Chapter 15 International Business Finance. Key sections Factors affecting exchange rates Nature of exchange risk and types How control exchange risk?. Introduction. Globalization –to make something worldwide in scope/application
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Globalization –to make something worldwide in scope/application
Multinational corporations or MNC’s
financial markets, taxes, cultures, etc.
Trade growing rapidly, capital flows even faster
US Balance of Trade Deficit – 2004- $600 billion, up from less than $500 billion in 2003.
-We are a deficit nation and have to borrow from other countries – Japan and China
- Will they continue to lend? Pressure on the dollar?
Price of a foreign currency in terms of the domestic currency
Exchange risk – future rates may be different
Exchange markets –method of transferring purchasing power
1949-1970 – exchange rates fixed (more or less)
Since 1973 – floating rates
Determined by supply/demand; change minute by minute
Most exchange controls eliminated
1999 – 11 European countries adopted common currency, the Euro (€)
No more DM, FF, Lira
Easier to travel and trade goods and services
Eliminates price differences
Broadens/deepens capital markets
Devaluation – currency made cheaper
Direct quote = number of units of home currency to buy one unit of foreign currency
Indirect – foreign units per home unit
Spot rate – rate agreed today for exchange in two days
Forward rate – rate agreed today for future exchange
Cross rates – two foreign currencies for each other
How many yen per British pound?
Market conditions (supply/demand)
Economic situation – growth or no-growth
Balance of Payments – surplus or deficit?
Relative interest rates – high rates attract capital flows
Relative inflation rates
All based on “perceived value”
Forward contract requires delivery at a fixed date of fixed amounts of two currencies at a fixed exchange rate
Most active markets – 30, 60, 90 day periods but up to ten years
Direct ($/£)Indirect (£/$)
Spot $1.5315 £ .6530
1 month 1.5285 .6542
3 months 1.5231 .6566
6 months 1.5149 .6601
Can buy £ forward today and will know the precise amount due
. Locks in exchange rates
. Protects against future fluctuations
Owe UK supplier £1 million in six months
. Risk comes from writing contract in foreign currency
. One of us is going to have to take risk
Spot rate (two day delivery) = $1.5315
Six month forward = $1.5149
Owe £1,000,000 in six months
Buy forward, locks in $1,514,900
Cost is $1,600,000 or $85,100 more
Hedge – take action to offset risk
Prepay? Gives up interest.
Buy foreign currency denominated asset (bank account)? Probably OK.
Buy forward? Very flexible – customized
Use futures or options? Another possibility
Foreign currency receivables
Foreign currency securities in a portfolio
Foreign subsidiaries have foreign currency revenue/expenses and asset/liabilities
Assets in foreign currency depreciate if currency devalues
Liabilities also decline
What is the net exposed position?
Translation exposure – translating accounting statements into dollars
Transactions exposure – when receipts or payments are in foreign currency
Overall impact on value of the firm or its competitive position
What happens to GM if yen appreciates?
- Affected by product, market structure and price elasticity
Purchase of foreign security – Portfolio
Return unknown – risky
Exchange rates introduce greater variability
Purchase of a company or factory
Worldwide foreign direct investment was $1.4 trillion in 2000
Assets (balance sheet) and income statement kept in local currency
Profits returned in dollars
Changes in taxes
Government controls such as required local equity participation
May be possible to hedge with insurance, government or private