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International Financial Management
Is the acquisition and the use of funds for cross-border trade, investment, and other commercial activities
International Financial Management Tasks
- Choose a capital structure- determine the ideal long-term mix of debt versus equity financing
- Raise funds for the firm– Acquire equity, debt, or intracorporate financing for funding activities and investments.
- Working capital and cash flow management– Manage funds passing in and out of the firm’s value-adding activities.
- Capital budgeting– Assess financial attractiveness of major investment projects (e.g., Foreign market expansion and entry).
- Managing currency risk– Manage the multiple- currency transactions of the firm and the exposure to exchange-rate fluctuations.
- Manage the diversity of international accounting and tax practices– Learn to operate in a global environment with diverse accounting practices and international tax regimes.
- The mix of long-term equity and debt financing firms use to support their activities
- Equity financing is obtained by selling stocks
- Debt financing comes from either loans from banks and other financial intermediaries
Global Money Market
- Financial markets where firms and governments raise short-term financing
- It is the meeting point of those who want to invest money and those who want to raise funds
Global Capital Market
- Financial markets where firms and governments raise intermediate-term and long-term financing
- Participating in the global capital market allows firms to access funds from a larger pool of capital at competitive interest rates.
Causes of Rapid Rise in Global Capital Markets
- Governments’ deregulation of financial markets made capital easier to move across national borders.
- Innovation in information and communication technologies accelerated the ease and pace of global financial transactions.
- Globalization pressured firms to seek new and lower cost ways to finance global operations and to manage global financial management activities.
- Widespread securitization led to conversion of illiquid financial instruments, such as bank loans, into tradable securities, such as bonds
Advantages of the Global Capital Markets for the Firm
- Compared to being restricted to financial markets in the home country, the global market provides a broader base from which the firm can draw funds.
- Greater breadth of financing sources means firms can often access funds at substantially lower cost.
- The market provides a variety of investment opportunities for MNEs, professional investment firms, and individuals.
- The firm obtains capital by selling shares of stock
- Main advantage is the firm obtains capital without incurring debt and having to repay funds to providers
- Main disadvantage is the firm's ownership is diluted
Global Equity Market
- The worldwide market of funds for equity financing
- The stock exchanges worldwide where investors and firms meet to buy and sell shares of stock
- The firm borrows money from a creditor in exchange for repayment of principal and interest
- The main advantage over equity financing is the firm does not sacrifice any ownership interest
- Is obtained from two sources: loans from banks and the sale of bonds
China's Banking Center
- China is rapidly becoming the world's largest economy and center of global banking
- The country's big trade surplus and foreign investment inflows together have created massive reserves of foreign exchange
The Eurocurrency Market
- Represent money deposited in banks outside its country of origin, is a key source of loanable funds
- U.S dollars account for the largest share of such funds
- Are a major source of debt financing
- It enables the issuer (borrower) to raise capital by promising to repay the principal along with the interest on a specified date (maturity).
Global Bond Market
The international marketplace in which bonds are bought and sold, primarily through banks and stockbrokers
Sold outside the bond issuer's country and denominated in the currency of the country in which they are issued
Sold outside the bond issuer's home country and denominated in its own currency
- Obtaining funds from within firm's network of subsidiaries and affiliates
- Minimizes transaction costs of borrowing from banks and avoids the ownership-diluting effects of equity financing
Arise from everyday business activities, such as paying for labor and materials or resources, servicing interest payments on debt, paying taxes, or paying dividends to shareholders.
Methods for transferring funds within the MNE
- Through trade credit, a subsidiary defers payment for goods received from the parent firm.
- Dividend remittances are commonly used to transfer funds from foreign subsidiaries to the parent, but vary depending on tax levels, currency risks, and other factors.
- Royalty payments are compensation paid to owners of intellectual property. Assuming the subsidiary has licensed technology, trademarks, or other assets from the parent or other subsidiaries, royalties can be an efficient way to transfer funds
A fronting loan
- The parent deposits a large sum in a foreign bank, which then transfers the funds to the subsidiary in the form of a loan
- Allows the parent to circumvent restrictions that foreign governments impose on direct intracorporate loans.
- If the loan is made through a bank in a tax haven country, the parent can minimize taxes that might otherwise be due if the loan were made directly
Transfer pricing (Intracorporate pricing)
- Refers to prices that subsidiaries and affiliates charge one another as they transfer goods and services within the same MNE
- Firms can use this to shift profits out of high-tax countries where a currency decaluation is forecast; and optimize the management of internal cash flows
- MNEs pool surplus funds into a central depository that functions either globally or for a region.
