Multinational Business Finance
Professor M. Vaziri
 Importance of Multi-National
Corporations (MNCs) :
• Technology Transfer
• Global Trade
 Global Integration of Money &
Capital.
 Law of Comparative & Absolute
Advantage
 MNC & Risk Management
 Types of MNC :
• Labor, Capital, Technology
Seekers, Cost Minimizer.
 MNC & Host Countries.
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International Monetary System
IMS

Structure of IMS: Framework within which the foreign
Exchange rates are determined, capital flows &
international trade are accommodated & Balance of
Payments Adjustments are made

History of IMS: The Gold Standard (1876-1913):

Gold as a medium of exchange- Pharaohs (3000 PC)

The Greeks, Romans & Persians Used gold coins &
passed through the mercantile era to the 19th century

No multinational agreement, but each country declared
a par value for its currency in terms of gold based on
rule of games or "Gold Standard"
International Monetary System
IMS-cont..
 Mercantilism of 19th Century: Need for IMS:


Europe adapted the IMS in 1870 & the U.S.. in 1879

$20.67/Ounce of Gold, £4.274/Ounce:

$20.67/£4.2474=£4.8665/$

Limitation of gold reserve & supply of money

Limit the flow of goods and gold & suspension of GS
Inter War Years: 1914-1944:

Free Fluctuating of Exchange Rates with consideration of the
gold and par value of other currencies.

Short sell of week currencies, re-evaluation of £, the collapse of
the Austrian banking system-total abandonment of GS
International Monetary System
IMS-cont..

The Bretton Wood Agreement: (1944)

Dollar based Monetary System (par value based on $)

Fixed value in term of $, but not required to convert

Only $ remained convertible to gold: $35/Ounce

Only 1% of par allowed for fluctuation

Devaluation was not allowed for purpose of high export

10% devaluation for week currency or approval of IMF

IMF & World Bank were created

Former Soviet Union did participate at Bretton Wood but chose not
to join IMF or World Bank
International Monetary System
IMS-cont..

International Monetary Fund IMF:

Mission:Rendering temporary assistance to currencies with cyclical,
seasonal or random fluctuation.

Help countries with a structural trade problem

IMF is funded based on quota of expected post WWII trade

The Original quota were 25% in gold or $ (Gold tranche), & 75% local
currency.

A member country can borrow up to its original 25% in gold or convertible
currencies in any 12 month plus 100% of its total quota. A member country
can also borrow up to 120% of its quota in convertible currency or gold,
even through it only paid 25% in convertible currency or gold.
International Monetary System
IMS-cont..

International Monetary Fund IMF Cont..:

At the present time, each of the 151 member can borrow
up to 150% annually of its quota or up to 450% during a
three years period

Cumulative access could be up to 600% of members quota

Distribution of the quota is prelude to distribution of vote

U.S. Vote:19.1%, UK:6.6%,Germany:5.8%,
France:4.8%,Japan:4.5%,Canada:3.2%

General Agreement to Borrow: IMF ability to borrow from
member countries, currently more than $180 billion.

Special Drawing Rights (SDR): created according to Rio de Janeiro agreement
(1967) to help increase the global trade between nations

SDR is distributed based on members quota and valued based on 16 then 5 currency

First $/SDR determined then value of other currencies are measured
International Monetary System
IMS-cont..
 Monetary Development: (1944-1971)

EFTA (1957) & EEC (1959), rapid increase in world trade

U.S.. deficit of 1959 & International Monetary Reserve
dilemma: BOP deficit to create more reserve for LDCs

Doubt of convertibility of major reserve currencies

"Interest Equalization Tax"on foreign borrowing &
creation of Euro-bond

Mandatory control of direct foreign investment ,control of
foreign lending by U.S banks,& high U.S deficit

official Currency Swaps: Group of Ten Industrialized
Nations as a interest credit between central banks


International Monetary System
IMS-cont..
Floating Exchange Rate-Crises of 1971:

U.S. BOT had reached to all-time high in 1971

U.S lost one-third of her official gold & president Nixon suspended
convertibility of $ to gold

U.S.imposed 10%surcharge on imports & freezed P&W

Most European currencies gained against $
Smithsonian agreement: December of 1971

Group ten Industrialized Nations signed on Dec, 17 1971

$ devaluated to $38/Ounce, Yen evaluated against $ :16.9%,Canada 7.4%

Floatation of 2.25% (Max 4.5%) is allowed

$ lost its value sharply: $42.22 in free market, $70 in official London market
International Monetary System
IMS-cont..

