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©2004 Prentice Hall18-1
Chapter 18:InternationalFinancial Management
International Business, 4th Edition
Griffin & Pustay
©2004 Prentice Hall18-2
Chapter Objectives_1
Analyze the advantages and disadvantages of the major forms of payment in international trade
Identify the primary types of foreign-exchange risk faced by international businesses
Describe the techniques used by firms to manage their working capital
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Chapter Objectives_2
Evaluate the various capital budgeting techniques used for international investments
Discuss the primary sources of investment capital available to international businesses
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Financial Issues in International Trade
Which currency to use for the transaction
When and how to check credit Which form of payment to use How to arrange financing
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Method of Payment
Payment in advance Open account Documentary collection Letters of credit Credit cards Countertrade
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Forms of Drafts
Sight draft: requires payment upon transfer of title to the goods from the exporter to the importer
Time draft: extends credit to the importer by requiring payment at some specified time– Date draft: specifies particular date
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Figure18.1 Using a Sight Draft
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Documentation for Letters of Credit
Export licenses Certificates of product origin Inspection certificates
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Types of Letters of Credit
Advised letter of credit Confirmed letter of credit Irrevocable letter of credit Revocable letter of credit
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Figure 18.2 Using a Letter of Credit
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Countertrade
Occurs when a firm accepts something other than money as payment for its goods or services
Forms– Barter– Counterpurchase (parallel barter)– Buy-back– Offset purchase
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Map 18.1 Countertrade by Marc Rich
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Table 18.1 Payment Methods for International Trade
Method Timing -Payment Timing - Delivery
Risks - Exporter
Risks - Importer
Availability of Financing
Conditions for Use
Payment in
advance
Prior to delivery After payment None Exporter may fail to deliver
N/A Exporter has strong bargaining
Open account According to credit terms
When goods arrive in importer’s country
Importer may fail to pay
None Yes Exporter has complete trust in importer
Documentary collection
At delivery (sight draft); at later time (time draft)
Upon payment (sight draft); upon acceptance (time draft)
Importer may default or fail to accept draft
None Yes Risk of default is low
Letter of credit After terms of letter are fulfilled
According to terms
Issuing bank may default, incorrect documents
Exporter honors terms of letter but not contract
Yes Exporter lacks knowledge; Importer has good credit
Credit card According to normal procedures
When goods arrive in importer’s country
None Exporter fails to deliver
N/A Transaction size is small
Countertrade When exporter sells countertraded goods
When goods arrive in importer’s country
Exporter may not be able to sell
None No Importer lacks convertible currency
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The Itaipu Dam the Parana River between Brazil an Paraguay
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Foreign-Exchange Exposure
Transaction exposure Translation exposure Economic exposure
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Transaction Exposure
Financial benefits and costs of an international transaction can be affected by exchange rate movements that occur after the firm is legally obligated to complete the transaction
Transactions– Purchase of goods, services, or assets– Sales of goods, services, or assets– Extension of credit– Borrowing of money
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Options for Responding to Transaction Exposure
Go naked Buy forward currency Buy currency future Buy currency option Acquire an offsetting asset
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Political uncertainty can affect transaction exposure
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Go Naked
Benefits No capital outlay Potential for
capital gain if home currency rises in value
Costs Potential for capital
loss if home currency falls in value
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Buy Forward Currency
Benefits Elimination of
transaction exposure
Flexibility in size and timing of contract
Costs Fees to banks Lost opportunity
for capital gain if home currency rises in value
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Buy Currency Future
Benefits Elimination of
transaction exposure Ease and relative
inexpensiveness of futures contracts
Costs Small brokerage free Inflexibility in size
and timing of contract Lost opportunity for
capital gain if home currency rises in value
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Buy Currency Option
Benefits Elimination of
transaction exposure Potential for capital
gain if home currency rises in value
Costs Premium paid up front
for option because of its “heads I win; tail I don’t lose” nature
Inflexibility in size and timing of option
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Acquire Offsetting Asset
Benefits Elimination of
transaction exposure
Costs Effort or expense of
arranging offsetting transaction
Lost opportunity for capital gain if home currency rises in value
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Translation Exposure
Impact on the firm’s consolidated financial statements of fluctuations in exchange rates that change the value of foreign subsidiaries as measured in the parent’s currency
Reduce translation exposure through the use of a balance sheet hedge
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Economic Exposure
Impact on the value of a firm’s operations of unanticipated exchange rate changes– Affects all areas of operations
Management of economic exposure involves analyzing likely changes in exchange rates
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Map 18.3 Changes in Currency Values Relative to the U.S. $, July 2003
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Management of Working Capital
Corporate Financial Goals– Minimizing working-capital balances
– Minimizing currency conversion costs
– Minimizing foreign-exchange risk
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Figure 18.3 Payment Flows Without Netting
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Evaluating Investment Projects
Net Present Value Internal Rate of Return Payback period
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Net Present Value Approach
A dollar today is worth more than a dollar in the future
Estimate the cash flows the project will generate and then discount them back to the present
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Other Factors to Consider When Using Net Present Value Approach
Risk Adjustment Choice of Currency Whose Perspective: Parent’s or
Project’s?
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Before investing $500 million in this Chilean copper mine, Placer Dome carefully analyzed the risks
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Figure 18.4 Internal Sources of Capital for International Businesses
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