Upload
anirudh-jindal
View
64
Download
0
Tags:
Embed Size (px)
DESCRIPTION
Citation preview
A Company’s Forex Management ~ Finance Function
Anish Bengeri (5)
Anirudh Jindal (22)
Sachin Mittal (35)
Agenda
• The Finance Function
• Capital Structure
• Global Capital Markets
• Offshore Financing and Offshore Financial Centers
• Capital Budgeting in Global Context
• Internal Sources of Funds
• Foreign Exchange Risk Management
• Taxation of Foreign Source Income
Financial Functions In Multinational Firms
Finance is the Life Blood of the Business and so the case of MNCs also. The only difference in finance of domestic companies and MNCs is that the finance in domestic companies is in domestic currency where as in case of the MNCs the finance is in multi currencies.
Finance is required for many purposes like purchase of raw material, purchase of machinery, purchases of the related items, payment of salaries, meeting the operational expenses, etc., so the finance is required for all these purposes.
There are three types of financing namely :- Short – Term Financing Financing Foreign Trade Long- Term Financing
Types of Financing
• Financing the working capital requirements of multinational companies’ foreign affiliate’s poses a complex decision problem.
• This complexity stems from the large number of financing options available to the subsidiary of an MNC.
• Subsidiaries have access to funds from sister affiliates and the parent, as well as external sources.
Short Term Financing
• Foreign Trade is the main business of the traders of ever country. Almost all the MNCs are heavily involved of foreign trade in addition to their other international activities.
• Hence, the people who are responsible for the management of the MNCs must have the practical knowledge of the institutions to facilitate the international movement of goods.
Financing Foreign Trade
• The following are the long term financing particularly for the capital equipment's and other big items given to the MNCs who are actively engaged in the Foreign Trade :-
• Export Financing• Export Credit Subsidies and• Export Credit Insurance
Long Term Financing
Finance and Treasury Functions in the Internalization Process
Chief Financial Officer (CFO)—vice president of finance Responsible for controllership and treasury functions
Acquires financial resources—generates funds from internal and external sources
Allocates financial resources—increases stockholders’ wealth by allocating funds to different projects and investment opportunities
Manages cash flows
Role of CFO
OPERATIONS
OBJECTIVES
STRATEGY
EXTERNAL INFLUENCES
COMPETITIVE ENVIRONMENT
PHYSICAL AND SOCIETAL FACTORS
Functions• Marketing• Exporting and
importing• Global manufacturing• Supply chain management• Accounting• FINANCE• Human resources
Modes
MEANSOverlayingAlternatives
Finance in International Business
V P , S a les /M ark etin g
C on tro lle r
C ash M an ag er C red it M an ag er
E xp osu reM an ag em en t
B u d g e tP lan n in g
B id S u p p ort P rocess F ore ig nC u rren cy
G lob a l F in an ce C ap ita lE xp en d itu re
F in an c ia lP lan n in g
Treasu re r
V P , F in an c e V P , O p era tion s V P , R & D
P res id en t an d C O O
C h a irm an an d C E O
B oard o f D irec tors
Location of Treasury Function in the Corporate Organizational Structure
Capital Structure
Companies follow financing trends in their own country and industry
Companies can use local and international debt markets to raise funds
Leveragin
g Debt Financin
g
• The degree to which a firm funds the growth of the business by debt• Interest on debt is tax deductible• Amount of leverage used varies from country to country
Equity
Capital
• Capital—stocks or shares• Dividends paid to investors are not deductible• Choice of debt versus equity affected by a variety of factors
Debt Mark
ets
• Subsidiaries or foreign companies may find it easier to obtain credit than local companies
• Back to back loan - made between a firm in country A with a subsidiary in country B and a bank in country B with a branch in country A
EUROCURRENCIES - any currency that is banked outside of its country of origin• Major sources of Eurocurrencies include:
– foreign governments or individuals who want to hold dollars outside of the U.S.