Jamaican Agreement: January 1976

Floating Rate has been established ( has continued today)

Gold was demonetarized as a reserved asset

IMF agreed to sell $25 million ounces of gold to its members and
used the proceeds to help the poor nations

IMF quota increased to $41 and then to $180 billion

10% of the voting power given to OPEC members

Non-oil producing countries have more access to IMF

Floating Exchange Rate System has officially adopted & continued until
present time
International Monetary System IMS-cont..
• Plaza Agreement
• Louvre Agreement
http://www.econ.iastate.edu/classes/econ355/choi/cur.htm
Balance of Payments (BOP)
 Definition of BOP: Record of transactions between
residents of one country & rest of the world
 Functions of BOP:
• Helps force market potential of a country
• Helps to understand the currency fluctuation of a country
• It is a poor description of National Economy
• Useful in measuring economic performance if there is FER
$ was indexed at 100 at 1970: If index is greater than 100,$ gain Vs
other countries currencies.
Accounts of BOP:
• Trade Balance : Net balance in merchandise traded
• Current Account: Trade account+earning & expe on services
• Performed service: travel, shipping, banking, insurance, etc
• Debt service: interest, dividend received or paid abroad.
Gravurev.ppt
Balance of Payments (BOP) Con..
• Basic Balance: Current account+long term capital (such as direct
investment)
• Overall Balance: basic Balance+short term capital +Error & Omission
• Unilateral Transfer: no corresponding flow of G&S-non military goods,
grants, foreign aids, donation, inheritance
• Capital account: record of investment & payments
 Macro Modeling of BOP:
 Aggregates Income: Y=C+S, Where,
 C=Agg Consumption & S=Agg Saving
 Aggregate Expenditure: E=C+Id, where Id=Domestic investment
 Y-E=S-Id
If Y is greater than E, S is greater than Id
Gravurev.ppt
Balance of Payments (BOP) Con..
 Coping with Current account deficit (CAD):
 Relationship between CAD & currency depreciation
 According to General Equilibrium View : not a simple one
 1976-1980: $ depreciate, CAD decreased
 1980-1985 $ appreciate, CAD increased
 Impose high tariffs & quotas:
 Since S-Id=X-M, (unless S & Id changes), if M decline, X must
decline : less import means less demand for foreign currency, less
supply of domestic currency, and an increase in value of domestic
goods, which mean less export.
 End Foreign ownership of domestic assets
 No capital account surplus means interest rate will increase &
investment & income will decline
 Stimulate savings: If S is greater than Id,
we will have capital
outflow, causing deficit to decrease in both Government budget &
Current Account.
Gravurev.ppt
Foreign Exchange
Market(FEM)
FF
The Functions of FEM
1. Transfer of Purchasing Power.
2. International Credit such as L.C.
3. Minimize Exposure to Foreign Exchange
Risk
4 Market for Hedging & Arbitrageur
5 Market for currency Swaps, futures &
forward/Spot Transactions
Participants in FEM
1. Banks & Non-banks
2. FEM Dealers- benefited from
bid-ask spread
3. Market Makers-Position on
certain Currencies
4. FEM Brokers (56%)
5. Exporter, Importer, Tourists
MNCs, Portfolio Managers
6. Speculators & Arbitrageur
7. Central Banks
Types of FEM Transactions



Spot Transactions: one day settlement (63% of market)
Forward Transactions: one, two, six & 12 month (6%)
Swaps Transactions: Simultaneous purchase or sale of FE,
with two value dates: spot-forward, forward-forward
Example: sell £20 mil forward
for $ deliver in two months
at $1.4870/£ & simultaneously
buy back £20 mil forward for
delivery in three month at
$1.4820/£.
Swaps Transactions
Forward Transactions
Spot Transactions
Types of Quotations

Direct Quotation :


Home currency in terms of foreign currency.
$/ff=$.1265/ff: American Way
 Indirect Quotation:



Foreign currency in terms of home currency
ff/$=ff7.9045/$.
Bid & ask spread:
buy(bid) at ff7.9030/$ & ask(offer) at ff7.9070/$
 Difference between bid-ask is dealer
premium=transaction cost


Cross Rates:


Dutch Guilder/$ over Danish Koran
DF3.0245/DK9.7215=DG.3111/Korana
Point Quotation:

