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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.
Chapter 14 International Short-Term Financing and Investment 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 Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-2 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 Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-3 Sources of external financing • Standby Eurocredits: Eurocurrency lines and revolving commitments • Euronotes: note issuance facilities and Eurocommercial papers Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-4 Why foreign currency financing? • Foreign currency financing introduces FX risk only if there is no exposure already • It may be cheaper Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-5 Three-month interest rates (Australia) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-6 Three-month interest rates (U.S.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-7 Three-month interest rates (Japan) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-8 Three-month interest rates (U.K.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-9 Effective financing rate from an Australian perspective (USD) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-10 The effective financing rate with bid-offer spread e Sa1 (1 ia ) Sb Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-18 The effective rate of return with bid-offer spread r Sb1 (1 ib ) Sa Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-19 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 Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-20 Measuring risk: probability distributions E (e ) σ ( e) n i ei pi n i pi ei E (e) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-21 Measuring risk: historical data 1n et nt e ( e) n 1t n et e Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-22 Financing with and investment in a portfolio of currencies wy wz eip, j wy eiy n m i 1j y z pi p j wz e zj Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-23 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 Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-24 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 Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa (cont ) 14-25 Bilateral netting 500 000 Before Netting A B 300 000 After A 200 000 B Netting Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-26 Multilateral netting After Netting Before Netting A B D C B A B D C Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa (cont ) 14-27 Multilateral netting (cont.) 400 000 A B 200 000 1600 000 B C B D C 300 000 C 500 000 400 000 C 600 000 D 900 000 1200 000 A D 700 000 600 000 B D 1200 000 300 000 A C A 100 000 C 900 000 Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-28 Advantages of centralised cash 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 Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa (cont ) 14-29 Advantages of centralised cash 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 Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-30 When is decentralised management preferred? • When delays are expected in transferring funds to countries with inefficient banking systems • When local representation is necessary Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-31 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 Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 14-32 ... t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 1 4- 7 Three-month interest rates (Japan) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International. .. t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 1 4- 10 Effective financing rate from an Australian perspective (JPY) Copyright 2010 McGraw-Hill... t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 1 4- 11 Effective financing rate from an Australian perspective (GBP) Copyright 2010 McGraw-Hill