Chapter 21: International Financial Management
Chapter 21
International Financial Management
Discussion Questions
21-1.
What risks does a foreign affiliate of a multinational firm face in today’s
business world?
In addition to the normal risks that a domestic firm faces (such as the risk
associated with maintaining sales and market share, the financial risk of
too much leverage, etc.), the foreign affiliate of a multinational firm is
exposed to foreign exchange risk and political risk.
21-2.
What allegations are sometimes made against foreign affiliates of multinational
firms and against the multinational firms themselves?
Some countries have charged that foreign affiliates subverted their governments
and caused instability for their currencies in international money and foreign
exchange markets. The less developed countries (LDC’s) have, at times, alleged
that foreign business firms exploit their labor with low wages. The multinational
companies are also under constant criticism in their home countries. The home
country’s labor unions charge the MNC’s with exporting jobs, capital, and
technology to foreign nations, while avoiding their fair share of taxes. In spite of all
these criticisms, the multinational companies have managed to survive and prosper.
21-3.
List the factors that affect the value of a currency in foreign exchange markets.
Factors affecting the value of a currency are: inflation, interest rates, balance
of payments, and government policies. Other factors that have an influence
include the stock market, gold prices, demand for oil, political turmoil, and
labor strikes. All of the above factors will not affect each currency in the same
way at any given point in time.
Chapter 21: International Financial Management
21-2
21-4.
Explain how exports and imports tend to influence the value of a currency.
When a country sells (exports) more goods and services to foreign countries
than it purchases (imports), it will have a surplus in its balance of trade.
Since foreigners are expected to pay their bills for the exporter’s goods in the
exporter’s currency, the demand for that currency and its value will go up.
On the other hand, continuous deficits in balance of payments are expected to
depress the value of the currency of a country because such deficits would
increase the supply of that currency relative to the demand. Of course, a number
of other factors may also influence these patterns such as the economic and
political stability of the country.
21-5.
Differentiate between the spot exchange rate and the forward exchange rate.
The spot rate for a currency is the exchange rate at which the currency is traded
for immediate delivery. An exchange rate established for a future delivery date
is a forward rate.
21-6.
What is meant by translation exposure in terms of foreign exchange risk?
The foreign-located assets and liabilities of a multinational corporation are
denominated in their respective foreign currencies and need to be translated
back to their local currency. This is called accounting or translation exposure.
The amount of loss or gain resulting from this currency exposure and the
treatment of it in the parent company’s books depends upon the accounting
rules established by the parent company’s government.
21-7.
What factors influence a U.S. business firm to go overseas?
Factors that influence a U.S. business firm to go overseas are: avoidance
of tariffs; lower production and labor costs; usage of superior American
technology abroad in such areas as oil exploration, mining, and manufacturing;
tax advantages such as postponement of U.S. taxes until foreign income is
repatriated, lower foreign taxes, and special tax incentives; defensive measures
to keep up with competitors going overseas; and the achievement of
international diversification. There also is the potential for higher returns than
on purely domestic investments.
Chapter 21: International Financial Management
21-8.
What procedure(s) would you recommend for a multinational company in
studying exposure to political risk? What actual strategies can be used to guard
against such risk?
In studying exposure to political risk, a company may hire outside consultants
or form their own advisory committee consisting of top level managers from
headquarters and foreign subsidiaries.
Strategic steps to guard against such risks include:
a. Establish a joint venture with a local entrepreneur.
b. Enter into a joint venture with firms from other countries.
c. Purchase insurance.
21-9.
What factors beyond the normal domestic analysis go into a financial feasibility
study for a multinational firm?
An international financial feasibility study must go beyond domestic factors to
also consider the treatment of foreign tax credits, foreign exchange risk, and
remittance of cash flows.
21-10.
What is a letter of credit?
A letter of credit is normally issued by the importer’s bank; in which the bank
promises to pay money for the merchandise when delivered.
Chapter 21: International Financial Management
21-11.
Explain the functions of the following agencies:
Overseas Private Investment Corporation (OPIC).
Export-Import Bank (Eximbank).
Foreign Credit Insurance Association (FCIA).
International Finance Corporation (IFC).
Overseas Private Investment Corporation (OPIC)—A government agency that
sells insurance policies to qualified firms. This agency insures against losses
due to inconvertibility into dollars of amounts invested in a foreign country.
Policies are also available from OPIC to insure against expropriation and
against losses due to war or revolution.
Export-Import Bank (Eximbank)—An agency of the U.S. government that
facilitates the financing of U.S. exports through its miscellaneous programs.