Difference between forward rate & spot rate (swap rate).
TRIANGULAR ARBITRAGEUR
Buying & selling of one currency for another & returning to the original one.
U.S $
$
1
£
S(£/$)=0.526
DM
2.205
UK £
S($/£)=1.8930
1
4.190
DM
S($/DM)=0.453
0.239
1
If S(DM/$)*S(£/DM)*S($/£) is greater than one, successful arbitrageur.
(2.205*0.239*1.893)=$0.9979, not successful arbitrageur
The Interest Rate Parity Theory
DEF: Except for transaction costs, the differences in
national interest rate, for security of similar risk &
maturity should be equal but opposite in sign, to
forward exchange rate discount or premium for foreign
currency.
 It links National Monetary Market Rate to Foreign
Exchange Rate.
Forward Exchange Rate Discount & Premium:
 (Forward Rate-Spot Rate)/(Spot Rate)*12/n*100
 (Spot Rate-Forward Rate)/(Forward Rate)*12/n*100
DM2.5885-2.5639/2.5639*12/3*100=+3.8379 per year:
 It means DM is in 3.8379%, 3-month forward
premium or the U.S. $ is in 3.8379%, 3-month
forward discount.
The operation of Covered Interest
Arbitrageur
 Test for Parity
– UK 3-Month Interest Rate=12% per year
– U.S. 3-month Interest Rate=7% per year
– Transaction Cost=.15% should be calculated at the
beginning of transaction
– Size of Transaction=$2,800,000.00
 Covered Interest Arbitrageur actions:
– Step 1. Borrow $2.8mil at 7%/year for 3-month
– Step 2. Exchange $2.8 mil for £ at spot rate of
$1.4000/£ & receive £2mil.
– Step 3. Invest £2mil for 3-month in UK at 12%/year
or 3%/Quarter.
– Step 4. Sell £2.06mil forward at 3-month forward
rate of $1.3860/£: which include £2mil principal &
£60,000 interest for the 3-month (3%*2mil=$60mil
– Step 5. Pay transaction cost of $4,200 ($2.8*.15)
The operation of Covered Interest
Arbitrageur-Con...
 Covered Interest Arbitrageur actionscon..:
– Step 6. Three month after, redeem UK investment
of £2,06mil
– Step 7. Fulfill forward contract by selling £2060mil
at $1.3860/£ forward rate & receive $2.855160.
– Step 8. Repay loan of $2.8mil plus 3-month interest
at 1.75%/Quarter ($2.8*1.75%=$49000).
 Profit Calculation:
–
–
–
–
Proceed from investment in UK=$2,855,160.
Principal+interest from borrowing=$2,849,000
Transaction cost=$4200
Net profit=$2,855160-2,849000-4200=$1,950.00
Speculation in FEM
 Spot Market Speculation:
• Spot rate:DG2.9000/$,Forward Rate=DG2.8000/$
• 6-month expected spot rate=DG2.700/$
• With $40,000, buy:$40,000*DG2.9=DG116000
• Sell at DG2.7/$ for $42965 (116000/2.7)
• Make profit of 2965 or14.82%/Year
 Forward Market Speculation
 Buy $40,000*DG2.8=DG112000
 Buy back $ at DG2.7=$41,481
 Profit=$1,481
1.
Factors to be considered
in
forecasting
the
ER
Expected changes in spot rate,
2.
Inflation rate differential,
3.
Interest rate differential,
4.
BOP problems,
5.
Growth of Money supply
6.
Business Cycle,
7.
Change in International Monetary Reserve,
8.
Increase in official-nonofficial rate spread
9.
FE policies such as , FE. control, ceilings on interest rate, high import
duties, export subsidies, excess G-Spending,
10. Elasticity of demand for exchange rate, Forward rate discount or
premium
Foreign Change Market Cont..

Purchasing power Parity (PPP)Theory :




Def: If the spot rate between two countries starts in equilibrium, any
change in the difference of rate of inflation between them tends to be
offset over the long run by equal, but opposite change in spot
exchange rate.
If inflation rate in China increases by 4%, Chin's Ys deprecate by 4%
Current Account Balances are very sensitive to change in inflation
Rate
International Fisher Effect (Fisher Open):

Difference in interest rate between two countries is equal, but
opposite in sign to the spot exchange rate of foreign currency to
home currency
 Fisher Effect (Irving Fisher):

Differences in inflation rate between countries is equal to the interest
rate differential between them.
Foreign Change Market Cont..

