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Chapter 18:InternationalFinancial Management

International Business, 4th Edition

Griffin & Pustay

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Chapter Objectives_1

Analyze the advantages and disadvantages of the major forms of payment in international trade

Identify the primary types of foreign-exchange risk faced by international businesses

Describe the techniques used by firms to manage their working capital

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Chapter Objectives_2

Evaluate the various capital budgeting techniques used for international investments

Discuss the primary sources of investment capital available to international businesses

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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

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Method of Payment

Payment in advance Open account Documentary collection Letters of credit Credit cards Countertrade

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Forms of Drafts

Sight draft: requires payment upon transfer of title to the goods from the exporter to the importer

Time draft: extends credit to the importer by requiring payment at some specified time– Date draft: specifies particular date

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Figure18.1 Using a Sight Draft

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Documentation for Letters of Credit

Export licenses Certificates of product origin Inspection certificates

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Types of Letters of Credit

Advised letter of credit Confirmed letter of credit Irrevocable letter of credit Revocable letter of credit

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Figure 18.2 Using a Letter of Credit

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Countertrade

Occurs when a firm accepts something other than money as payment for its goods or services

Forms– Barter– Counterpurchase (parallel barter)– Buy-back– Offset purchase

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Map 18.1 Countertrade by Marc Rich

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Table 18.1 Payment Methods for International Trade

Method Timing -Payment Timing - Delivery

Risks - Exporter

Risks - Importer

Availability of Financing

Conditions for Use

Payment in

advance

Prior to delivery After payment None Exporter may fail to deliver

N/A Exporter has strong bargaining

Open account According to credit terms

When goods arrive in importer’s country

Importer may fail to pay

None Yes Exporter has complete trust in importer

Documentary collection

At delivery (sight draft); at later time (time draft)

Upon payment (sight draft); upon acceptance (time draft)

Importer may default or fail to accept draft

None Yes Risk of default is low

Letter of credit After terms of letter are fulfilled

According to terms

Issuing bank may default, incorrect documents

Exporter honors terms of letter but not contract

Yes Exporter lacks knowledge; Importer has good credit

Credit card According to normal procedures

When goods arrive in importer’s country

None Exporter fails to deliver

N/A Transaction size is small

Countertrade When exporter sells countertraded goods

When goods arrive in importer’s country

Exporter may not be able to sell

None No Importer lacks convertible currency

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The Itaipu Dam the Parana River between Brazil an Paraguay

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Foreign-Exchange Exposure

Transaction exposure Translation exposure Economic exposure

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Transaction Exposure

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

Transactions– Purchase of goods, services, or assets– Sales of goods, services, or assets– Extension of credit– Borrowing of money

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Options for Responding to Transaction Exposure

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

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Political uncertainty can affect transaction exposure

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Go Naked

Benefits No capital outlay Potential for

capital gain if home currency rises in value

Costs Potential for capital

loss if home currency falls in value

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Buy Forward Currency

Benefits Elimination of

transaction exposure

Flexibility in size and timing of contract

Costs Fees to banks Lost opportunity

for capital gain if home currency rises in value

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Buy Currency Future

Benefits Elimination of

transaction exposure Ease and relative

inexpensiveness of futures contracts

Costs Small brokerage free Inflexibility in size

and timing of contract Lost opportunity for

capital gain if home currency rises in value

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Buy Currency Option

Benefits Elimination of

transaction exposure Potential for capital

gain if home currency rises in value

Costs Premium paid up front

for option because of its “heads I win; tail I don’t lose” nature

Inflexibility in size and timing of option

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Acquire Offsetting Asset

Benefits Elimination of

transaction exposure

Costs Effort or expense of

arranging offsetting transaction

Lost opportunity for capital gain if home currency rises in value

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Translation Exposure

Impact on the firm’s consolidated financial statements of fluctuations in exchange rates that change the value of foreign subsidiaries as measured in the parent’s currency

Reduce translation exposure through the use of a balance sheet hedge

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Economic Exposure

Impact on the value of a firm’s operations of unanticipated exchange rate changes– Affects all areas of operations

Management of economic exposure involves analyzing likely changes in exchange rates

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Map 18.3 Changes in Currency Values Relative to the U.S. $, July 2003

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Management of Working Capital

Corporate Financial Goals– Minimizing working-capital balances

– Minimizing currency conversion costs

– Minimizing foreign-exchange risk

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Figure 18.3 Payment Flows Without Netting

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Evaluating Investment Projects

Net Present Value Internal Rate of Return Payback period

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Net Present Value Approach

A dollar today is worth more than a dollar in the future

Estimate the cash flows the project will generate and then discount them back to the present

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Other Factors to Consider When Using Net Present Value Approach

Risk Adjustment Choice of Currency Whose Perspective: Parent’s or

Project’s?

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Before investing $500 million in this Chilean copper mine, Placer Dome carefully analyzed the risks

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Figure 18.4 Internal Sources of Capital for International Businesses