international financial

management

international business, 5th edition

chapter 18

Chapter Objectives 1
Analyze the advantages and
disadvantages of the major forms of
payment in international trade
Identify the primary types of foreignexchange risk faced by international
businesses
Describe the techniques used by firms to
manage their working capital

18-2

Chapter Objectives 2
Evaluate the various capital budgeting
techniques used for international
investments
Discuss the primary sources of
investment capital available to
international businesses

18-3

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

18-4

Method of Payment
Payment in
advance
Open account
Documentary
collection

18-5

Letters of credit
Credit cards
Countertrade

Forms of Drafts Used with

Documentary Collection

Sight
draft

18-6

Time
draft

Advantages/Disadvantages of
Documentary Collection
Advantages

Disadvantages

Reasonable fees

Refusal of
shipments

Enforceable debt
instrument
Simple collections
process
Prompt payments
18-7

Decline draft
acceptance
Potential for
default

Figure 18.1 Using a Sight Draft

18-8

Documentation for
Letters of Credit
Export
licenses
Certificates of
product origin

18-9

Inspection
certificates

Types of Letters of Credit

Advised letter of credit

Confirmed letter of credit

Irrevocable letter of credit

Revocable letter of credit

18-10

Figure 18.2 Using a

Letter of Credit

18-11

Forms of Countertrade
Barter
Counterpurchase
Buy-back
Offset purchase

18-12

Map 18.1 Countertrade by Marc Rich

18-13

Foreign-Exchange Exposure

Transaction
exposure
Translation
exposure
Economic
exposure
18-14

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.

18-15

Transactions Leading to
Transaction Exposure

18-16

Product purchases

Product sales

Credit extensions

Money borrowing

Options for Responding to

Transaction Exposure

Go naked
Buy forward currency
Buy currency option
Acquire an offsetting asset

18-17

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

18-18

Buy Forward Currency

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

18-19

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

Buy Currency Option

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

18-20

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

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

18-21

Political uncertainty can affect

transaction exposure.

18-22

Translation Exposure
Translation exposure is the impact
on the firms consolidated financial
statements of fluctuations in
exchange rates that change the
value of foreign subsidiaries as
measured in the parents currency.

18-23

Economic Exposure
Economic exposure is the
impact on the value of a
firms operations of
unanticipated exchange rate
changes.

18-24

Map 18.3 Changes in Currency

Values Relative to the U.S. $

18-25

Corporate Financial Goals

Minimize working-capital balances

Minimize currency conversion costs

Minimize foreign-exchange risk

18-26

Figure 18.3
Payment Flows without Netting

18-27

Minimizing Currency Conversion Costs

Bilateral
netting

18-28

Multilateral
netting

Evaluating Investment Projects

Net
present value
Internal
rate of return

18-29

Payback
period

Using the Net Present Value Approach

Risk adjustment

Choice of currency

Perspective

18-30

Figure 18.4 Internal Sources of Capital

18-31

External Sources of Funding

Investment bankers
Sale of stock
Loans
Swaps

18-32