PART 2
THE ENVIRONMENT OF INTERNATIONAL BUSINESS
CHAPTER 10
FINANCIAL MANAGEMENT AND ACCOUNTING IN THE GLOBAL FIRM
Instructor’s Manual by Marta Szabo White, Ph.D.
I. LECTURE STARTER/LAUNCHER
■ This chapter explores international financial management, which refers to obtaining
and using funds for cross-border trade, investment, and other commercial activities.
Financial management is a principal function for all companies, but it is more complex
for firms engaged in international business. This is because the company has to learn to
manage financial transactions in one or more foreign currencies, and buy and sell in
different environments that may restrict capital flows, and involve various accounting
and tax systems.
■ Ask students to think about how they handled their money the last time they traveled
internationally. For example, for students in the United States, if they visited Canada or
Mexico a few years ago, they probably found that the U.S. dollar was quite strong. That
is, their dollars purchased relatively more Canadian dollars and Mexican pesos.
However, while the Mexican currency has tended to stabilize at around 10.75 per U.S.
dollar, the Canadian dollar has increased in value (costing U.S. 1.06) and Canadians
find U.S. prices more attractive.
■ If students visited France, Germany, Spain, or any other country that is a member of
the European Union in recent years, the situation is more extreme. In March 2002,
shortly after the euro was adopted, each U.S. dollar purchased about €1.15. In October
2015, the dollar had fallen in value compared to the euro, and US$1 only bought €0.88
(it’s easy to update this example with current exchange rates; for example, visit
http://www.xe.com/ucc). This may discourage U.S. tourists in Italy or Spain from buying
there – even the newest, fashion-forward clothing at Zara — because of the high dollar
price. Ask students to visit one of many currency conversion websites (such as
http://www.xe.com/ucc) and calculate how much a room at the InterContinental Hotel
Group http://www.intercontinental.com would cost today in U.S. dollars in:
New York City, USA
Glasgow, Scotland.
Frankfurt, Germany
Mexico City, Mexico
Tokyo, Japan
Shanghai, China
Bangkok, Thailand
Buenos Aires, Argentina
Dubai, United Arab Emirates
■ Ask students to think about how challenging it would be for a SME to suddenly
conduct business in a new currency. Consider a local firm – select one or give it a
name, such as Beta Co. – that has always issued quotes and received payment in
British pounds, and suddenly must prepare quotes in Mexican pesos or German euros
for potential foreign customers. How does the firm do this? How can it prepare quotes
that assure that when it is paid, it will receive the price charged?
■ International financial management is even more complicated than covering currency
risk. If Beta Co. has to increase capacity at its home-country plant to meet the new
international demand, how will it finance the new materials, equipment, and labor it
needs? Will the local bank finance this increased capacity for international sales?
Assuming Beta Co. is paid on time, how will the additional income be accounted for and
taxed? Will Beta Co. be required to pay taxes on the income it earns from selling in
Germany and Mexico?
[1] YOUTUBE
Foreign Exchange Hedging
James Tompkins
Understanding Finance
Published on Mar 25, 2014
This is the eleventh lecture in the “International Finance” series in which Dr. Tompkins
discusses how corporations and other entities can protect themselves from unexpected
exchange rate movements. To the extent that unexpected exchange rate movements
are a risk, this lecture examines managing this risk. The goal is not only to understand
how each hedge works, but the advantages and disadvantages of each.
https://www.youtube.com/watch?v=GCPRCt8qFkA
2:00.35 Minutes
Yes, that is two hours… but something to use outside of class if you are unable to be in
class. Create a quiz that students must take subsequent to watching this video.
[2] YOUTUBE
Capital Structure
Flay Initiative
Published on Oct 28, 2012
The concept of Capital Structure! It explains the sources from where a company can
issue money. What do the terms Debt and Equity mean? This video also explains what
collateral is!
https://www.youtube.com/watch?v=PnkHpAc5sRc
4.14 Minutes
[3] YOUTUBE
Forward Contract Introduction
Khan Academy
Uploaded on Mar 18, 2011
Cute cartoon introduction to forward contracts using apples and pies.
https://www.youtube.com/watch?v=H9UEZdAnnt8
3.10 Minutes
II. LEARNING OBJECTIVES AND THE OPENING VIGNETTE
LEARNING OBJECTIVES
After studying this chapter, students should be able to:
10.1 Understand how to choose a capital structure.
10.2 Understand how to raise funds for the firm.
10.3 Explain how to manage working capital and cash flow.
10.4 Describe how to perform capital budgeting.
10.5 Explain how to manage currency risk.
10.6 Understand how to manage the diversity of international accounting and tax prac-
tices.
Key Themes
■ In this chapter, there are six themes:
[1] Choosing a capital structure.
[2] Raising funds for the firm.
[3] Managing working capital and cash flow.
[4] Performing capital budgeting.