– MNEs with excess cash– European banks with excess foreign currency– countries with large balance-of-trade surpluses held as reserves
• Characteristics of Eurocurrency market– completely unregulated offshore market– both short and medium term– Eurocurrency deposits yield higher interest– Eurocurrency loans tend to be cheaper
LONDON INTER-BANK OFFERED RATE (LIBOR) - interest rate that banks charge each other on Eurocurrency loans
Global Capital Markets
INTERNATIONAL BOND MARKET
An attractive place to borrow money that fills an important niche in financing
Tends to be less expensive than local markets Foreign bonds - sold outside of the borrower’s country but in the currency
of the country of issue Eurobonds - underwritten by banking syndicate and sold in countries other
than the one in whose currency the bond is denominated• sold in several financial centers• some have currency options allowing the creditor to demand repayment
in one of several currencies Global bond - combination of domestic bond and Eurobond
• registered in each national market
Equity Securities and the Euromarkets
EQUITY SECURITIESInvestor takes an ownership position in return
for shares of stock, the promises of capital gain, and dividends.
Many companies are using private placements to raise equity capital
VENTURE CAPITALISTInvests money in a new
venture in exchange for stock
EQUITY CAPITAL MARKETS (stock markets)
Listing may be on home country or foreign exchange
MARKET CAPITALIZATION Total number of shares of stock listed times
the market price per share in part the increase has resulted from privatization in emerging
markets and global economic growth
EUROEQUITY MARKETMarket for shares sold outside the issuing company’s home
country
Firms often list on only one big foreign exchange
e.g., 379 foreign companies listed on the New York Stock Exchange
Companies with investments in several countries may list on different exchanges
AMERICAN DEPOSITARY RECEIPT (ADR)
A negotiable certificate issued by a U.S. bank and
representing shares of stock of a foreign company
GLOBAL DEPOSITARY RECEIPTS and EUROPEAN DEPOSITARY RECEIPTS
Other markets for Euro equities
GLOBAL SHARE OFFERING
Simultaneous offering of actual shares on different exchanges
Electronic trading of stocks is a major source of competition for
stock exchanges
19863.60%
96.40%1994
12.70%
87.30%1998
93.10%
6.90%
Emerging markets
Developed markets
Growth of Emerging Stock Markets
Cities or countries that engage in a variety of financial transactions Provide significant tax advantages Centers for the Eurocurrency market Markets are less regulated than domestic markets Provide an alternative, cheaper source of funding May be:
• Operational centers - extensive banking activities involving short-term financial transactions
• Booking centers - little banking activity• financial transactions recorded to take advantage of secrecy and
low tax rates Good locations for establishing financial subsidiaries
Offshore Financial Centers
Large foreign-currency marketfor loans/deposits
OffshoreFinancial
CenterGood
communications
Pass-through forinternational
loan funds
Efficient andexperienced
financialcommunity
Favorableregulatory
climate
Economic andpolitical stability
Large net supplierof funds to worldfinancial markets
Good supportiveservices
Characteristics of Offshore Financial Centers
Internal Sources of Funds
FUNDS
Working capital, i.e., the difference between
current assets and current liabilities
Used to expand operations or satisfy demands for capital
SOURCES OF FUNDSMNEs have more complex
arrangements due to the number of subsidiaries and the diverse environments in which they
operate
Loans
Dividends
Intercompany receivables and payables
Investments through equity capital
Funds may flow from
subsidiaries to parent or vice versa
Dividends,royalties,and fees
FrenchSubsidiary
BrazilianSubsidiary
ParentCompany
Loans
Extensions ofaccounts payable
Invests moreequity capital
Loans Guaranteeloans
Internal Sources of Working Capital for MNEs
GLOBAL CASH MANAGEMENT
Requires the collection and payment of cash resulting from the normal operational cycle Generates and invests cash through dealings with financial institutions
Assesses a company’s cash needs using budgets and forecasts
Involves decisions about the degree of centralization of cash• transfers of cash may be in the form of dividends, royalties, management
fees, and repayment of loans• governments concerned about the outflow of foreign exchange may
curtail cash transfers abroad
MULTILATERAL NETTING
