Introduction to Global Business 1e - Cengage

Introduction to Global Business 1e - Cengage

1. Explain how foreign exchange risk affects firms and investors. 2. Describe different ways to hedge exchange rate risk. 3. Discuss sources of funds to finance international trade and investment. 4. Apply net present value analyses to the capital budgeting decisions facing firms with international operations. 5. Discuss how exchange rate risk affects firms cash flows and its impact on stock returns. 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 142

EXHIBIT 14.1 THE PRICE IN DOLLARS OF ONE BARREL OF CRUDE OIL, MARCH 2007 TO MARCH 2009 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 143 Measuring Foreign Exchange Exposure Exchange Rate Risk The impact of random change in the value of one currency with respect to other currencies Transactions Risk How short-term changes in exchange rates can affect operating costs and revenues of

firms engaged in international business activities Translation Risk The short-term effects of currency movements on the consolidated accounting statements of a firm 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 144 Interpreting Financial Performance Consolidated Accounting Statements Are the income statements and balance sheets of a multinational corporation and of its all

subsidiaries abroad Are required reporting to home country tax authorities Are affected by currency translation risks 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 145 World Currency Markets Special Drawing Right (SDR) A basket of currencies consisting of dollars, euros, pounds, and yen created by the International Monetary Fund (IMF)

Economic Risk The ways in which long-term exchange rate movements affect firms 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 146 Hedging Foreign Exchange (Forex) Risk with Derivatives Hedging Is the use of currency derivatives to reduce potential transaction, translation, and economic risks of currency movements that

could lead to losses for a firm or investor Speculators Trade in currencies and currency derivatives to earn profits and to help to make currency prices efficient 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 147 Derivatives: Futures Contracts Currency Futures Contracts Standardized agreements to buy or sell a specified amount of currency at a date in the

future at a pre-determined price Long Position Buying a currency contract and profiting on the increased value of the underlying currency over time Short Position Selling a currency contract and profiting on the decreased value of the currency over time 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 148 EXHIBIT 14.2 PAYOFFS FOR FUTURES CONTRACTS

2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 149 Trading Markets Organized Exchanges Trade futures contracts in major currencies and offer price transparency and efficiency Eliminate counterparty risk due to guaranteed payments on contacts 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

1410 Trading Market Terms Marked-to-Market Futures contracts in which gains (losses) are earned (paid) in cash at the end of each trading day Margin The small commitment fee needed to purchase a futures contract Margin Call Losses that cause the contract holders balance to fall below the maintenance margin at the end of the trading day thus requiring additional

investment in the contract to continue holding the contract 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1411 Forward Contracts Currency Forward Contracts Are contracts in the currencies of emergingmarket countries offered by large banks in the OTC market Are less standardized than future contracts such that they can be customized by the seller/counterparty to meet the hedging needs of the buyer

Are not marked-to-market daily Over-the-Counter (OTC) Market The derivatives market run by large banks 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1412 Options Contracts Call Option An investors right (but not obligation) to buy an asset (e.g., a currency) at a pre-determined (strike) price Put Option

An investors right (but not obligation) to sell an asset (e.g., a currency) at a pre-determined price Premium The price paid by the buyer to the seller for an option contract 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1413 EXHIBIT 14.3 PAYOFFS FOR CALL AND PUT OPTIONS CONTRACTS

2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1414 Swap Contracts Currency Swaps Allow firms to exchange currencies at a previously agreed exchange rate as a way to hedge exchange rate movements Plain Vanilla Currency Swap An interest rate swap, often combined with a currency swap, if the interest being swapped is in different currencies

2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1415 EXHIBIT 14.4 VANILLA CURRENCY SWAP 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1416 Financing International Trade and Investment Money Center Banks

Large global banks Clearing House Interbank Payments System (CHIPS) Provides large, wholesale dollar payments services for businesses, banks, and governments Society of Worldwide Interbank Financial Telecommunications (SWIFT) Provides secure communications for contracts, invoices, and other trade documents that accompany cash payments Syndicate A group of banks that collectively make a participation loan to a large international firm 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

1417 International Payment Methods and Documentation Payment In Advance The safest method for exporters, but it exposes importers to risk related to delivery of goods Commercial Letter Of Credit (LC)

Provides payment protection to both exporters and importers, as the importers bank writes a guarantee of payment Bankers Acceptance Open Account When a bank sells a LC into the financial

marketplace as a money market instrument A simple agreement wherein the exporter sends an invoice with the goods and the exporter pays upon the receipt 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1418

International Bond Markets Bond Ratings Moodys and Standard and Poors rating services which are important in assuring foreign investors of the credit quality of bond issues Domestic Bonds Debt contracts sold by firms domiciled in a country in the home currency Foreign Bonds Bonds that are issued by foreign firms in another country in the home currency of that country Eurobonds

Bonds that are sold in any country outside the home country, but in the home countrys currency 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1419 EXHIBIT 14.5a INTERNATIONAL BONDS AND NOTES BY CURRENCY AND ISSUER 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1420 EXHIBIT 14.5b INTERNATIONAL BONDS AND NOTES BY CURRENCY AND ISSUER

