Practical financial management lasher 7th ed chapter 018

Chapter 18 International Finance International Finance Business has become increasingly international International business has changed from import/export to operating fullscale businesses in other countries Multi-national companies (MNCs) have worldwide operations Investing in foreign securities is common Globalization Currency Exchange Companies expect to be paid in their home currency – Buying from a firm in another country requires that country’s currency – A US department store importing British sweaters must exchange dollars for British pounds The Foreign Exchange Market Organized to trade/exchange currencies – Network of brokers/banks based in financial centers around the world Exchange Rate Tables – State the price of one currency in terms of another – Exchange rate tables show two reciprocal rates for each currency, Direct Quote Indirect Quote Exchange Rates Concept Connection Example 18-1 Exchange Rates An American retail store orders 500 sweaters from Britain costing £35,000, when the exchange rate is $1.5740 = 1£ Store’s Cost is – £35,000 x $1.5740 = $55,090 Exchange rates affect both: • • The volume of trade between the two countries The cost of imported products in the US Exchange Rate Risk Exchange rates move constantly Exchange rate risk is the chance of a gain or loss from exchange rate movement that occurs during a transaction Exchange Rate Risk Exchange rate movements affect the profitability of international transactions – – British sweaters: Buyer ordered at $1.5740/£ – If exchange rate moves down store profits for a cost of $55,090 If pay at $2.0000/£, order costs $70,000, and buyer makes $14,910 less than expected This variability in cost/profit is exchange rate risk Spot and Forward Rates Spot Rate – The exchange rate for “immediate” delivery of currency – Forward Rate – The price of currencies to be delivered in future – Major currencies have well- Spot deliveries are made in two developed forward markets for days delivery 1, and months ahead Hedging with Forward Exchange Rates Exchange rate risk can be hedged with forward contracts Lock in exchange rates for anticipated foreign currency needs – Eliminates exchange rate risk – Accomplished by buying the currency at the forward rate for future delivery 10 Eurobonds Most are denominated in U.S dollars Advantages to foreign buyers – Securities regulations in foreign countries require less disclosure – Issued in bearer form – Most governments don’t withhold income taxes on Eurobond interest 25 Political Risk The chance that a foreign government will expropriate property or that terrorists will destroy it Other value-reducing foreign risk exposure: – Raising taxes – Limiting the amount of profit that can be withdrawn – Requiring the purchase of key inputs from local suppliers – Limiting the prices of products sold within the country – Requiring part ownership by citizens of the host country 26 Transaction and Translation Risks Transaction gains/losses – – Arise from exchange rate changes that occur during current international transfers of money Have real profit, cash flow and tax impact Translation gains/losses – Arise when assets and liabilities held in a foreign country are translated for consolidation on a parent company’s books in its home currency Relevance of Translation Gains and Losses – Translation gains/losses only exist on paper Not “realized” – – Shown cumulatively as an adjustment to equity Not taxable since not realized 27 Free Trade, the Theory of Comparative Advantage, and Protectionism Free Trade – Implies that firms Protectionism – Exists when one or both countries in both countries are free to pass laws to limit or prohibit market or manufacture their importing goods and foreign products in either country business ownership 28 The Theory of Comparative Advantage A two country–two product community will be better off if each nation specializes in what it does best and buys the other product from the other country Comparative Advantage is a powerful argument for free trade in the long run But there is a great deal of economic pain among workers and investors in the short run 29 Globalization A general movement of the world economy toward free trade – Along with an increase in international business – Governments are promoting the process Proponents say increased production due to unrestricted trade leads to a higher standard of living for everyone 30 Anti-Globalization Most agree on the comparative advantage benefit of free trade: More total production….BUT Not all agree globalization is a good thing – Free trade includes putting factories in poor countries, paying extremely low wages, and making huge profits on the cheap labor Many say this amounts to exploitation of underdeveloped countries Opponents also maintain that it leads to – – A widening gap between rich and poor Excessive corporate power 31 The Migration of Jobs Outsourcing Today outsourcing means moving work overseas – Leads to a loss of jobs at home – Originally limited to low end jobs But outsourcing of knowledge-based jobs began in the 1990’s – Certain low wage nations have some highly educated people e.g., India – Technology is making it possible to transfer knowledge functions electronically 32 Labor Migration and Illegal Immigration Developed countries often lack the people to low-end jobs – Creates incentives for labor migration from undeveloped countries The problem is serious in US due to the historical ease of entering the country and staying without permission – 11.5 million illegal immigrants – Currently a major political problem 33 The Balance of Trade with China and its Inconvertible Currency China has moved towards a free market economy in the last 30 years An undervalued currency makes Chinese products extremely cheap in US – – – – Inconvertible – Exchange rate doesn’t float – Another major political issue 40% price advantage over US manufacturers Trade deficit of more than $280 billion per year A conservative U.S government maintains the low