21-1
International Financial Management
Author’s Overview
The instructor should stress the importance of international financial management (and international
trade) to the class. The students can easily appreciate the everyday events that bring the world closer
together. An important point is that international finance has the same elements as domestic financial
management, only the issues tend to be more involved. The firm must not only make a profit on a
transaction, but convert that profit into the appropriate currency in a satisfactory manner. With the
U.S. becoming a mature economy, it is increasingly important that students understand how to
conduct business across international borders. The rise of the euro as a world currency has changed
the way Europe does business. With 164 member countries in the World Trade Organization,
international trade will continue, with the WTO trying to maintain an even playing field.
While we have attempted to integrate international material throughout the book, this chapter
concentrates only on international issues and is a good introduction to the complexities of
international financial decision-making for those instructors wanting more depth in this area.
Chapter Concepts
LO2. A company operating in many foreign countries must consider the effect of exchange rates
on its profitability and cash flow.
LO3. Foreign exchange risk can be hedged or reduced.
LO4. Political risk must carefully assessed in making a foreign investment decision.
21
21-2
Annotated Outline and Strategy
I. Introduction
A. Many factors have contributed to greater economic interaction among the world’s
nations.
1. Advances in communication and transportation.
2. Adaptation of political systems.
3. International flows of capital and technology.
B. International business operations are complex and risky and require special
understanding.
PPT One U.S. Dollar to the British Pound and Euro (Figure 21-1)
PPT International Sales of Selected U.S. Companies (Table 21-1)
II. The Multinational Corporation (MNC): Nature and Environment
A. Basic forms of MNC
1. Exporter: exportation to foreign markets of domestically produced products.
2. Licensing Agreement: granting of a license to an independent local (in the
foreign country) firm to use the “exporting” firm’s technology.
4. Fully Owned Foreign Subsidiary
B. International Environment versus Domestic Environment
21-3
2. Potentially more profitable.
3. More complex: the laws, customs, and economic environment of the host
country may vary in many respects:
a. Rates of inflation
b. Tax rules
III. Foreign Exchange Rates
A. To facilitate international trade, currencies must be exchanged. For example, an
exporter will usually desire payment in the currency of his home country. The
importer must swap his domestic currency for the currency desired by the exporter in
order to pay his bill.
1. Examine Figure 21-2 and some of the currencies versus the dollar.
2. Currencies are not stable over time.
Perspective 21-1: Use Figure 21-2 to show how currencies move up and down over time.
PPT Exchange Rates to the Dollar (Figure 21-2)
B. Factors affecting exchange rates
1. Supply of and demand for the currencies of the various countries.
3. Inflation rate differentials (Purchasing Power Parity Theory).
5. Balance of payments
7. Other factors
a. Capital market movements
21-4
C. Many variables affect currency exchange rates. The importance of each variable or
set of variables will change as economics and political conditions change throughout
the world.
Perspective 21-2: There are a number of easily understood examples in the text on spot and
forward rates as well as cross rates.
1. Spot rate: the exchange rate between currencies with immediate delivery
3. Cross rates: the exchange rate between currencies such as Danish krone and
British pounds based on their exchange rate with another currency such as
U.S. dollars.
PPT Key Currency Cross Rates (Table 21-2)
Finance in Action: Coca-Cola Manages Currency Risk
As a large MNC, Coca-Cola, with about $46 billion in sales, must manage billions of dollars in
currency risk. Coke used 73 functional currencies along with the U.S. dollar in 2016. The
IV. Managing Foreign Exchange Risk
A. Three types of foreign exchange risk exposure
1. Accounting or translation exposure: depends upon accounting rules
2. Transaction exposure: in the U.S., foreign exchange gains and losses are
3. Economic exposure to different countries’ GDP performance.
PPT Currency Futures Hedging (Table 21-3)
21-5
Perspective 21-3: The instructor might wish to discuss the different ways foreign exchange risk
can be reduced.
B. There are three strategies used to minimize transaction exposure:
1. Hedging in the forward exchange market: the recipient (seller) of foreign
2. Hedging in the money market: the recipient borrows foreign currency in the
3. Hedging in the currency futures market: futures contracts in foreign
currencies began trading in the International Monetary Market (IMM) of the
V. Foreign Investment Decisions
A. Reasons for U.S. firms to invest in foreign countries
1. Fear of import tariffs (in foreign countries)
2. Lower production costs, particularly with regard to labor costs
4. Tax advantages
6. International diversification
PPT Risk Reduction from International Diversification (Figure 21-3)
B. Foreign firms are expanding their investment in the United States
1. Foreign investments in the United States provide employment for millions of
people.
2. Reasons for foreign expansion in the U.S.
a. International diversification
21-6
g. Labor restrictions overseas
Perspective 21-4: This is a good place to talk about current political risk.
C. Analysis of Political Risk
1. The structure of the foreign government and/or those in control may change
many times during the lengthy period necessary to recover an investment.
“Unfriendly” changes may result in:
a. Foreign exchange restrictions
2. Safeguards against political risk
a. A thorough investigation of the country’s political stability prior to
investment.
b. Joint ventures with local (foreign) companies
VI. Financing International Business Operations
A. Letters of credit: in order to reduce the risk of nonpayment, an exporter may require
an importer to furnish a letter of credit. The letter of credit is normally issued by the
importer’s bank and guarantees payment to the exporter upon delivery of the
merchandise if the specified conditions are met.
B. Funding of transactions
2. Loans from the parent company or sister affiliate. See Figure 21-4.
a. Parallel loans: an arrangement where two parent firms in different
21-7
countries each make a loan to the affiliate of the other parent. The
PPT A Parallel Loan Arrangement (Figure 21-4)
PPT A Fronting Loan Arrangement (Figure 21-5)
3. Eurodollar loans: loans from foreign banks that are denominated in dollars.
a. There are many participants in the Eurodollar market from
throughout the world, particularly the U.S., Canada, Western Europe,
4. Eurobond market: long-term funds may be secured by issuing Eurobonds.
These bonds are sold throughout the world but are denominated primarily in
U.S. dollars.
a. Disclosure requirements are less stringent.
5. International equity markets: selling common stock to residents of a foreign
country provides financing and also reduces political risk.
Perspective 21-5: The instructor may wish to indicate the importance of international equity
markets in the current age of the MNC.
a. Multinational firms list their shares on major stock exchanges around
the world. Half the stocks listed on the Amsterdam stock exchange
21-8
are foreign.
b. Marketing securities internationally requires firms to adjust their
Finance in Action: Political Risk in Argentina
This box provides an opportunity to discuss the risk of expropriation. The government of
6. International Finance Corporation (IFC): the IFC was established in 1956 and
is a unit of the World Bank. Its objective is to promote economic
development in the 189 member countries of the World Bank that own it.
a. A multinational firm may be able to raise equity capital by selling
VII. Some Unsettled Issues in International Finance
A. The complexity of the multinational business environment generates questions for
which there are no easy answers.
1. Should a foreign affiliate design a capital structure similar to that of the
coordinated financial management.
VIII. Appendix 21A: Cash Flow Analysis and the Foreign Investment Decision
Perspective 21-6: The appendix represents a reasonably complicated consideration of a foreign
investment decision by a corporation. Because adequate coverage requires an hour or more, it is
relegated to the appendix.
A. Cash Flow Analysis
B. Tax Factors
C. Foreign Exchange Considerations