Lecture International finance: An analytical approach (3/e): Chapter 14 - Imad A. Moosa

Chapter 14 - International short-term financing and investment. To explain why short-term foreign currency financing and investment are considered, to consider the choice between domestic and foreign currency financing and investment, to identify the costs and benefits of financing/investment with a portfolio.

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Chapter 14

International Short-Term

Financing and Investment

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PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa

Slides prepared by Afaf Moosa

Objectives

• To explain why short-term foreign currency financing and investment are considered

• To consider the choice between domestic and

foreign currency financing and investment

• To identify the costs and benefits of

financing/investment with a portfolio

14-2

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Internal financing

• A multinational firm can utilise internal financing by:

 requesting a transfer of funds from a subsidiary

 increasing mark-ups on supplies sent to subsidiaries

14-3

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Sources of external financing

• Standby Eurocredits: Eurocurrency lines and

revolving commitments

• Euronotes: note issuance facilities and

Euro-commercial papers

14-4

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Why foreign currency financing?

• Foreign currency financing introduces FX risk only if there is no exposure already

• It may be cheaper

14-5

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Three-month interest rates

(Australia)

14-6

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Three-month interest rates (U.S.)

14-7

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Three-month interest rates (Japan)

14-8

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Three-month interest rates (U.K.)

14-9

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Effective financing rate from an

Australian perspective (USD)

14-10

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Australian perspective (JPY)

14-11

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Australian perspective (GBP)

14-12

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International short-term investment

• International short-term investment is the placement

of excess funds in short-term investments

denominated in various currencies

14-13

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The effective financing rate

S i

e

S i

e



 ) 1 1

)(

1 (

14-15

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The effective rate of return

S i

r

S i

r



 ) 1 1

)(

1 (

14-16

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The effect of changes in the

exchange rate

i e

• Foreign currency appreciation

i e

• Foreign currency depreciation

i e

• No change

14-17

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The effective financing rate with

bid-offer spread

1 )

e

14-18

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The effective rate of return with

bid-offer spread

1 )

S

S i

r

14-19

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Implications of CIP

• If covered interest parity (CIP) holds, the effective

financing rate and the rate of return will be equal to the domestic interest rate

14-20

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Measuring risk: probability

distributions

2 1

2

1

) ( )

( σ

) (

e E e

p e

p e e

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Measuring risk: historical data

e

e n

e

1

2 2

1

1 )

( 1

14-22

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Financing with and investment in a portfolio of currencies

m j

z j

y i

z j z

y i y

p j i

z y

p p

e w e

w e

w w

14-23

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Centralised versus decentralised

cash management

• Centralised: receipts and payments in various

currencies are managed by a central body

• Decentralised: receipts and payments are managed

by branches and subsidiaries

14-24

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Advantages of centralised cash

management

• Netting involves the calculation of the overall position

in each currency by adding up short and long

positions of branches and subsidiaries

• Netting provides a natural hedge when there is a

short position in one currency and an equivalent long position in the same currency

14-25

(cont )

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Bilateral netting

500 000Before

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100 000

CA

14-28

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management (cont.)

• Currency diversification means that even if the

combined position is not zero, centralised cash

management may result in a combined position that

is so diversified that foreign exchange risk is reduced significantly, removing the need to hedge individual

positions

14-29

(cont )

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management (cont.)

• Pooling: by pooling cash balances in a centralised

location, the cash requirements of any branch or

subsidiary anywhere can be met without having to

keep balances denominated in various currencies in every locality

14-30

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When is decentralised management preferred?

• When delays are expected in transferring funds to

countries with inefficient banking systems

• When local representation is necessary

14-31

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Factors determining where cash

balances are held

• Whether or not funds are needed in the future

• Whether or not there is a forward market

• Political risk

• Liquidity considerations

14-32

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