Chapter 21
International Financial
Management
Introduction
The world has become smaller due to
Advances in communication &
transportation
International flows of capital and
technology
Cooperation between different
countries
As a result, firms become MNCs
Today’s agenda
Multinational Corporation (MNC)
Foreign Exchange Rates
Managing Foreign Exchange Risk
Financing International Business
Operations
Multinational
Corporations
MNCs are firms doing business in
more than one country (home country)
4 basic forms of MNCs
- Exporter
- Licensing or Franchising
- Joint Venture
- Foreign Subsidiary
Reasons for investment
aboard
Fear of import tariffs (e.g.Toyota)
Lower production costs in foreign country
Tax advantages
Proximity to market
International diversification (the overall risk
of the MNC is reduced when foreign and
domestic operations are not correlated)
Following competitor
International vs
Domestic Environment
In addition to normal business risks,
the MNC is faced with foreign
exchange risk and political risk
Higher risk, higher return. So MNC is
more profitable
Int’l vs Domestic
Environment cont’
International environment is more
complex
Different from the domestic market in:
- Inflation rates
- Tax rules
- Structure and operation of financial
institution
- Financial policies and practices
Foreign Exchange
Rates
Exchange rate is the price of one currency
in terms of another
Rates are determined by the supply and
demand for each currency
Factors affecting exchange rates: relative
inflation/interest rates, balance of payments,
government policies, confidence in future
economic performance
Making money through
the FX rates
Assume today’s exchange rate
between USD/CAD is 1 to 1.5 and the
bank saving rates in the States and
Canada are 3% and 4% respectively
US investors are attracted to the high
saving rate in Canada
They convert USD1000 into CAD 1500
and save it in Canadian bank
Making money through
the FX rates cont’
One year later, they get
CAD 1500 (1+4%) = CAD 1560
Assume the exchange rate by that
time is 1 to 1.48, the US investor will
convert the CAD 1560 back to USD
(1560/1.48) i.e. USD 1054
The rate of return is USD (10541000)/1000 = 5.4% (compare with
domestic return of 3%)
Reminder
The US investor is lucky and makes a gain
in the saving rate as well as the foreign
exchange rate
However, the movement of large sums of
money between borders would cause the
exchange rates and available saving rates
to adjust (e.g. Canadian bank may lower the
saving rate due to large amount of deposits)
Foreign Exchange
Rates cont’
Two types of exchange rates
Spot rate – exchange rate between
currencies for immediate delivery
Forward rate – exchange rate that is
established for future delivery
Forward rate may be used to reduce
the foreign exchange risk
Using forward rate to
reduce FX risk
Using the previous example, once the US
investor has converted USD1000 into
CAD1500 and deposits it in Canadian bank,
he/she may afraid that CAD will depreciate
after a year (i.e. exchange rate a year later
may be 1USD/1.55CAD, then the return to
US investor is [(1560/1.55)-1000]/1000 =
0.65%; much lower than the domestic return
of 3%)
Using forward rate to
reduce FX risk cont’
To remove the FX risk, the US investor may
lock in a one-year forward exchange rate of
say 1USD/1.51CAD (sell CAD in advance)
By doing so, the investor is sure that the
return will be [(1560/1.51)-1000]/1000 =
3.3%; a bit higher than the domestic return
Normally the forward exchange rate will
move in a direction to prevent arbitrage
(making profit without taking risk)
Who will buy at the
forward rate?
Example: A US importer issue a purchase
order to buy 1 M CAD raw material from a
Canadian supplier. The goods will be
shipped to US a year later. Once the goods
are shipped, the US importer has to pay 1 M
CAD to the Canadian supplier. The spot rate
is 1 USD to 1.50 CAD. The one-year
forward rate is 1 USD to 1.51 CAD.
Fearing that the CAD may appreciate
against USD on the shipment date, the firm
decides to buy CAD at the forward rate now
Managing FX Risk
Other than using forward exchange rate, US
investor may reduce FX risk by
Hedging in the currency futures market –
buying or selling standardize forward
contract
Hedging in the currency options market –
similar to currency futures but with an option
not to exercise the future contract ( a
premium is required in advance)
Financing International
Business Operations
-
-
-
Eurodollar loans – major source of shortterm loans for MNCs
The borrowing costs are lower because
Smaller overhead costs for lending banks
given the huge size of transactions
High credit of borrowers (MNCs)
Absence of reserve or capital requirement
by the local government
Financing Int’l Bus.
Operations cont’
Eurobond market – long-term bonds
sold throughout the world but are
denominated primarily in USD, DEM,
SFC and YEN
Advantages of Eurobonds:
- Less stringent disclosure requirement
- Lower registration fees
- Some tax advantages exist
Summary
The birth of MNCs - their risks and
benefits
Exchange rate – spot and forward
rates
Managing FX risk – through
forward/future/option contracts
Additional sources of finance for MNCs
– Eurodollar and Eurobond markets
Summary of this
course
Through out this course, we have been
learning how to raise capital for a
company and how to invest the capital
raised
That is, make use of share/bondholders’ money to create more value
for the firm
Personal Application
Start saving as early as possible
Make use of other’s money to create
more money for yourself (leverage)
Meaningful Life
It is more important to share with
people what we have for we are in the
same boat
Life Journey
Meaningful Life cont’
Unless life is lived for others, it is not
worthwhile (Mother Theresa)
We are borne not to fight against each
other but to help each other (Johnny
Tong)
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