Instructional-Material-on-Financial-Management-101-108

Lesson 9: Management of Short-term, Intermediate and Long-term Funds

Overview

  • Key Aspects of International Managerial Finance:

    • Foreign Direct Investment (FDI): Involves transferring capital, managerial, and technical assets to a foreign country by a multinational corporation (MNC).

    • Capital Structure: Involves the selection between long-term debt and equity capital.

    • Investment Cash Flows and Decisions: Measures the amount invested in foreign projects and their corresponding cash flows.

    • Short-term financing options include domestic sources like accounts payable, as well as bank and nonbank sources available in the local environment and the Euromarket.

Module Objectives

  • Discuss sources and types of spontaneous financing.

  • Explore various types of negotiated short-term financing.

  • Identify factors influencing the cost of short-term borrowings.

  • Differentiate between financial markets.

Foreign Direct Investment (FDI)

  • Definition: Transfer of capital, managerial, and technical assets to another country by an MNC.

  • Approaches:

    • OLI Paradigm:

      • O: Owner-specific advantages

      • L: Location-specific characteristics

      • I: Internalization through control of value chain

    • Strategic Motives: Companies seek markets, raw materials, production efficiency, and safety.

  • Equity Participation: MNCs may own 100% (wholly owned subsidiary) or part (joint ventures).

  • Risks: Involves business, financial, inflation, exchange rate, and additional political risk compared to portfolio investments.

Investment Cash Flows and Decisions

  • Difficulty in Measurement: Variation in returns and NPVs from parent and subsidiary perspectives.

  • Tax Considerations: Tax definitions can complicate the measurement of cash flows and returns.

  • Blocked Cash Flows: Repatriated cash flows may be partially or wholly blocked by host governments, affecting parent returns.

  • Risk Types:

    1. Business and financial risks

    2. Inflation and exchange rate risks

    3. Political risks

  • Discount Rate: Based on local cost of equity capital with adjustments for exchange rate and political risks.

International Capital Markets

  • MNCs have greater access to the Euromarket and various financial instruments, leading to potentially lower long-term financing costs.

  • Capital Structure Variances: Differences arise from access to various currencies and markets based on geography.

International Diversification

  • Reduces risk in cash flows through international diversification.

  • Mixed evidence on debt ratios; factors include imperfections in foreign markets, political risks, and agency costs.

Country Factors

  • Unique host country factors cause differences in capital structures such as legal, tax, political, social, and financial aspects.

  • No one-size-fits-all capital structure; MNCs must adapt to global and domestic factors.

Long-term Debt

  • Types:

    • International Bond: Sold outside the country of the borrower across several countries.

    • Foreign Bond: Issued by a foreign entity, denominated in local currency.

    • Eurobond: Issued and sold across countries, denominated differently than the issuer's currency.

Equity Issues and Markets

  • MNCs can raise equity by distributing parent stock internationally.

  • Despite advancements, world equity markets remain dominantly national.

  • Call for more cooperation to enhance the international stock market landscape.

Joint Ventures

  • Host country laws may require MNCs to limit ownership in foreign subsidiaries to below 50%.

  • MNCs may favor debt over equity in foreign investments to minimize political risks and manage capital structure.

Short-term Financial Decisions

  • Local markets provide both short- and long-term financing, with subsidiaries often endorsed by parent MNC backing.

  • Euromarket: An alternative to local regulated markets, providing borrowing opportunities without local currency risks.

The Money Market

  • Definition: Financial relationship between short-term fund suppliers and demanders. Exists for interest-bearing assets.

  • Components:

    • Marketable Securities: Instruments like Treasury bills, commercial paper, and certificates of deposit.

    • Eurocurrency Market: Equivalent to the domestic money market but operates internationally.

The Capital Market

  • Supports long-term fund transactions, including governmental and corporate securities.

  • Key Instruments:

    • Bonds, preferred stock, and common stock.

  • Market Types:

    • Broker Market: Facilitates buyer-seller interaction for securities.

    • Dealer Market: Orders executed by market-making dealers.

  • Market Makers: Provide liquidity by buying/selling securities at set prices.

Activity Questions

  1. Define the money market and Eurocurrency market.

  2. Describe the capital market and primary securities traded.

  3. Differentiate broker and dealer markets.

  4. Explain international capital markets including Eurobond and international equity markets.