INTERNATIONAL FINANCIAL MANAGEMENT 4

©2004 Prentice Hall 18-2Chapter Objectives_1  Analyze the advantages and disadvantages of the major forms of payment in international trade  Identify the primary types of exchange risk

Chapter 18:

International

Financial

Management

International Business, 4 th Edition

Griffin & Pustay

©2004 Prentice Hall 18-2

Chapter Objectives_1

 Analyze the advantages and

disadvantages of the major forms of

payment in international trade

 Identify the primary types of exchange risk faced by international

foreign-businesses

 Describe the techniques used by firms

to manage their working capital

Chapter Objectives_2

 Evaluate the various capital budgeting techniques used for international

investments

 Discuss the primary sources of

investment capital available to

international businesses

©2004 Prentice Hall 18-4

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

©2004 Prentice Hall 18-6

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

Figure18.1 Using a Sight Draft

©2004 Prentice Hall 18-8

Documentation for Letters of Credit

 Export licenses

 Certificates of product origin

 Inspection certificates

Types of Letters of Credit

 Advised letter of credit

 Confirmed letter of credit

 Irrevocable letter of credit

 Revocable letter of credit

©2004 Prentice Hall 18-10

Figure 18.2 Using a Letter of Credit

©2004 Prentice Hall 18-12

Map 18.1 Countertrade by Marc Rich

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

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

©2004 Prentice Hall 18-14

The Itaipu Dam the Parana River between Brazil an Paraguay

Foreign-Exchange Exposure

 Transaction exposure

 Translation exposure

 Economic exposure

©2004 Prentice Hall 18-16

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

Options for Responding to

Transaction Exposure

 Go naked

 Buy forward currency

 Buy currency future

 Buy currency option

 Acquire an offsetting asset

©2004 Prentice Hall 18-18

Political uncertainty can affect

transaction exposure

©2004 Prentice Hall 18-20

Buy Forward Currency

in value

Buy Currency Future

 Lost opportunity for capital gain if home currency rises in value

©2004 Prentice Hall 18-22

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

Acquire Offsetting Asset

 Lost opportunity for capital gain if home currency rises in

value

©2004 Prentice Hall 18-24

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

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

©2004 Prentice Hall 18-26

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

July 2003

Management of Working Capital

 Corporate Financial Goals

– Minimizing working-capital balances

– Minimizing currency conversion costs

– Minimizing foreign-exchange risk

©2004 Prentice Hall 18-28

Figure 18.3 Payment Flows Without

Netting

Evaluating Investment Projects

 Net Present Value

 Internal Rate of Return

 Payback period

©2004 Prentice Hall 18-30

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

Other Factors to Consider When Using

Net Present Value Approach

 Risk Adjustment

 Choice of Currency

 Whose Perspective: Parent’s or

Project’s?

©2004 Prentice Hall 18-32

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

Figure 18.4 Internal Sources of Capital

for International Businesses