20
Financial Management
This chapter covers:
•Currency values
affect on international
business
•The importance of
financial management
•Financial
management tools
•Derivatives as
hedging devices
•Financial executives
networking and
cooperation
•Payments other than
money
•Hard vs. soft
currencies
•International finance
centers
International Business
by Ball, McCulloch, Frantz,
Geringer, and Minor
McGraw-Hill/Irwin
Copyright © 2006 The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
 Realize that the currencies of countries change in value in terms of
each other
 Understand how currency value changes affect international business
transactions
 Recognize the importance of financial management to an IC
 Know about financial management tools
 Understand the growing use of derivatives as hedging devices
 Explain how financial executives network and cooperate
 Understand why exporters sometimes accept payment in forms other
than money
 Differentiate between hard, convertible currencies and soft,
nonconvertible ones
 Explain the importance of international finance centers
20-2
Fluctuating Currency
Exchange Rates
 Transaction risks



Usually involve a
receivable or a payable
denominated in a foreign
currency
Result from a purchase
from a foreign supplier or
a sale to a foreign
customer
Methods of protection

20-3
Engage in hedging or
accelerate or delay
payments
Transaction Risks
 Forward Hedge
 The international
company contracts with
another party to deliver to
that party at an agreed
future date a fixed
amount of one currency
in return for a fixed
amount of another
currency
 Majority of forward
hedge contracts are with
the company’s bank or
banks
20-4
 Currency Option Hedges
 A covered position
 Financial manager has
funds when entering the
contract or they are due
from another business
transaction on or before
the due date
 An Uncovered Position

Financial manager uses
the foreign exchange
market to take advantage
of an expected rise or fall
in the relative value of a
currency
Transaction Risks

20-5
Credit or Money Market
Hedge
 Company desiring hedge
is borrower
 Exporter can
 Lend the money
 Put it in a CD
 Use it in a swap
 Use it as operating
capital
 Must compare interest
rates between countries
Transaction Risks
 Acceleration or Delay of Payment
 If an importer expects the currency in its country
to depreciate in terms of the currency of its
foreign supplier
 It will be motivated to buy the necessary
foreign currency as soon as it can
 This assumes the importer must pay in the
currency of the exporter
 Payment accelerations or delays are frequently
called leads or lags
20-6
Transaction Risks
 Acceleration or Delay
of Payment
 Leads
 Immediate purchases
of a foreign currency
to satisfy a future need
because the buyer
believes it will
strength vis-à-vis the
home currency
20-7
 Acceleration or Delay
of Payment
 Lags
 Delayed purchases of
a foreign currency to
satisfy a future need
because the buyer
believes it will
weaken vis-à-vis the
home currency
Transaction Risks
 Objectives of Intra-
international Company
Payments
 Within the strictures of
applicable laws and the
minimum working
capital requirements of
the parent and affiliates
 ICs can maximize their
currency strength and
minimize their
currency weaknesses
20-8
Transaction Risks
 Objectives of Intra-international Company
Payments
 Keep as much money as is reasonably possible in
countries with high interest rates
 Keep as much money as is reasonably possible in
countries where credit is difficult to obtain
 Maximize holdings of hard, strong currencies
 Minimize holding of currencies that are subject
to currency controls
20-9
Transaction Risks
 Exposure Netting
 Taking open positions in
two currencies that are
expected to balance each
other
 Two ways to accomplish
exposure netting
 Currency groups
 A combination of a
strong currency and a
weak currency
20-10


Currency Groups
 Some groups of
currencies tend to move
in close conjunction with
one another even during
floating rate periods
A Strong Currency and a
Weak Currency
 Involves two payables (or
two receivables), one in a
currently strong currency
and the other in a weaker
one
Transaction Risks
 Exposure Netting
 Advantages
 Avoids the costs of hedging
 However, is also more risky
 Price

20-11
Adjustments
Sales management often desires to make sales in a country
whose currency is expected to be devalued
 In such a situation, financial management finds that
neither hedging nor exposure netting is possible or
economical
Translation Risks

20-12
The losses or gains that
can result form
restating the values of
the asset and liabilities
arising from
investments abroad
from one currency to
another
Translation Risks
 Realistic Information
 Management must base important decisions on
the updating of all asset and earnings values
 Management Fears
 Managers fear that shareholders and analysts will
regard translated and reported foreign exchange
losses as speculation or bad management
 Neutralizing the Balance Sheet
 Having monetary assets in amounts
approximately equal to monetary liabilities
20-13
Swaps

