international business, 5th edition

chapter 18
international financial
management
 Chapter Objectives 1

• Analyze the advantages and

disadvantages of the major forms of
payment in international trade
• Identify the primary types of foreign-
exchange risk faced by international
businesses
• Describe the techniques used by firms to
manage their working capital

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 Chapter Objectives 2

• Evaluate the various capital budgeting

techniques used for international
investments
• Discuss the primary sources of
investment capital available to
international businesses

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 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

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 Method of Payment

• Payment in • Letters of credit

advance
• Credit cards
• Open account
• Countertrade
• Documentary
collection

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 Forms of Drafts Used with
Documentary Collection

Sight Time
draft draft

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 Advantages/Disadvantages of
Documentary Collection

Advantages Disadvantages
• Reasonable fees • Refusal of
shipments
• Enforceable debt
instrument • Decline draft
acceptance
• Simple collections
process • Potential for default

• Prompt payments

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 Figure 18.1 Using a Sight Draft

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 Documentation for
Letters of Credit

Export
licenses

Certificates of Inspection
product origin certificates

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 Types of Letters of Credit

Advised letter of credit

Confirmed letter of credit

Irrevocable letter of credit

Revocable letter of credit

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 Figure 18.2 Using a
Letter of Credit

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 Forms of Countertrade

Barter

Counterpurchase

Buy-back

Offset purchase

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 Map 18.1 Countertrade by Marc Rich

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 Foreign-Exchange Exposure

Transaction
exposure

Translation
exposure

Economic
exposure

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 Transaction Exposure

A firm faces transaction exposure

when the 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.

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 Transactions Leading to
Transaction Exposure

Product purchases Product sales

Credit extensions Money borrowing

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 Options for Responding to
Transaction Exposure

Go naked

Buy forward currency

Buy currency option

Acquire an offsetting asset

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 Go Naked

To ‘go naked’ is to Characteristics

ignore transaction • Does not require
exposure and assume advance capital
foreign-exchange risk.
• Offers potential for
currency appreciation
• Creates risk for
depreciation of
exchange currency
• Avoids fees to
intermediaries

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 Buy Forward Currency

Buying the exchange Characteristics

currency forward in the
• Guarantees price
foreign-exchange market
locks in the ‘price’ to be • Protects against decline
paid. in value of currency
• No capital up front
• Eliminates potential for
profits associated with
currency appreciation
• Requires fees to
intermediaries

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 Buy Currency Option

Buying currency options Characteristics

gives buyer the
• Guarantees price
opportunity, but not the
obligation to buy currency • May exercise option or
at a given price in the let it expire depending
future. upon currency values
• More expensive than
other hedging choices
• Allows for appreciation
benefits while avoiding
risk of depreciation

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 Acquire an Offsetting Asset

Acquiring an offsetting Characteristics

asset of equivalent
• Eliminates exposure
size denominated in
purchase currency • Requires effort and
eliminates net expense to arrange
transaction exposure. transaction
• Lost opportunity for
capital gain if home
currency appreciates

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 Political uncertainty can affect
transaction exposure.

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 Translation Exposure

Translation exposure is the 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.

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 Economic Exposure

Economic exposure is the

impact on the value of a
firm’s operations of
unanticipated exchange rate
changes.

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

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 Corporate Financial Goals

Minimize working-capital balances

Minimize currency conversion costs

Minimize foreign-exchange risk

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 Figure 18.3
Payment Flows without Netting

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 Minimizing Currency Conversion Costs

Bilateral Multilateral
netting netting

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 Evaluating Investment Projects

Net
present value

Internal Payback
rate of return period

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 Using the Net Present Value Approach

Risk adjustment

Choice of currency

Perspective

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Figure 18.4 Internal Sources of Capital

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 External Sources of Funding

Investment bankers

Sale of stock

Loans

Swaps

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