prices of Chinese goods benefit Americans 34 Sovereign Debt Sovereign governments collect taxes and spend on services – If spending exceeds taxes have a deficit and gov’t borrows by selling bonds Deficits accumulate into national debts – Interest also paid out of taxes In a recession tax income falls but services and interest continue – – – Gov’t depends on continued borrowing Investors recognize weakness and stop lending CRISIS – Government may fail European Sovereign Debt Crisis At least of 17 Eurozone countries are facing financial crises – Could cause governments to fail Started with the post 2008 recession Important Note: Eurozone countries give up an economic control when join the zone – Can’t print money to pay on national debts Troubled countries are – Greece, Ireland, Italy, Portugal and Spain 36 Banks and Contagion When a bond issuer is in financial trouble the value of its existing bonds falls European banks invest in those bonds so their assets shrink when countries are in crisis – – Banks fail if the value of their assets falls too far Banks holding sovereign debt are all over Europe The failure of a country in crisis can trigger bank failures across Europe – – Banks stop lending Lack of commercial credit deepens the recession Hence we say the crisis is contagious Actions to Combat the Crisis Stronger Eurozone countries (largely Germany and France), the European Central Bank (ECB), and the IMF have contributed to several bailouts of Greece and other troubled countries – – Demanded cuts in gov’t spending in those countries Austerity programs – Not popular with populations European Financial Stability Facility was set up to provide emergency lending Tensions in the Eurozone People in the healthy economies, are tired of pouring money into failing countries People in crisis countries resent austerity programs forced on them Financial experts say there’s as much as a 75% chance that at least one country will exit the zone [...]... was required to hold its exchange rate nearly constant relative to the US dollar – Proved unworkable post WWII 19 Convertibility Not all currencies are convertible – Can’t be exchanged for other currencies at market-determined rates – The currencies of China and Russia have historically been inconvertible Inconvertibility is an impediment to international trade 20 The Balance of Trade The net financial. .. underdeveloped countries Opponents also maintain that it leads to – – A widening gap between rich and poor Excessive corporate power 31 The Migration of Jobs Outsourcing Today outsourcing means moving work overseas – Leads to a loss of jobs at home – Originally limited to low end jobs But outsourcing of knowledge-based jobs began in the 1990’s – Certain low wage nations have some highly educated people... the home country of the borrower Foreign Bond Issued by a foreign company but denominated in local currency Eurobond denominated in a currency other than that of the country in which it is sold – – – 24 Eurobonds Most are denominated in U.S dollars Advantages to foreign buyers – Securities regulations in foreign countries require less disclosure – Issued in bearer form – Most governments don’t withhold... contracts are denominated in U.S dollars even though none of the contracting parties are American 22 The Eurodollar Market Eurodollars are American dollar deposits in foreign banks The Eurodollar market is created when banks lend deposits to international businesses and foreign governments – Borrowers use Eurodollars To pay for U.S exports To invest in American stocks and bonds As a medium of exchange Deposits... interested in maintaining a balance and sometimes intervene to keep rates within reasonable limits – Buy and sell their own currencies 18 The International Monetary System Rules by which countries exchange currencies A floating exchange rate system has been in place since the early 1970s – Floating  Free market forces determine rates Between 1945 and the early 1970s a fixed exchange rate system was used... – Arise when assets and liabilities held in a foreign country are translated for consolidation on a parent company’s books in its home currency Relevance of Translation Gains and Losses – Translation gains/losses only exist on paper Not “realized” – – Shown cumulatively as an adjustment to equity Not taxable since not realized 27 Free Trade, the Theory of Comparative Advantage, and Protectionism Free... nation’s currency strengthens – Imported goods become cheaper – The nation’s exported goods become more expensive in foreign countries 16 Governments and the International Monetary System A strong dollar makes imports cheaper improving our standard of living But it makes US products more expensive in other countries so people buy fewer and we manufacture less for export reducing employment A weak dollar... wage nations have some highly educated people e.g., India – Technology is making it possible to transfer knowledge functions electronically 32 Labor Migration and Illegal Immigration Developed countries often lack the people to do low-end jobs – Creates incentives for labor migration from undeveloped countries The problem is serious in US due to the historical ease of entering the country and staying without... exceeds taxes have a deficit and gov’t borrows by selling bonds Deficits accumulate into national debts – Interest also paid out of taxes In a recession tax income falls but services and interest continue – – – Gov’t depends on continued borrowing Investors recognize weakness and stop lending CRISIS – Government may fail European Sovereign Debt Crisis At least 5 of 17 Eurozone countries are facing financial. .. without permission – 11.5 million illegal immigrants – Currently a major political problem 33 The Balance of Trade with China and its Inconvertible Currency China has moved towards a free market economy in the last 30 years An undervalued currency makes Chinese products extremely cheap in US – – – – Inconvertible – Exchange rate doesn’t float – Another major political issue 40% price advantage over US