Foreign Currency Option (FCO) :






Def: FCO is a contract that gives buyers the right to buy or sell a given
amount of foreign exchange at a fixed price (exercise price or strike price)
per unit for a specific period of time..
Types of FCO: American Option: Right to exercise on any day before the
expiration date, European Option: only on the expiration date.
In-the Money Option: When you make profit, At-the-money option: when
profit is zero, and Out of-the money option: when you have a loss
FCP is a flexible transaction of over 1 mil in major trading currencies for
any time period up to one year, tailored to the customer's need.
This is a good alternative to the forward market.
FCP Premium: A percentage of transaction:

paid advance & according to following factors
 1. Strike price relative to spot rate
 2. Supply & demand for option
 3. Relative interest rate between countries
 4. Relative currency risk, and
 5. Maturity of the option.
Foreign Exchange Market Cont..

Maturity dates & size of FCO:




An Exercise on FCP:


Saturday proceeding the third Wednesday of expiration Month March,
June, September, and December.
Contract size: Cited as fixed contract per unit, such as DM62,500/per unit of
option: with one mil$ one can buy:$ one mil/¨DM62,500=16 FCP contract
Price of FCP: No of cents per unit: £12,500*.02=$250.
March $1.45 call option payees $.02 per £ ( purchase £12,500 at $1.45
option with expiration date of March.
 If price of £ increase to $1.5100, buy £ at £1.4500 & sell £ 1.5000 & make
$1.5100-1.4500=.06 per £ or 12500*.06=$750.
 Subtract transaction cost of 250, & make a net profit of $750-250=$500.
Currency Future Market (CFM):




Def of CFM: CF are contract between the future dealers & client.
It does not involve commercial banks & traders
Difference between CFM & Forward Exchange Market, as inflation,
contract is drawn up between banks & client;
Major Participants in CFM are: Importer & Exporter, Speculators &
Arbitrageur, and those who invest abroad.
Multinational Capital Budgeting

DEF: Selecting multinational assets & allocating the
required funds with consideration of the following:
• Cheap loan from foreign government
• Foreign Exchange rate risk.
• Multiple ties of taxation of different countries
• Restrictions on repatriation of income.

NPV=-CO+CFl (1+t)/(1+i)*t, where:
•
•
•
•
•
•
NPV=Net Present Value
Co=cost of project
E=Market value of equity
CFl=Before tax expected cash flow
t=tax rate
I=WACC=interest rate
Multinational Capital Budgeting
cont..

Factors Affecting Inventories Cash Flow:
• Blocked Funds: Limitation of transfer of foreign exchange for trade or
currency non-convertibility, if used for financing of the project, it alters
the cost of capital for the firm.
• Remittance restriction: only remitted cash flow is relevant.
• Differences in tax structure.
• Concessionary loan.
• Effect on the sales of other divisions

NPV=-CO+CFl (1+t)/(1+i)*t, where:
•
•
•
•
•
•
NPV=Net Present Value
Co=cost of project
E=Market value of equity
CFl=Before tax expected cash flow
t=tax rate
I=WACC=interest rate
Multinational Capital Budgeting
cont..

Calculation of Incremental Cash Flow:
• Cash Flow associated with the project
• Cost of Capital
• Cash flow during the life of the project B

Incremental Cash flow is different from total cash flow:
•
•
•
•
•
•
Cannibalization: new product taking sales away from existing product
Sales creation-opposite of cannibalization
Opportunity cost_windfall profit tax
Sunk cost
Transfer pricing
National inflation difference, unexpected exchange rate, interest rate
difference, political & economical environment, and
• Difficulty in estimating terminal value.
Financing the International Trade
Export-Import Financing

Functions of Financing the trade:

Managing the risk of completion of the transaction.

Protection against foreign exchange rate risk.

A measure of financing the transaction.

Solve the dilemma of seller maintaining the legal right to
title until paid & buyer reluctant to pay until receiving the
merchandise .
Financing the International Trade
Export-Import Financing (con...)

Types and Mechanisms of Financing:

Letter of Credit (L/C):Issued by a importer bank at the
request of an importer. Importer bank promises to pay the
exporter upon receiving of required document specified in
L/C.

Types of L/C:

Irrevocable (can not be canceled without consent of all
parties) v.s. Revocable (can be canceled or amended
before payment).
Export-Import Financing (con...)

Confirmed (both banks of importer and exporter have
obligated to pay) v.s. Unconfirmed (only obligation of
issuing banks).