Company establishes one center to handle all internal cash, funds, and financial transactions Enables companies to reduce the amount of cash flow and move cash more
quickly and efficiently Advantages include:
• optimizing the use of excess cash• reducing interest expenses and maximizing interest yields• reducing costly foreign exchange, swap transactions, and intercompany
transfers• minimizing administrative paperwork• centralizing and speeding information
Multilateral cash flows in the absence of netting require each subsidiary to settle intercompany obligations• Not as advantageous as netting
GermanSubsidiary
$150,000
$200,000 $200,000
$100,000 United KingdomSubsidiary
FrenchSubsidiary
$50,000
$50,000
$200,000
ItalianSubsidiary
Multilateral Cash Flows
FrenchSubsidiary
ItalianSubsidiary
GermanSubsidiary
United KingdomSubsidiary
ClearingAccount
$100,000
$100,000$150,000
$150,000
Multilateral Netting
Foreign Exchange Risk Management
Translation (accounting)
exposure
Transaction (commitment)
exposure
Foreign exchange
risk
Economic (operational)
exposure
Arises from converting financial statements expressed in foreign currencies into home currency
All foreign currency denominated assets and liabilities as well as revenues and costs have to be translated in one basic currency
Assets and liabilities translated at current exchange rate are exposed, and those translated at historical rate are not exposed because we use the same rate in this case. The exposure depends on the translation method to be used
Combined effect of the exchange-rate change is either a net gain or loss• Does not represent an actual cash flow effect because the cash is only
translated into dollars, not converted into dollars
TRANSLATION EXPOSURE
Transaction exposure occurs when a company trades, borrows or lends in a foreign currency, or sells fixed assets of its subsidiaries in a foreign country. All these operations involve time delay between the commitment of the transaction (sale of an asset, for example) and the receipt or delivery of the payment
Arises because the receivable or payable changes in value as the exchange rate changes
In order to measure Transaction exposure, three techniques can be used: the firm can measure the variability of each currency in which it has some
transactions the measurement based on the correlation between two currencies is also used an increasingly implemented technique used for measurement is the VaR
(Value-at-Risk) model
TRANSACTION EXPOSURE
Economic exposure measures the change in the present value of the firm resulting from any change in the future cash flows of the firm caused by an unexpected change in the exchange rates.
Economic risk arises, when a multinational firm incurs costs in one currency and generates sales in another. Changes in foreign exchange rates affect the competitive position of the firm.
Economic exposure (operating exposure) is potential for change in expected cash flows that arise from the:
• Pricing of products • Sourcing and cost of inputs• Location of investments• Competitive position of the company in markets
ECONOMIC EXPOSURE
DEFINING AND MEASURING EXPOSURE• MNE must forecast the degree of exposure in each major currency in which it
operates• Exchange-rate movements are forecasted using in-house or external experts
CREATING A REPORTING SYSTEM• Substantial participation from foreign operations combined with central
control• Foreign input important to ensure forecasting effectiveness• Central control of exposure protects resources more efficiently
defines and controls overall company exposure• MNEs should devise uniform reporting system for its subsidiaries• Time periods of reports vary• Final reporting should be at corporate level
Exposure-Management Strategy
Exposure-Management Strategy (Contd.)
CENTRALIZED POLICY Top management should determine hedging policy Corporate treasurer should be able to design and implement a cost-effective
program Some decisions must be decentralized in order to react quickly to changes in the
international monetary environment Some companies run hedging operations as profit centers and nurture in-house
trading desks
FORMULATING HEDGING STRATEGIES Safest position has exposed assets equal to exposed liabilities Operational strategies
• involve adjusting the flow of money and resources to reduce foreign-exchange risk
• using local debt to balance local assets
• taking advantage of leads and lags for intercompany payments
A lead strategy means collecting foreign-currency receivables before they are due when the currency is expected to weaken, or paying foreign-currency payables before they are due when a currency is expected to strengthen.
