clearing account arrangement facilitate exchange or goods over a period of time balance must be cleared at end (goods or cash) 18-13 Sales Without Money— Countertrade
18-14 Sales Without Money-Countertrade • U.S. government’s positions on countertrade • Other governments’ positions on countertrade • Twin problems • product quality and delivery reliability • third-party organization inspections • bank guarantee of quality • New directions
American Countertrade Association membership by industry Computers 7% Construction 6% Defense 7% Electronics 8% 18-15 Figure 18.6 How Important is Countertrade? Source: Shelley Neumeier, “Why Countertrade is Getting Hot,” Fortune, June 29, 1992, p. 25.
18-16 Industrial Cooperation • Joint venture • two or more companies or state agencies combine assets to form a new entity • they share management, profits and losses • Co-production and specialization • factory in LDC produces certain agreed upon components, while the DC company produces the other components • product is assembled at both locations for their respective markets • Subcontracting • LDC factory manufactures a product according to specifications of the DC company and delivers the product to the DC company, which then markets it.
18-17 Industrial Cooperation • Licensing • LDC and DC partners enter into a license agreement • LDC enterprise uses DC technology to manufacture product • DC company is paid a license fee in money or product • Turnkey plants • DC party is responsible for building entire plant, starting it, and training LDC personnel • turns over the keys to the LDC party • LDC wants to pay in products of the new plant
18-18 International Financial Centers • Volatile, floating currency exchange rates • Capital and exchange markets • Inflation rates • Electronic cash management • Using derivatives correctly • Handle internal and external invoicing • Help weak currency affiliate • Strengthen affiliate evaluation and reporting systems