Revolving (valid for more than one transaction) v.s. nonrevolving (only good for one transaction).

Cumulative revolving (amount that is not used can be
added together) v.s. non-cumulative (amount which is not
used can not add together).

Issuers of L/C: L/Cs can be issued by foreign bank and
confirmed by local bank or confirmed by third party.
Export-Import Financing (con...)

It can be issued only by local bank or issued by foreign
bank with no confirmation from domestic bank.

Draft: Bill of Exchange (B/E): Order written by an
exporter to be paid a specific amount of money by the
importer or importer bank at a specific period of time.

Party who initiates the draft is called Drawer or
Originator (Usually exporter).

Party the draft being written for is Drawee (usually
importer). If drawee is buyer, draft is called trade draft, if
it is bank, it is called bank draft.
Export-Import Financing (con...)


Conditions for Draft:
It must be in writing and signed by a drawer.

It must contain an unconditional promise to pay a definite
sum of money to drawer at a specific time.

It could be written to order or bearer with receiving bank
or person being a holder in due course.

Types of draft: Sight Draft, Time Draft, Clean Draft,
Documentary Draft

Bill of Lading (B/L): Composed of merchandise receipt,
contract (obligation of career), documents of title
Export-Import Financing (con...)

Types of B/L:

Straight B/L: Carrier delivers the merchandise to the
designated person when paid in advance or Order B/L;
grant the title to the specified person.

Clean B/L: Merchandise received by the carrier must be
in a good condition v.s Foul B/L merchandise could have a
margin of damage.
 Other Financing

related Documents:
Commercial Invoice: Price , financial terms, shipping
condition such as FOB, FAS, C&F and CIF.
Export-Import Financing (con...)

Public and Private Financing agencies:

Export Credit Insurance: Credit for export and insurance for default
importer.

Foreign Credit Insurance Association (FCIA)

Export Import Bank

Private Export Funding Corporation (PEFCO)

Overseas Private Insurance Corporation. (OPIC)

www.freetradeat10.com

www.mexonline.com/nafta.htm

http://www.usmcoc.org/naftafor.html
The Fundamentals of
Counter Trading
Def: Financing the international trade with exchange of
goods and credit
Types of Counter trading
 Barter Trading: Goods for Goods - Pepsi for Vodka
 Counter purchase : Partial payment in cash and
merchandise. German Car to Iran for Oil and Cash.
 Compensation arrangement or Buyback:: Buyback
the output of capital invested: Russia buys gas from
a gas pipeline built for Iran.
 Switch Trading: Exchange the blocked currency for
hard currency by switching the trade: Blocked funds
of Canada can be traded at a discount for other
currency for trading with Romania.
 www.countrywatch.com
Working Capital Management
Def: Managing of Current Assets & Liabilities :
Flow Prospective: Managing the location of liquid funds
to find both the currency in which liquid funds are
held and country where such funds are placed










Tax Structure
Exchange Rate
Liquidity consideration
Import Restrictions
Political and social consideration
Rate of return for excess cash investment
Inconvertibility of the fund
Exchange control
Conversion Blockage
Heavy withholding TAX ON FOREIGN INCOME, DIVIDEND,ROYALTY,
AND OTHER RESTRICTION FOR REMITTANCE OF THE FUND.
International Fund Transfer

Recovering funds from affiliate without piquing host
country’s sensitivity with a large Dividend drain

Allocation of a large overhead from parent to an affiliate

Facilitate the entry of local capital to joint venture

FUND TRANSFER STRATEGIES:
 If
foreign exchange losses are expected, speed up the transfer
 Consideration
for the age and size of the affiliate
 Availability
of the fund to the affiliate
 Availability
of the joint venture
 Transferability
 Consideration
of royalty fees and other foreign income
for transaction, speculative and precautionary
Managing International Receivables &
Inventory

Receivable: Lead and Lag Techniques:

Provide funds to affiliate in exchange for equities

Sell in and provide credit in long run from one affiliate to
others

Re-invoicing centers: separate subsidies to manage
intercompany transactions when the title passes to reinvoice center but goods are directed to the affiliate.