[5] Managing currency risk.
[6] Managing the diversity of international accounting and tax practices.
■ This chapter, FINANCIAL MANAGEMENT AND ACCOUNTING IN THE GLOBAL
FIRM, discusses how firms obtain and use funds for cross-border trade, investment,
and other commercial activities.
■ Financial management, always a major business function, is more complex for firms
doing business internationally. Firms must transact in foreign currencies, navigate
environments that may restrict capital flows, deal with diverse accounting systems, tax
laws, and institutional settings.
Teaching Tips
■ This is likely to be the final chapter of the course, and as you teach FINANCIAL
MANAGEMENT AND ACCOUNTING IN THE GLOBAL FIRM, it helps to integrate many
concepts discussed earlier. Encourage students to imagine the financial challenges for
a firm that is trying to sell internationally. In addition to product and market issues, there
are complex financial markets, global e-commerce, and many new financial instruments
to help (and complicate) global transactions.
■ Explain that financial management implies a focus on reducing risk and maximizing
opportunity. Financial managers must be able to access capital from many global
sources – bond markets, stock exchanges, banks, venture capital firms, and
intra-corporate financing – depending on where capital is cheapest.
■ Remind students that firms doing business internationally need capital to fund R&D,
manufacturing, marketing, sourcing, and foreign operations or subsidiaries. Discuss the
special challenges to small firms that may get orders from foreign customers. Ask them
how they might finance the production of goods, while they await payment from foreign
customers. Equity investment? This means relinquishing some ownership of the firm.
Loans? This means leveraging the firm. These basic sources of capital can be
enhanced by global financial instruments that help a firm manage its risk.
Commentary on the Opening Vignette:
MARKEL CORPORATION: NAVIGATING THE CHALLENGES OF CURRENCY RISK
Key message
■ Swings in the $4 trillion-a-day world currency market can significantly impact a small
firm.
■ Markel Corporation is a Pennsylvania-based, family-owned SME that supplies tubing
and wire for the automotive and fluid-handling industries. It has exported since the
1980s to Germany, Spain, and Japan, with a substantial proportion of its annual sales
generated abroad.
■ This case underscores the pivotal role that managing currency risk plays, particularly
for a small international firm. Anything less than due diligence could make or break
Markel.
Uniqueness of the situation described
■ The key point is that Markel quotes prices in its customers’ currencies. Foreign
customers prefer this, and this has earned Markel a strong market share in this industry.
■ However, Markel faces the recurring challenges of fluctuating international currencies
and high financial risk.
■ When the U.S. dollar weakened significantly against the euro, Markel suffered
exchange-rate losses of more than $600,000.
■ Explanation- Suppose Markel sells merchandise to its Spanish importer for €50,000,
payable in 90 days. The delay in getting paid exposes Markel to currency risk. If the
euro depreciates during the 90-day period, Markel will receive fewer dollars.
To manage this risk, Markel developed a three-part strategy:
[1] Quote prices in the customer’s currency, which results in more consistent
prices for the customer and generates more sales.
[2] Purchase forward contracts to stabilize future dollar-denominated revenues
while waiting to get paid.
[3] Emphasize efficient company operations to make it through the times when
exchange rates move in the wrong direction and hurt sales.
Classroom discussion
■ Discuss the advantage of quoting prices in local currencies: it may be risky for Markel,
but it helps the company gain market share.
■ Discuss how the currency game works both ways.
◘ An appreciating dollar made Markel’s products more expensive to European
and Japanese customers, decreasing demand for Markel products.
◘ By the mid-2000s the euro had strengthened, increasing the buying power of
European customers and boosting Markel’s sales.
■ Then, discuss how a forward contract works:
A forward contract is an agreement to buy or sell currency at an agreed-upon exchange
rate for delivery at a specific future date.
■ Assume Markel sells product to a Spanish importer for €50,000, payable in 90 days.
◘ If the Euro appreciates (dollar depreciates), it would receive more dollars.
◘ If the Euro depreciates (dollar appreciates) during the 90-days, Markel would
receive fewer dollars.
■ But does Markel want to risk being exposed to currency swings? Probably not
◘ So, Markel hedges risk by entering a forward agreement to sell €50,000, 90
days in the future at an exchange rate agreed upon today. This assures Markel
receives a known dollar amount. Explain:
■ Markel buys a €50,000 contract at $1.05 per Euro, or $52,500 payable when it sells
the euros.
◘ Assume that in 90 days, the Euro has appreciated and trades higher, at $1.08.
It gets $52,500. Had Markel NOT bought the contract and just waited out the risk,
it could have made $54,000 (an extra $1,500).
◘ Assume that in 90 days, the euro has depreciated and trades lower, at $1.00.
It still gets $52,500. Had Markel NOT bought the contract, it would have gotten
only $50,000.
■ The point here is that firms like Markel usually don’t try to make money on foreign
exchange trading.