Dr. anil dangwal
m. s. ansari
mba-2nd sem. (11)
What is a company’s
motivation to invest capital
Fill product gaps in foreign markets
where excess returns can be earned.
To produce products in foreign markets
more efficiently than domestically.
To secure the necessary raw materials
required for product production.
How does a firm make an
international capital budgeting
1. Estimate expected cash flows in the foreign
2. Compute their U.S.-dollar equivalents at the
expected exchange rate.
3. Determine the NPV of the project using the U.S.
required rate of return, with the rate adjusted
upward or downward for any risk premium
effect associated with the foreign investment.
Types of Exchange-Rate Risk
Translation Exposure -- Relates to the change in
accounting income and balance sheet statements
caused by changes in exchange rates.
Transactions Exposure -- Relates to settling a particular
transaction at one exchange rate when the obligation
was originally recorded at another.
Economic Exposure -- Involves changes in expected
future cash flows, and hence economic value, caused by
a change in exchange rates.
Management of exchange rate risk exposure
What should a firm do if it knew that a local foreign currency was
going to fall in value (e.g., drop from $.70 per peso to $.60 per
Exchange cash for real assets (inventories) whose value
is in their use rather than tied to a currency.
Reduce or avoid the amount of trade credit that will be
extended as the dollar value that the firm will receive is
reduced and reduce any cash that does arrive as quickly
Obtain trade credit or borrow in the local currency so
that the money is repaid with fewer dollars.
Generally, one cannot predict the future exchange
rates, and the best policy would be to balance
monetary assets against monetary liabilities to
neutralize the effect of exchange-rate fluctuations.
A reinvoicing center is a company-owned financial
subsidiary that purchases exported goods from
company affiliates and resells (reinvoices) them to
other affiliates or independent customers.
International Financing Hedges
Commercial Bank Loans and Trade Bills
Foreign commercial banks perform essentially the same
financing functions as domestic banks except:
• They allow longer term loans.
• Loans are generally made on an overdraft basis.
• Nearly all major commercial cities have U.S. bank
branches or offices available for customers.
•The use of “discounting” trade bills is widely utilized in
Europe versus minimal usage in the United States.
International Financing Hedges
Currency-Option and Multiple-Currency
1. Currency-option bonds provide the holder with the
option to choose the currency in which payment is
received. For example, a bond might allow you to choose
between yen and U.S. dollars.
2. Currency cocktail bonds provide a degree of exchange-
rate stability by having principal and interest payments
being a weighted average of a “basket” of currencies.
3. Dual-currency bonds have their purchase price and
coupon payments denominated in one currency, while a
different currency is used to make principal payments.
Currencies and the Euro
Each country has a representative currency like the $
(dollar) in the United States or the ₤ (pound) in Britain.
On January 1, 1999, the “euro” started trading.
The euro is the common currency of the European
Monetary Union (EMU), which currently includes the
following 12 European Union (EU) countries:
Austria, Belgium, Finland, France, Germany, Gr
eece, Ireland, Italy, Luxembourg, the
Netherlands, Portugal, and Spain.
Currency Market Hedges
A currency option is a contract that gives the holder the
right to buy (call) or sell (put) a specific amount of a
foreign currency at some specified price until a certain
Currency options hedge only adverse currency
movements (“one-sided” risk). For example, a put option
can hedge only downside movements in the currency
Options exist in both the spot and futures markets.
The value depends on exchange rate volatility.
Macro Factors Governing
Purchasing-Power Parity (PPP)
1. The idea that a basket of goods should sell for
the same price in two countries, after exchange
rates are taken into account.
2. For example, the price of wheat in Canadian and
U.S. markets should trade at the same price
(after adjusting for the exchange rate). If the
price of wheat is lower in Canada, then
purchasers will buy wheat in Canada as long as
the price is cheaper (after accounting for
International Trade Draft
The international trade draft (bill of exchange)
is a written statement by the exporter
ordering the importer to pay a specific amount
of money at a specified time.
Sight draft is payable on presentation to the
party (drawee) to whom the draft is
Time draft is payable at a specified future
date after sight to the party (drawee) to
whom the draft is addressed.