A lag strategy means delaying collection of foreign-currency receivables if the currency is expected to strengthen, or delaying payment of foreign-currency payables when the currency is expected to weaken.
Contractual arrangements
• Forward contract - Establishes a fixed exchange rate for future transactions
• Foreign-currency option - Purchaser has the right, but not the obligation, to buy or sell a certain amount of foreign currency at a set exchange rate within a specified period of time
• More flexible than forward contract
Capital Budgeting Decision in an International Context
Capital budgeting is the process whereby MNEs determine which projects and countries will receive capital investment funds.
Parent company needs to compare the net present value or internal rate of return of a foreign project with that of its other projects and with that of others available
Unique aspects of capital budgeting for foreign projects• Parent cash flows must be distinguished from project cash flows
• Remittance of funds to the parent affected by differing tax systems, and legal and political constraints on movement of funds
• Differing rates of inflation must be anticipated
• Parent must consider possible changes in exchange rates
• Must evaluate political risk in foreign market
• Terminal value is difficult to estimate
Taxation of Foreign Source Income
International Tax Practices
Taxing Branches and Subsidies
Transfer Prices
Double Taxation and Tax Credit
International Tax Practices
INTERNATIONAL TAX PRACTISES
Difference in Tax Practices
Differences in Types of Taxes
Differences in GAAP
Differences in Tax Rates
Approaches to Corporate Taxation
Separate Entity
Approach
Integrated System
Approach
Taxing Branches and Subsidies
FOREIGN BRANCH• Foreign Branch Income
(or loss) is directly included in the parent’s taxable income
• If the branch suffers a loss, the parent is allowed to deduct that loss from its taxable income, reducing it overall tax liability
FOREIGN SUBSIDIARY• A foreign corporation is an
independent legal entity set up in a country according to the laws of incorporation of that country.
• When an MNE purchases or establishes such an entity, it is called a subsidiary. Subsidiary income is either taxable to the parent or tax deferred (not taxed until it is submitted as a dividend to the parent).
CONTROLLED FOREIGN CORPORATION• The tax status of a subsidiary
depends on whether the subsidiary is a controlled foreign corporation (CFC) and whether the income is active or passive.
• Active income is derived from the direct conduct of a trade or business. Passive, or subpart F income, comes from sources other than those connected with the direct conduct of a trade or business (generally in tax haven countries).
Determining Subsidiary Income
A price on goods and services one member of a corporate family sells to another.
Transfer pricing applies to transactions between related entities and is not usually an arm’s length price (price between two unrelated entities).
Transfer Prices and Taxation• Companies establish arbitrary transfer prices because of differences in
taxation between countries.• The OECD is concerned about how companies manipulate transfer prices
to minimize their tax liability worldwide.
Transfer Prices
Double Taxation and Tax Credit
Value-added tax (VAT) has been in existence since 1967 in most Western European countries. Under a VAT, each company pays a percentage of the value added to a product at each stage of the business process. The EU has worked hard to reduce and standardize VAT rates among its members.
The purpose of tax treaties is to prevent double taxation or to provide remedies when it occurs. When agreeing to a treaty, countries generally grant reciprocal reduction on dividend withholding and exempt royalties, and sometimes interest payments, from any withholding tax.
Tax Treaties Eliminating Double Taxation• The purpose of tax treaties is to prevent double taxation or to provide
remedies when it occurs.
Future: Technology and Cash Flows
• Greater emphasis on moving corporate cash worldwide to take advantage of differing rates of return and minimize tax bills.
• OECD countries are trying to break barriers to bank secrecy.
• Technological innovation will allow companies to transfer funds more quickly worldwide.