Chapter_14.ppt

Chapter 14
International Short-Term Financing
and Investment

Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
Objectives
• To explain why short-term foreign currency financing
and investment are considered
• To consider the choice between domestic and
foreign currency financing and investment
• To identify the costs and benefits of
financing/investment with a portfolio
14-2

Internal financing
• A multinational firm can utilise internal financing by:
requesting a transfer of funds from a subsidiary
increasing mark-ups on supplies sent to subsidiaries
14-3

Sources of external financing
• Standby Eurocredits: Eurocurrency lines and
revolving commitments
• Euronotes: note issuance facilities and Euro-
commercial papers
14-4

Why foreign currency financing?
• Foreign currency financing introduces FX risk only if
there is no exposure already
• It may be cheaper
14-5

Three-month interest rates (Australia)
0
4
8
12
16
20
1984Q4 1987Q4 1990Q4 1993Q4 1996Q4 1999Q4 2002Q4 2005Q4 2008Q4
14-6

Three-month interest rates (U.S.)
0
4
8
12
16
1984Q4 1987Q4 1990Q4 1993Q4 1996Q4 1999Q4 2002Q4 2005Q4 2008Q4
14-7

Three-month interest rates (Japan)
0
2
4
6
8
10
1984Q4 1987Q4 1990Q4 1993Q4 1996Q4 1999Q4 2002Q4 2005Q4 2008Q4
14-8

Three-month interest rates (U.K.)
0
4
8
12
16
1984Q4 1987Q4 1990Q4 1993Q4 1996Q4 1999Q4 2002Q4 2005Q4 2008Q4
14-9

Effective financing rate from an Australian
perspective (USD)
-16
-8
0
8
16
24
1984Q4 1987Q4 1990Q4 1993Q4 1996Q4 1999Q4 2002Q4 2005Q4 2008Q4
14-10

perspective (JPY)
-24
-16
-8
0
8
16
24
1984Q4 1987Q4 1990Q4 1993Q4 1996Q4 1999Q4 2002Q4 2005Q4 2008Q4
14-11

perspective (GBP)
-20
-10
0
10
20
30
1984Q4 1987Q4 1990Q4 1993Q4 1996Q4 1999Q4 2002Q4 2005Q4 2008Q4
14-12

International short-term investment
• International short-term investment is the placement
of excess funds in short-term investments
denominated in various currencies
14-13

Short-term investment
• Time deposits
• Certificates of deposit:
Tap CDs
Tranche CDs
Rollover CDs
14-14

The effective financing rate
S
i
e
S
i
e










1
)
1
)(
1
(
14-15

The effective rate of return
S
i
r
S
i
r










1
)
1
)(
1
(
14-16

The effect of changes in the exchange rate


 i
e
• Foreign currency appreciation


 i
e
• Foreign currency depreciation


 i
e
• No change
14-17

The effective financing rate with bid-offer
spread
1
)
1
(
0
1








 
b
a
a
S
S
i
e
14-18

The effective rate of return with bid-offer
spread
1
)
1
(
0
1








 
a
b
b
S
S
i
r
14-19

Implications of CIP
• If covered interest parity (CIP) holds, the effective
financing rate and the rate of return will be equal to
the domestic interest rate
14-20

Measuring risk: probability distributions
 2
1
2
1
)
(
)
(
σ
)
(
e
E
e
p
e
p
e
e
E
i
n
i
i
n
i
i
i







14-21

Measuring risk: historical data
 








n
t
t
n
t
t
e
e
n
e
e
n
e
1
2
2
1
1
1
)
(
1

14-22

Financing with and investment in a portfolio of
currencies
1
1
1 1
,









n
i
m
j
z
j
y
i
z
j
z
y
i
y
p
j
i
z
y
p
p
e
w
e
w
e
w
w
14-23

Centralised versus decentralised cash
management
• Centralised: receipts and payments in various
currencies are managed by a central body
• Decentralised: receipts and payments are managed
by branches and subsidiaries
14-24

Advantages of centralised cash management
• Netting involves the calculation of the overall position
in each currency by adding up short and long
positions of branches and subsidiaries
• Netting provides a natural hedge when there is a
short position in one currency and an equivalent long
position in the same currency
14-25
(cont.)

Bilateral netting
A B
500 000
Before
Netting
300 000
A B
200 000
After
Netting
14-26

Multilateral netting
B
Before Netting After Netting
B
C
A
D
B
C
A
D
14-27
(cont.)

Multilateral
netting (cont.) 300 000
A
C
400 000
B
200 000
B
B
1600 000
500 000
C
C
400 000
900 000
D
B
600 000
1200 000
D
A
300 000
900 000
C
A
1200 000
700 000
D
600 000
D
C
100 000
C
A
14-28

(cont.)
• Currency diversification means that even if the
combined position is not zero, centralised cash
management may result in a combined position that
is so diversified that foreign exchange risk is reduced
significantly, removing the need to hedge individual
positions
14-29
(cont.)

(cont.)
• Pooling: by pooling cash balances in a centralised
location, the cash requirements of any branch or
subsidiary anywhere can be met without having to
keep balances denominated in various currencies in
every locality
14-30

When is decentralised management preferred?
• When delays are expected in transferring funds to
countries with inefficient banking systems
• When local representation is necessary
14-31

Factors determining where cash balances are
held
• Whether or not funds are needed in the future
• Whether or not there is a forward market
• Political risk
• Liquidity considerations
14-32

Chapter_14.ppt

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