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Chapter 18

International Financial Management

Learning Objectives

• Analyze the pros and cons of major

payment forms in international trade

• Identify types of foreign-exchange risk

faced by international businesses

• Learn how firms manage working capital

• Evaluate capital budgeting techniques

• Explore sources of investment capital

Financial Issues in Foreign Trade

Choice of Currency

Importer’s Currency

Exporter’s Currency

Third Currency

Credit Checking

Credit

References

Established

Sources

Banking

Operations

Government

Agencies

Methods of Payment

Advance Payment

Documentary

Collection

Credit Cards

Open Accounts

Letters of Credit

Countertrade

Advance Payment

Use of Cash Lower Risks

Higher Risks Faster Payment

Importer Exporter

Open Account: Importer’s Point of View

Expedites the Receipt of Goods

Offers Short-Term Financing

Eliminates Fees for Bank Services

Requires Less Paperwork

Open Account: Exporter’s Point of View

Increases Risk of Non-Payment

Waives Expertise of Bankers

Lacks Supporting Documentation

Requires Use of Working Capital

Other Payment Methods

Documentary Collection

Sight Drafts and

Time Drafts

Acceptances

Banker’s

Acceptances

Bills of Lading

Documentary Collection: Advantages

Reasonable Bank Fees

Enforceable Debt Instruments

Simplified Collection Process

Reduced Costs of Financing

Documentary Collection: Disadvantages

Importer May Refuse Shipment

Costs for Unaccepted Goods

Importer May Default on Payment

Legal Recourse May Be Expensive

Letter of Credit

Bank Guarantees Payment

Invoice

Bill of Lading

Proof of Insurance

Certificate of Origin

Customs Documents

Packing List

Export License

Inspection Certificates

Documents Needed for Letters of Credit

Letters of Credit Take Different Forms

•Advised

•Confirmed

•Irrevocable

•Revocable

Credit Cards

•Retailers•Consumers

Countertrade

Trade by Bartering

Counterpurchase

Buy-Back Arrangements

Off-Set Purchase Agreements

Facilitate Countertrade

Clearinghouse

Accounts

Switching

Arrangements

Countertrade by Marc Rich

Financing Trade

• Exporting Firms

• Banks and Lenders

• Government Sponsors

Summary of Discussion

Managing Foreign Exchange Risk

Transaction Exposure

•Buying

•Selling

•Lending

•Borrowing

Responding to Transaction Exposure

Strategy Benefit(s) Cost(s)

•Go Naked No Capital Outlay Potential Loss of Capital

•Forward Currency No Exposure Fees, Opportunity Cost

•Currency Future No Exposure Fees, Opportunity Cost

•Currency Option No Exposure Up-Front Premium, Inflexible

•Offsetting Asset No Exposure Time, Opportunity Cost

Translation Exposure

Financial Statements of Parent and

Subsidiary

Accounting Exposure: Assets and Liabilities

Presented in Different Currencies

Balance Sheet Hedge: Assets and Liabilities

Presented in the Same Currency

Risk of

Exposure

Higher

Economic Exposure

Unexpected Exchange-Rate

Changes

Operational

Exchange-Rate

Expertise

Management of Working Capital

Minimize Working Capital

•Opportunity Cost

•Needs for Cash

Cash Management

•Cash Holdings

•Cash Flows

Currency Conversion

Minimizing Costs

Bilateral Netting

Multilateral Netting

Multilateral Netting In Action (all quantities in Millions of USD equivalents)

Payments Owed by

S. Korean

Subsidiary

Mexican

Subsidiary

British

Subsidiary

Receipts

Transfer

S. Korean

Subsidiary— 5 4 9 + 1

Receipts

Due to

Mexican

Subsidiary2 — 3 5 – 1

British

Subsidiary6 1 — 7 0

Payments8 6 7 21

Minimize Foreign-Exchange Risk

Leads and Lags Strategy

Currency Value Expected to Rise

Currency Value Expected to Fall

Holdings

Increase

Decrease

International Capital Budgeting

Net Present Value

•Cash Flows

•Discount Rate

Net Present Value for International Projects

Risk Adjustment

Currency Selection

Choice of Perspective

Internal Rate of Return

1. Estimate Cash Flows

2. Calculate Interest Rate

3. Compare to Hurdle Rate

Payback Period

Long-Run

ProfitsSimple

to Use

Sources of International Investment Capital

• Investment Banks

• Stock Markets

• Borrowed Funds

• Swap Market

External Sources of Investment Capital

Internal Sources of Investment Capital

Strategic Transfer Pricing

•Market

•Nonmarket

Market-Based Method

Reduce Intra-

Corporate

Conflict

Promote

Overall

Profitability

AdvantagesDisadvantages

Foment Conflict

Reduce Efficiency

Reduce Tariffs and

Repatriate Profits

Nonmarket Method

Tax Havens

Minimal Corporate Income Tax

Stable Political and Business Climate

Efficient Court System

Banking and Communications

Government Response

Arm’s Length Testing

Advance Pricing

Agreement

Chapter 18

International Financial Management

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