BLOCK_18e_Chap021_PPT_Accessible

Foundations of Financial Management Overview

• Title: Foundations of Financial Management 18th edition

• Publisher: McGraw Hill LLC

• All rights reserved. Limited reproduction/distribution.

Learning Objectives

• Describe a multinational company.

• Recognize the impact of exchange rates on profitability and cash flow for companies operating internationally.

• Understand that foreign exchange risk can be hedged or reduced.

• Assess political risks in foreign investment decisions.

• Explore financing options for international operations, which are greater than for domestic operations.

The Changing Landscape of International Business

• Growing Interdependency:

  • Necessitates sound international business relations to enhance future cooperation.

  • Integrates capital markets, which can lead to vulnerability from currency crises and government defaults.

  • Events like terrorism can impact market stability, causing unexpected declines.

• Currency and Trade:

  • Currency crises significantly affect trade between nations, impacting sales and earnings.

  • Notable events: Advent of Euro, which has affected U.S. corporate earnings abroad, and BREXIT (Britain's exit from the EU).

Multinational Corporation (MNC) Characteristics

• Definition: A firm that conducts business activities (30% or more) outside its national borders.

• Types of MNC operations:

  • Exporter:

    • Least risky method, capitalizes on foreign demand without long-term investment.

  • Licensing Agreement:

    • Licensed to local manufacturers to utilize firm's technology for a royalty.

  • Joint Venture:

    • Collaboration with a local firm in foreign countries, preferred for lower political risk.

  • Fully Owned Foreign Subsidiary:

    • Higher risk, profitable but complex operations that can shape trade and economic growth in host countries.

Foreign Exchange Rates

• Definition: The relationship between the values of two currencies.

• Example: $2.00 per pound means £0.50 per dollar (1/$2.00).

• Currency values can fluctuate significantly—no guarantee of strength compared to other currencies, including the U.S. dollar.

Factors Influencing Exchange Rates (1 of 3)

• Inflation:

  • Purchasing power parity theory links rates of exchange to inflation differentials.

  • Example: $1.00 buys a dozen apples in the U.S., whereas 1.25 euros buys a dozen in Germany, leading to an exchange rate of €1.25/$1.00.

Factors Influencing Exchange Rates (2 of 3)

• Interest Rates:

  • Movements from low-yield to high-yield markets. Interest rate parity theory explains interplay between interest differentials and exchange rates.

  • Exchange rates adjust to maintain equilibrium in both foreign exchange and money markets.

• Balance of Payments:

  • Catalogs economic transactions, determining currency strength through trade surplus or deficit.

Factors Influencing Exchange Rates (3 of 3)

• Government Policies:

  • Direct or indirect interventions can manipulate currency values.

  • Monetary and fiscal policies applying government spending can lead to inflation and affect currency value.

Managing Foreign Exchange Risk

• Foreign Exchange Risk:

  • The risk of revenue drops or cost increases due to currency fluctuations.

  • Accounting exposure and transaction exposure are critical for multinational companies.

Types of Foreign Exchange Risk

• Translation Exposure:

  • Affects consolidated figures of parent companies based on changing exchange rates; guided by accounting rules (e.g., SFAS 52).

• Transaction Exposure:

  • Realized through foreign exchange fluctuations from agreement to payment, increasing volatility in reported earnings.

Strategies to Mitigate Transaction Exposure

• Use Forward exchange market hedge, Money market hedge, or Currency futures market hedge to manage risks associated with fluctuations in foreign exchange rates.

Financing International Business Operations

• Importance of assessing political stability and relationship dynamics among trading partners.

• Credit arrangements:

  • Letters of credit help reduce nonpayment risk; they are evaluated by the importer’s bank.

• Options to mitigate loss risk include obtaining export credit insurance.

Political Risk Analysis

• Factors:

  • Government interference, restrictions on foreign ownership, blocking profit repatriation, and asset expropriation by host governments.

• Mitigation tools: Joint ventures and insurance against political risk, such as through U.S. International Development Finance Corporation (DFC).

Conclusion and Future Considerations

• Financial decisions for MNCs are complex, influenced by various sources of financing, leverage levels, dividend policies, and differences in interest and market conditions globally.

Visual Data and Trends

• Visual graphics and tables provide insights into exchange rates, foreign sales percentages, and risk analysis from international diversification. Document contains illustrations and key financial metrics pertaining to foreign exchange cross rates and political risk analysis.