intern

ation

al bu

siness, 5

th edition

chapter 18international financial management

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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 Used with Documentary Collection

Sightdraft

Time draft

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Advantages/Disadvantages of Documentary Collection

Advantages

• Reasonable fees

• Enforceable debt instrument

• Simple collections process

• Prompt payments

Disadvantages

• Refusal of shipments

• Decline draft acceptance

• Potential for default

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Figure 18.1 Using a Sight Draft

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Documentation for Letters of Credit

Export licenses

Certificates ofproduct 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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Forms of Countertrade

Barter

Buy-back

Offset purchase

Counterpurchase

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Map 18.1 Countertrade by Marc Rich

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Foreign-Exchange Exposure

Transactionexposure

Translationexposure

Economicexposure

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Transaction Exposure

A firm faces transaction exposure when the 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.

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Transactions Leading to Transaction Exposure

Product purchases Product sales

Credit extensions Money borrowing

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Options for Responding to Transaction Exposure

Go naked

Buy forward currency

Buy currency option

Acquire an offsetting asset

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Go Naked

To ‘go naked’ is to ignore transaction exposure and assume foreign-exchange risk.

Characteristics

• Does not require advance capital

• Offers potential for currency appreciation

• Creates risk for depreciation of exchange currency

• Avoids fees to intermediaries

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Buy Forward Currency

Buying the exchange currency forward in the foreign-exchange market locks in the ‘price’ to be paid.

Characteristics

• Guarantees price

• Protects against decline in value of currency

• No capital up front

• Eliminates potential for profits associated with currency appreciation

• Requires fees to intermediaries

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Buy Currency Option

Buying currency options gives buyer the opportunity, but not the obligation to buy currency at a given price in the future.

Characteristics

• Guarantees price

• May exercise option or let it expire depending upon currency values

• More expensive than other hedging choices

• Allows for appreciation benefits while avoiding risk of depreciation

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Acquire an Offsetting Asset

Acquiring an offsetting asset of equivalent size denominated in purchase currency eliminates net transaction exposure.

Characteristics

• Eliminates exposure

• Requires effort and expense to arrange transaction

• Lost opportunity for capital gain if home currency appreciates

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Political uncertainty can affect transaction exposure.

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Translation Exposure

Translation exposure is the 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.

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Economic Exposure

Economic exposure is the impact on the value of a

firm’s operations of unanticipated exchange rate

changes.

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Map 18.3 Changes in Currency Values Relative to the U.S. $

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Corporate Financial Goals

Minimize working-capital balances

Minimize foreign-exchange risk

Minimize currency conversion costs

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Figure 18.3 Payment Flows without Netting

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Minimizing Currency Conversion Costs

Bilateral netting

Multilateralnetting

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Evaluating Investment Projects

Net present value

Payback period

Internalrate of return

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Using the Net Present Value Approach

Risk adjustment

Choice of currency

Perspective

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Figure 18.4 Internal Sources of Capital

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External Sources of Funding

Investment bankers

Sale of stock

Loans

Swaps