Inventory:

Taking advantage of free trade zone

Consideration for inflation rate

Consideration for currency devaluation, price freeze, import
restrictions etc..
MNC’s Strategy & Direct Investment
1. Theory of MNC
• Most MNC’s are oligopolies.
• They operate in product and factor market imperfection.
• They have intangible capital in the form of trade markets, patents,
general marketing skills, organizational abilities to raise the market
and introduce new products, quality control, advertising, distribution,
after-the-sale service and ability to forecast exchange markets.
2. Investment Strategy
• Vertical Integration - diversification across the industry.
• Horizontal Integration - investment within the industry.
• Trade innovation and barriers prohibit market entry by continuous
introduction of new products, different services and product
differentiation.
3. Follow-the-Lead Behavior
• Cost reduction and economy of scale; low cost production site with
low price -- oligopoly price leadership and cost minimizer.
MNC’s Strategy & Direct
Investment (con...)
4. Joint Venture
5. Pricing Conversion

High prices in home country
to compensate for low prices
overseas.
6. Investing in Each Other’s
Market
• “if you undercut me in my
home market, I will do the
same thing in your market.”
Process Classification
Process
U.S.
E.C.
Japan
Material
Savings
19%
54%
48%
Labor
Savings
61%
18%
16%
Capital
Savings
19%
24%
28%
Multiple
Factors
1%
4%
8%
Swaps - A Brief Overview
•
Interest Rate Swaps:
– No Principal ever changes hands.
– Maturity varies from under one year to
over 15 years.
– Types:
» Coupon Rate Swap -- fixed rate to
float rate.
» Basis Swap -- float rate to float rate.
•
Currency Swaps:
– to receive one currency for another
currency at a fixed or flexible rate.
International Financial Market
Sources of Capital
• International Market: business operation
• External Market:
–
–
–
–
A.
B.
C.
D.
Domestic Market: domestic funds for domestic use.
International Market: domestic funds for foreign use.
International Market: foreign funds for domestic use.
Offshore Market: foreign funds for foreign use
ie. London, N.Y., Tokyo, Zurich, Singapore, Bahrain,
Bahamas.
Eurodollar vs Eurocurrencies Market
• U.S. Dollar time deposits in a bank outside the
U.S.A.
• Bank may be foreign bank or overseas branch of a
U.S. bank.
• Deposits could be in: Call Money, Overnight Draft,
3-month CD.
Eurodollar deposits are not demand deposit and can’t be
transferred by a check drawn on the bank having the deposit.
It can be transferred by a wire or cable from a balance-hold in a
corresponding bank located in the U.S.
Banks in which Eurodollar or Eurocurrencies are deposited are
generally called Eurobanks.
Reasons for Existence of Eurodollar
Market
1.
2.
3.
4.
5.
6.
7.
Convenient money market
Major source of short-term bank loans
Arbitrage purpose
U.S. long-time trade deficit
Money regulation in the U.S.
Military expenses of the 1960’s and 1970’s
Freezing of foreign assets in the U.S. in the 1970’s and
1980’s
Size of the Market
• According to the report by Bank for International
Settlement, the size of the market has increased 4
times since the 1970’s to $2,056 billion.
• A Majority of the dollar deposits are in Europe
(60%), and the rest are in Asia -- mainly in Japan
and Singapore.
• The Expansion of the market is very similar to the
money creation principle of a commercial bank.
Euro-capital Market
• Money Market (Euro-Line of
Credit, Revolving Credit,
Syndicated Short-term and
Medium-term loans)
• Euro-CD, such as Spot Rate CD,
Roll-over Credit where the interest
is paid in floating rate and TAPS,
CD’s for less than a year with min
$25,000 denomination which could
be in a series of identical CD’s
(Tranche) or single issue, and Fivecurrency CD (denominated in a
basket of five different currencies).
Eurobonds
1. The Euronote Market: short to medium-term debt
instruments (negotiable promissory notes) sold in
the Eurocurrency market.
– They are underwritten by different facilities, such as
Revolving Underwriting Facilities (RUF), Note Insurance
Facilities (NIF) and Standby Note Issuance Facilities
(SNIF).
2. Euro-commercial Papers (ECP) - one, three and sixmonth maturities.
3. Euro Medium-term Notes (EMTN): bridges
maturity gap between ECP and Eurobond.
4. Euro-bond Market
– Straight Fixed Rate Issue -fixed CR, specified maturity date and
full principal repayment upon final maturity.
– Floating Rate Notes (FRN) - semiannual coupon, variable rate,
fixed maturity or perpetuities.
– Euro-Equity Convertibles - similar to straight bond with added
feature to convert to a certain number of stocks prior to
maturity.
Eurobonds
4. Euro-bond Market (con...)
– Dual currency Bonds - purchase price and coupon denominated
in one currency and the principal redemption value fixed in a
second currency.
– Currency Cocktail Bond - denominated in one of several
currency baskets such as SDR or ECU; stable interest and
principal payments.
– Stripped Bond - deep discounted bond issued in bearer form in
order to sell them to non-residents; Certificate of Accrual on
Treasury Securities (CATS).
5. Yankee Bond - issued by non-residents in U.S.
Dollars sold in the U.S.
6. Foreign Bond - issued by non-residents in nonDollars sold in the U.S.
Eurobonds
• 7. Treasury Bond - long-term obligation of federal
government (U.S.)
• 8. Corporate Bond (General, Debenture, Jr,
Subordinate) - long-term obligation of corporation.
• 9. Municipal Bond - long-term obligation of state and
local government.
• 10. Interest and Currency Swaps
Cost of Capitalization
Taking advantage of the capital market
imperfection M>N>C can lower the cost of
capitalization.




