c hapter 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
international financial management
Letters of credit
CountertradeMethod of Payment
Enforceable debt instrument
Simple collections process
Refusal of shipments
Decline draft acceptance
Potential for defaultAdvantages/Disadvantages of Documentary Collection
Advised letter of credit
Confirmed letter of credit
Irrevocable letter of credit
Revocable letter of credit
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.
Buy forward currency
Buy currency option
Acquire an offsetting asset
To ‘go naked’ is to ignore transaction exposure and assume foreign-exchange risk.
Does not require advance capital
Offers potential for currency appreciation
Creates risk for depreciation of exchange currency
Avoids fees to intermediariesGo Naked
Buying the exchange currency forward in the foreign-exchange market locks in the ‘price’ to be paid.
Protects against decline in value of currency
No capital up front
Eliminates potential for profits associated with currency appreciation
Requires fees to intermediariesBuy Forward Currency
Buying currency options gives buyer the opportunity, but not the obligation to buy currency at a given price in the future.
May exercise option or let it expire depending upon currency values
More expensive than other hedging choices
Allows for appreciation benefits while avoiding risk of depreciationBuy Currency Option
Acquiring an offsetting asset of equivalent size denominated in purchase currency eliminates net transaction exposure.
Requires effort and expense to arrange transaction
Lost opportunity for capital gain if home currency appreciatesAcquire an Offsetting Asset
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.
Economic exposure is the impact on the value of a firm’s operations of unanticipated exchange rate changes.
Minimize working-capital balances
Minimize currency conversion costs
Minimize foreign-exchange risk
rate of return
Choice of currency
Sale of stock