2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1421 International Stock Markets Diversification Buying securities in a portfolio with price patterns over time that are different from one another, which reduces the volatility of the portfolio Home Bias Investing most of retirement and other savings in ones home country, which reduces diversification

Contagion When stock markets in many countries move down in concert with one another and thereby reduce international diversification benefits 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1422 EXHIBIT 14.6 DIVERSIFICATION CAN REDUCE RISK FOR INVESTORS 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

1423 Consolidation Among International Exchange Markets New York Stock Exchange (NYSE) and Euronext, which comprises a group of European countries exchanges NASDAQ (National Association of Securities Dealers Automated Quotation system) and American Stock Exchange (AMEX) London Stock Exchange and Italys Borsa Italiana Chicago Mercantile Exchange (SME) and Chicago Board of Trade 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

1424 Government-Supported International Financing International Monetary Fund (IMF) Provides lender-of-last-resort short-term loans to countries in financial crisis Evaluates exchange rate policies Gives technical assistance to countries World Bank Provides long-term loans for economic reform and infrastructure development in emerging and developing markets 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1425 Government-Supported International Financing Terms Trade Finance Bank and government loans used by exporters to finance working capital (i.e., labor, materials, inventory, and accounts receivables) Term Financing Bank and government loans to importers to cover the cost of major purchases 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1426 Major Government-Supported International Financing Institutions Export-Import (Ex-Im) Bank A U.S. government export finance agency that supports U.S. firms competing against government-supported exports of other countries Bank of International Cooperation (JBIC) Japanese bank that supports exporters around the world that have at least thirty percent Japanese content

2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1427 Parent Firm Capital Budgeting Net Present Value (NPV) The difference between present value of future profits on an investment project minus the initial investment cost To calculate the NPV of capital investments in a foreign subsidiary: 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

1428 Assessing Country Risk in Multinational Capital Budgeting Decisions Country Risk The uncertainty in predicting how economic, political, inflation, and tax risk factors will affect an investment in a country Sensitivity Analysis An examination of optimistic, expected, and pessimistic scenarios to give a more complete picture of the risks and returns of investments abroad

2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1429 EXHIBIT 14.7 SELECTING ACCEPTABLE CAPITAL BUDGETING PROJECTS 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1430 The Cost of Capital: Domestic Versus Global Cost Of Capital Is the required rate of return

demanded by stock and bond investors Is used in net present value capital budgeting analyses as the discount rate 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1431 The Cost of Capital: Domestic Versus Global Weighted Average Cost Of Capital The sum of the costs of equity and debt weighted by the amount of financing from these

two capital sources The weighted average cost of capital for a firm is: 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1432 The Cost of Capital: Domestic Versus Global Cost Of Debt The weighted average of different interest rates paid on long-term borrowings Cost Of Equity

The rate of return on equity required by stockholders as estimated by Capital Asset Pricing Model (CAPM): 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1433 Estimating the Cost of Equity International CAPM (ICAPM) An asset pricing model that includes both domestic and global market factors to estimate the cost of equity or required rate of return on stocks The estimated rate of return required by

stockholders as estimated by ICAPM) is: 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1434 Currency Risk and Stock Valuation Cash Flow Sensitivity to Exchange Rate Risk Firms can experience positive and negative fluctuations in cash flows and profits due to currency movements that strengthen or weaken the value of their products in overseas markets 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

1435 Measuring Stock Values and Foreign Exchange Movements Measurement of Long-Run Exchange Risk (Adler and Dumas): 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1436 Market Factors Affecting Equity Valuations Exchange Rate Sensitivity

A stock value measured with the coefficient obtained by regressing the stocks return on a currencys return over time Exchange Risk Beta The sensitivity of a stock to market risk affected by currency movements 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1437 Measuring Stock Values and Foreign Exchange Movements (contd) Measurement of Exchange Risk (Armstrong, Knif,

Kolari, and Pynnnen): 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1438 KEY TERMS exchange rate risk transactions risk translation risk consolidated accounting statements economic risk Special Drawing Right (SDR) hedging speculators

currency futures contracts long position short position organized exchanges marked-to-market margin margin call currency forward contracts over-the-counter (OTC) market call option put option premium currency swaps plain vanilla currency swap money center banks

CHIPS (Clearing House Interbank Payments System) SWIFT (Society of Worldwide Interbank Financial Telecommunications) payment in advance commercial letter of credit (LC) 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1439 KEY TERMS bankers acceptance net present value

open account country risk syndicate sensitivity analysis bond ratings cost of capital domestic bonds weighted average cost of capital foreign bonds cost of debt eurobonds cost of equity diversification beta risk home bias international CAPM (ICAPM)

contagion size factor Export-Import (Ex-Im) Bank value factor trade finance exchange rate sensitivity term financing exchange risk beta Bank of International Cooperation (JBIC) 2014 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1440

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