WACC = KeE/E+D + KdD/E+D
Cost of Equity = Ke = d/p+g
Capital Asset Pricing Model = Ke = Rf + B*(Rm-Rf)
Cost of Debt: Cy, Y-T-M, H.P.Y. W.A.Y.T.M. , ...
MNC Influences Cost of
Capitalization by:
1. Availability of capital from domestic as well
as from international
– MNC have higher capacity to raise funds as extensions of
the MC curve making it easier to borrow more at a lower
rate.
2. Market segmentation
– if the required rate on a security in a market is different
from the required rate on a comparable security in an
efficient capital market, the cost of capitalization will be
lower if MNC has access to fully-integrated markets as it
shifts the MC curve further down.
– Cost of capital varies as the amount of employed TD/TA
increases; an after tax cost of capital decrease reduces
the overall cost of capital after a certain level of perceived
risk by the investor increases the cost of capital.
Carcoulv.ppt
MNC Influences Cost of
Capitalization by (con...):
3. Investor’s Premium for International
Diversification
– reduces the perceived risk by the investor and reduces the
cost of capitalization.
4. Managing Foreign Exchange Rate Risk and
Political Risk
5. Taking Advantage of Tax Treaties
– MNC could be subject to taxation both home and abroad.
– Retained earnings in foreign affiliate are not subject to
U.S. tax until they are reported, so it could reduce the cost
of equity. Transfer pricing also affects the tax liability of
MNC.
Carcoulv.ppt
MNC Influences Cost of
Capitalization by (con...):
6. Disclosure of International Financial
Statements
– improved financial disclosure will tend to increase the
relative weighting which investors place in favorable firm’s
statistics relative to others, especially in capital formation
from Eurocurrency Market.
– Rating of foreign bonds by Moody and S&P as asked by
Japanese to help reduce risk for the investor.
7. Financial Structure of Different Countries
– country debt ratio is different for different countries.
Carcoulv.ppt
Example
When MNC issues foreign currency-dominated debt, its cost
of repaying the principal and interest in terms of patent’s
own currency will be affected as follows:
If U.S. MNC borrows Deutschemarks for one year at 6% and the Mark
increases interest of $ by 8%, the before tax cost of capital:
° Kc = interest on DM*additional interest to exchange rate change +
additional principal due to exchange rate.
° If the interest rate in Germany = [(1.06*1.08)-1]*100 = 14.48% and if the tax
rate is 54%, then the after tax cost of capital = 14.48%(1-.54) = 7.82%.
After tax expected dollar cost to foreign affiliate of one year
foreign currency loan = r = (1-d)(1-t)-d, where r = interest
rate, d = expected foreign currency devaluation to dollar
and t = local tax.
Advice on Avoidance of Excess Cost
of Capitalization for MNC
 Under no condition should a firm borrow longterm in a foreign currency which has been
eliminated.
 Borrow long-term in foreign currency if you
anticipate cash outflow on principal and interest is
matched by anticipated operating receivable in the
same currency.
 Borrow for the purpose of diversifying long-term
currency commitments.
Gravurev.ppt
Short Term Financing

Definition: financing for less than a year.