Trades of assets and
liabilities in different
currencies or interest rate
structures to lessen risks or
lower costs
 There are several types of
swaps
 Spot and forward
market swaps
 Parallel loans
 Bank swaps
20-14
Swaps

Spot and Forward Market
Swaps
 Parent buys foreign
currency in the spot
market and lends to
subsidiary
 Parent shorts the same
amount of foreign
currency for period of
loan
 Cost depends on discount
rate in forward market
compared to spot market
20-15


Parallel Loans
 Each parent company
lends to its subsidiary in
the subsidiary’s currency
 Each loan is made and
repaid in one currency
avoiding exchange risk
Bank Swaps
 Historically swaps
between banks of two or
more countries to acquire
temporarily needed
foreign currency
Capital Raising and Investing

When a company wishes to raise capital, its financial
management must make a number of decisions
 The currency in which the capital will be raised
 Long-term estimate of the strength or weakness of that
currency
 How much of the money raised should be equity capital
and how much should be debt capital
 Where the money should be borrowed from
 Which capital market will be lowest cost
 How much money and for how long
 Whether other sources of money are available
20-16
Capital Raising and Investing

Equity Capital


Debt Capital

20-17
Capital raised by selling
common stock
representing ownership
of the company
Capital raised by selling
bonds representing debt
of the company
Advantages to
Interest Rate Swaps
 Swaps give the corporation
the flexibility to transform
floating-rate debt to fixedrate
 There are potential rate
savings
 Swaps may be based on
outstanding debt and may
thus avoid increasing
liabilities
 Swaps provide alternative
sources of financing
20-18
 Swaps are private
transactions
 There are no SEC reporting
or registration requirements
 The contract is simple and
straightforward
 Rating agencies take a
neutral to positive position
 Tax treatment is
uncomplicated
Currency Swaps
 Companies use currency
swap markets
 when they need to raise
money in a currency
issued by a country in
which they are not well
known
 Would therefore pay a
higher interest rate
than available to a
local or better-known
borrower
20-19
Derivatives
 Financial instruments such as futures, options and
swaps, the values of which are tied to price
movements of the underlying commodities or other
instruments
 Are derivatives safe?
 Proper management of derivatives s a tricky, three-stage
process.
 Identify where the risks lie
 Design an appropriate strategy for managing these risks
 Select the right tools to execute the strategy
20-20
Sales Without Money
 A number of countries
desire goods and products
for which they do not have
the convertible currency to
pay
 There are two
nonmonetary trade
themes
 Countertrade
 Industrial cooperation
20-21
Countertrade
International trade in which at least part of the
payment is in some form other than hard,
convertible currency
 There are six varieties of countertrade







20-22
Counterpurchase
Compensation
Barter
Switch
Offset
Clearing account arrangements
Countertrade
 Counterpurchase
 Goods supplied by the
developing country are
not produced by or out of
goods or products
imported from the
developed country
 Compensation
 Call for payment by the
developing country in
products produced by
developed country
equipment
20-23
 Barter
 An ancient form of
commerce and the
simplest sort of
countertrade
 The developing
country sends
products to the
developed country that
are equal in value to
the products delivered
by the developed
country to the
developing country
Countertrade
 Switch
 Frequently, the goods
delivered by the
developing country are
not easily usable or
salable
 A third party in
brought in to dispose
of them. This process
is called switch
trading
20-24
 Offset
 Occurs when the
importing nation requires
a portion of the materials,
components, or
subasemblies of a
product to be procured in
the local market
 The exporter may set up
or cooperate in setting up
a parts manufacturing
and assembly facility in
the importing country
Countertrade

Clearing Account
Arrangement
 Used to facilitate the
exchange of products
over a specific time
period
 When the period ends,
any balance
outstanding must be
cleared by the
purchase of additional
goods or settled by a
cash payment
20-25
Industrial Cooperation
 Industrial Cooperation
 Long-term relationships between developed
country companies and developing country
plants in which some or all production is done in
the developing country plant
 Five methods
 Joint venture
 Coproduction and specialization
 Subcontracting
 Licensing
 Turnkey plants
20-26
International Finance Center

New developments in international financial
management
Floating exchange rates
 Growth in the number of capital exchange markets
 Different and changing inflation rates among
countries
 Advances in electronic cash management systems
 The explosive growth of the use of derivatives to
protect against risks

20-27
International Finance Center

20-28
Additional functions
 Handle internal and
external invoicing
 Help weak currency
affiliates
 Strengthen affiliate
evaluation and
reporting systems