Transcript Chapter 18
Chapter 19 McGraw-Hill/Irwin International Corporate Finance Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. 1 Introduction • Today’s business and financial environment is global • Typical opportunities and risks are magnified in this global environment 19-2 Global Business • International Opportunities – U.S. is the largest economy in the world – Developing economies that are growing faster than the U.S. include China and India 19-3 International Opportunities • The four largest export partners for the U.S.: – Canada – Mexico – China – Japan 19-4 International Opportunities Trade restrictions and tariffs affect trading activity between countries • Trade Agreements – NAFTA – CAFTA – Mercosur 19-5 International Opportunities • Trading Zones – European Union • International organizations WTO and IMF promote and facilitate unrestricted trade 19-6 Corporate Expansion into Other Countries • Lowest level of corporate expansion is simple import and export operations • Highest level is direct capital involvement through Multinational Corporations (MNCs) 19-7 Foreign Currency Exchange • The FOREX market is one of largest financial markets in the world — OTC – Commercial banks – Investment banks – Foreign exchange dealers and brokers 19-8 Exchange Rates • The exchange rate is the price of one currency stated in terms of another • Currency transaction types – Spot transaction – Indirect quote – Direct quote 19-9 Exchange Rate • Arbitrage – Form of buying low and selling high – Opportunities to profit through exchange rate mispricing 19-10 Exchange Rate Risk • Potential for exchange rates to change unfavorably over time • Freely-floating regime – Exchange rates are free to change according to supply and demand for the currencies 19-11 Exchange Rate Risk • Managed-floating regime – Governments attempt to influence exchange rates by buying or selling their currency to change supply or demand • Fixed peg arrangement – A government fixes, or pegs, their currency’s value to another currency 19-12 The Forward Exchange Rate and Hedging • Spot exchange rates are for transactions occurring now • Exchange rate risk can be managed by negotiating forward exchange rates 19-13 The Forward Exchange Rate and Hedging • Hedging strategies are used to reduce exchange rate risk – Minimizes firm’s need to exchange foreign currency – Locks in exchange rates using forward rates 19-14 Interest Rate Parity • Difference between spot and forward rates are due to differences in the interest rates of two countries 19-15 Purchasing Power Parity • Illustrates the relationship between exchange rate changes and inflation • Law of one price – Identical products should have the same price, adjusted for currency exchange, no matter where in the world they sell Pd = Pf x Spot rate 19-16 Relative Purchasing Power Parity • Interest rate parity is the relationship between current spot rate and forward rate • Relative purchasing power parity describes how current spot rate will change in future 19-17 Relative Form of PPP Equation 19-18 Political Risks • Country’s political environment may adversely affect investments – – – – Government seizure of company’s assets Expropriation with minimal compensation Enactment of new taxation Limiting or blocking currency conversion 19-19 Minimizing the Impact of Political Risk • Use local financing • Purchase country risk insurance 19-20 International Capital Budgeting • Investing internationally comes with additional sources of risk – Managers should use a higher discount rate to adjust for higher risks 19-21 International Capital Budgeting Cash flow estimates will be in foreign currency, while the discount rate is usually evaluated from the domestic country perspective • Managers can adjust by – Converting all estimated cash flows to domestic currency using estimated exchange rates – Adjusting the discount rate to an equivalent rate in the foreign country to account for differing inflation rates 19-22