Two sources of short-term financing:


Unsecured short-term financing

Secured short-term financing
Categories of unsecured short-term financing

Trade Credit

Line of Credit

Bank Loan

Commercial Papers
Short Term Financing (con...)
Categories of Secured Short-term Financing
• Pledging the Account Receivable
• Factoring the Account Receivable
• Inventory Loans:
» 1. Floating Lien (Blanket Lien)
» 2. Trust Receipt (Chattel Mortgage)
• Field warehousing
• Public warehousing (Terminal Warehouse Agreement)
International Short Term
Financing
1.
2.
3.
4.
5.
6.
7.
8.
9.
Intercompany financing
Local currency financing
Euronotes and Euro-commercial papers
Funds from parent company
Funds from operation
Loan from sister subsidiary
Loan from local and international banks
Currency swaps
Link financing (third strong currency company
guarantees loan)
International Short Term
Financing (con...)
10. Edged Act and agreement banking
11. International Banking Facilities
12. Joint Venture
13. World Bank and IMF
14. Regional Development Bank, such as Inter-American
Development Bank
15. Export / Import Bank
16. Agency for International Development (AID)
17. OPIC
International Banking
Motivations: Access to dollar and Eurocurrency
deposits and international saving markets.
 Tasks of International Banking:
•
•
•
•
•
•
•
•
Financing exports and imports
Trading foreign exchange
Underwriting both Euro-bonds and foreign bonds
Borrowing and lending in Euro-currency market
Participate and organize foreign exchange market
Project financing
International cash flow management & fund transfer
Solicitation for local currency deposits to operate as full-service
banks
• Serve as consultant for MNC
Gravurev.ppt
Risks in International
Banking
1. Commercial Risk
•Facing difficulties in receiving the repayments
of principal and interest on due date.
•Lack of financial and economic information about
the clients and host countries and differences in
accounting disclosure practices and legal
procedures.
2. Country Risk
•Sovereign Risk: political, jurisdictional and
cultural differences.
•Exchange Rate Risk: shortage of foreign exchange
reserves; change in repayment schedules.
Advantages and Disadvantages of
International Banking
Advantages
• High rate of return for investment and relatively low loss ratio
• Ability to diversify loan portfolio.
• Excess demand for international loans, especially for development
programs.
• Usually international loans are safeguarded by official and non-official
insurance agencies, such as export credit insurance.
Disadvantages
• Unfamiliar political and social environments and rapidly changing
macroeconomic and financial variables.
• Unexpected events and regulators.
• Weak demand for domestic loans has relaxed standards for
international loans.
• Only a few credit-worthy countries are available.
• External debt problems of many foreign international countries,
especially Latin American countries and major international loan loss
by many international banks.
Types of International Bank
Offices

Correspondent Banking

Two way link between banks (home and foreign bank); services offered
include, but not limited to: accepting drafts, honoring L/C, and furnishing
credit information.
 Representative Offices
• Cannot accept deposits, make loans, accept L/C or cash checks; just help
and advise parent bank clients when they are doing business in host
country.
 Agencies Relationship
• Like branch banking without having authority to accept deposit from the
public; may accept deposits from other banks; can arrange loans, L/C and
trade foreign exchange.
 Bank Subsidiaries and Affiliates
• Can be a separately incorporated bank or owned and control by bank
(partially-owned or entirely-owned subsidiaries).

Types of International Bank
Offices
(con...)
Branch Banking

Extension of parent bank; can be full-service bank.
 International Banking Facilities (IBF)
• An accounting entity as well as a legal entity of a bank to capture a segment of the
Euromarket.
• They are not subject to FDIC rules or Fed’s Required Rate Ratio.
• Deposits limited to non-residents only and size limitation.
• They are exempt from state and local tax.
• They could be U.S.-owned IBF (exempt from federal tax) or foreign-owned IBF, such
as Japanese IBF and Italian IBF.
 Edged Act Banks
• Subsidiary of U.S. bank incorporated in U.S. under section 25 of federal banking law
to engage in international banking functions and finance all types of the loans in the
world.
• They are physically located in states other than their own within the U.S. (inter-state
banking).
• If they are state chartered - called Agreement Corporation, if nationally chartered called Edged Act Bank.
Professor VAZIRI
WISHS YOU:
GOOD LUCK WITH
"Final Exam"
CFP Diploma
Finance
Diploma
Decoratv.ppt
 Exam will cover the materials
discussed in the class
Review the notes and thebook.
Have your calculater ready
Have your formulas ready
Ask questions if you are
confused.
Leave a self stamt and adressed
envelope for your grade
reporting.
ISEFI IN THE MOVE TOWARD
INTERNATIONAL CFP COUNCIL
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France
Danemark
Espagne
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Pays-Bas
Finlande
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Suisse
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Autriche
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Lgnbleuv.ppt
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