In its direct loan program, the Eximbank lends money to foreign purchasers of
U.S. goods such as aircraft, electrical, equipment, heavy machinery, computers,
and the like. The Eximbank also purchases medium-term obligations of foreign
buyers of U.S. goods at a discount from face value. In this discount programs,
private banks and other lenders are able to rediscount (sell at a lower-price)
promissory notes and drafts acquired from foreign customers of U.S. firms.
Foreign Credit Insurance Association (FCIA)—An agency established by a
group of 60 U.S. insurance companies. It sells credit export insurance to
interested exporters. The FCIA promises to pay for the exported merchandises
if the foreign importer defaults on payment.
explore the opportunity of selling equity or debt (totaling up to 25 percent)
to the International Finance Corporation.
21-12.
What are the differences between a parallel loan and a fronting loan?
In a parallel loan, the exchange rate markets are avoided entirely—that is, the
Chapter 21: International Financial Management
21-13.
What is LIBOR? How does it compare to the U.S. prime rate?
LIBOR (London Interbank Offered Rate) is an interbank rate applicable for
large deposits in the Eurodollar market. It is a bench mark rate just like the
prime rate in the United States. Interest rates on Eurodollar loans are
determined by adding premiums to this basic rate. Generally, LIBOR is lower
than the U.S. prime rate.
21-14.
What is the danger or concern in floating a Eurobond issue?
When a multinational firm borrows money through the Eurobond market
(foreign currency denominated debt), it creates transaction exposure, a kind
of foreign exchange risk. If the foreign currency appreciates in value during
the bond’s life, the cost of servicing the debt could be quite high.
21-15.
What are ADRs?
ADRs (American Depository Receipts) represent the ownership interest in a
foreign company’s common stock. The shares of the foreign company are put in
trust in a New York bank. The bank, in turn, issues its depository receipts of the
foreign firm to the American stockholders.
21-16.
Comment on any dilemmas that multinational firms and their foreign affiliates
may face in regard to debt ratio limits and dividend payouts.
Debt ratios in many countries are higher than those in the United States.
A foreign affiliate faces a dilemma in its financing decision. Should it follow
the parent firm’s norm or that of the host country? Furthermore, should this be
decided at corporate headquarters or by the foreign affiliate? Dividend policy
may represent another difficult question. Should the parent company dictate
the dividends that the foreign affiliate must distribute or should it be left to the
discretion of the foreign affiliate?
Chapter 21: International Financial Management
21-6
Chapter 21
Problems
1. Spot and forward rates (LO2) The Wall Street Journal reported the following spot and
forward rates for the Swiss franc ($/SF) in June of 2009.
Spot ……………………………………
$0.8466
30-day forward …………………….
$0.8504
90-day forward …………………….
$0.8540
180-day forward …………………..
$0.8587
a. Was the Swiss franc selling at a discount or premium in the forward market?
b. What was the 30-day forward premium (or discount)?
c. What was the 90-day forward premium (or discount)?
d. Suppose you executed a 90-day forward contract to exchange 100,000 Swiss francs into
U.S. dollars. How many dollars would you get 90 days hence?
e. Assume a Swiss bank entered into a 180-day forward contract with Citicorp to buy
$100,000. How many francs will the Swiss bank deliver in six months to get the U.S.
dollars?
21–1. Solution:
a. The Swiss franc was selling at a premium above the spot
rate.
b.
Forward rate Spot rate 12
30-day forward premium 100
Spot rate 1
−
=
.8504 .8466 12 100
.8466
−
=
.0038 12 100
.8466
=
.004489 12 100=
Chapter 21: International Financial Management
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21–1. (Continued)
c.
Forward rate Spot rate 12
90-day forward premium 100
Spot rate 3
−
=
.8540 .8466 4 100
.8466
−
=
.0074 4 100
.8466
=
.008741 4 100=
.034964 100 3.49640%= =
d. 90–day forward rate = $.8540
Dollar value of 100,000 Swiss Franks
e. 180-day forward rate = $.8587
$100,000
Swiss franc equivalent of $100,000 SF$116,455.11
$.8587
==
2. Cross rates (LO2) Suppose a Polish zloty is selling for $0.3399 and a British pound is
selling for 1.448. What is the exchange rate (cross rate) of the Polish zloty to the British
pound? That is, how many Polish zlotys are equal to a British pound?
21–2. Solution:
One dollar is worth 2.942 Polish zloty ($1/.3399 and one British
pound is worth 1.4948 dollars.
answer is 4.40.