- The funds are then directed to needful subsidiaries or invested to generate income
- Strategic reduction of cash transfers within the MNE family through the elimination of offsetting cash flows
- Involves three or more subsidiaries or invested to generate income
Managers use this to decide which international projects are economically desirable
Net Present Value (NPV)
The NPV of a project depends on the initial investment, cost of capital, and the amount of incremental cash flow or other advantages the proposed project is expected to provide over time
Currency of Risk Management
Currency exchange rate fluctuations can harm business profits
Is a currency risk that firms face when outstanding accounts receivable or payable are denominated in foreign currencies
Is currency risk that firms face when a firm translates financial statements denominated in a foreign currency into the functional currency of the parent firm
Currency risk that results from exchange rate fluctuations affecting the pricing of products, the cost of inputs, and the value of foreign investments
Primary dealers in currency
Exchange rate based on the current rate of exchange
Exchange rate applicable at some future date, but specified at the time of the transaction
- The number of units of the domestic currency needed to acquire one unit of the foreign currency
- For example, “it costs $1.42 to acquire one euro.”
- The number of units of the foreign currency obtained for one unit of the domestic currency
- For example, "For $1, I can receive .74 euros"
- Seek to minimize the risk of exchange rate fluctuations, often by buying forwards or similar financial instruments.
- They include MNEs who conduct international trade.
Currency traders who seek profits by investing in currencies with the expectation that they will rise in value.
Currency traders who buy and sell the same currency in two or more foreign-exchange markets to profit from differences in the currency’s exchange rate, for the sake of generating profits.
- Refers to efforts to compensate for a possible loss from a bet or investment by making offsetting bets or investments.
- In international business, it refers to using financial instruments and other measures to reduce or eliminate exposure to currency risk.
A financial instrument to buy or sell a currency at an agreed-upon exchange rate at the initiation of the contract for future delivery
An agreement to buy or sell a currency in exchange for another at a pre-specified price and on a pre-specified date.
Gives the purchaser the right, but not the obligation, to buy a certain amount of foreign currency at a set exchange rate within a specified amount of time.
The exchange of one currency for another currency, according to a specified schedule.
Managerial Guidelines for Minimizing Currency Risk
- Seek expert advice
- Centralize currency management within the MNE
- Decide on the level of risk the firm can tolerate
- Devise a system to measure exchange-rate movements and currency risk
- Monitor changes in key currencies
- Be wary of unstable currencies or those subject to exchange controls
- Monitor long-term economic and regulatory trends
- Distinguish economic exposure from transaction and translation exposures
- Emphasize flexibility in international operations
- Degree to which firms regularly and comprehensively reveal substantial information about their financial condition and accounting practices.
- The more transparent a nation’s accounting systems, the more regularly and comprehensively its public firms report their financial results in a reliable manner.
- Improves the ability of investors to accurately evaluate company performance.
- In many developing an emerging market economies, accounting systems have low transparency.
- Is critical because subsidiaries’ financial records are normally maintained in the currencies of the countries where they are located.
- When headquarters consolidates financial records, foreign currencies are translated into the functional currency using one of two methods: the current rate method or the temporal method.
Current Rate Method
- All foreign currency balance-sheet and income statement items are translated at the current exchange rate – the spot exchange rate in effect on the day (in the case of balance sheets), or for the period (in the case of income statements), the statements are prepared.
- This method is typically used when translating records of foreign subsidiaries that are considered separate entities, rather than part of the parent firm’s operations.
- The choice of exchange rate depends on the underlying method of valuation.
- Assets and liabilities normally valued at market cost are translated at the current exchange rate.
Is imposed on income derived from business profits, intracorporate transactions, capital gains, and sometimes royalties, interest and dividends.
- Applies to firms that license or franchise products and services, or who charge interest.
- The government withholds some percentage of royalty payments or interest charges as tax.
A flat percentage tax on the value of goods or services sold, and paid by the ultimate user.
- Is payable at each stage of processing in the value chain of a product or service.
- VAT is calculated as a percentage of the difference between the sale and purchase price of a good.
- VAT is common in Canada, Europe, and Latin America.
- Countries hospitable to business and inward investment because of their low corporate income taxes
- They exist in part because tax systems vary greatly worldwide
- MNEs take advantage of tax havens either by establishing operations in them or by funneling business transactions through them