Multinational Business Multinational Business FinanceFinance

Professor M. VaziriProfessor M. Vaziri

Multinational Business Multinational Business FinanceFinance

Professor M. VaziriProfessor M. Vaziri Importance of Multi-National Corporations (MNCs) :

• Technology Transfer• Global Trade

Global Integration of Money & Capital. Law of Comparative & Absolute Advantage MNC & Risk Management Types of MNC :

• Labor, Capital, Technology Seekers, Cost Minimizer.

MNC & Host Countries.

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International Monetary SystemInternational Monetary SystemIMSIMS

Structure of IMSStructure of IMS: Framework within which the foreign Exchange : Framework within which the foreign Exchange rates are determined, capital flows & international trade are rates are determined, capital flows & international trade are accommodated & Balance of Payments Adjustments are madeaccommodated & Balance of Payments Adjustments are made

History of IMSHistory of IMS: The Gold Standard (1876-1913):: The Gold Standard (1876-1913):

Gold as a medium of exchange- Pharaohs (3000 PC)Gold as a medium of exchange- Pharaohs (3000 PC)

The Greeks, Romans & Persians Used gold coins & passed The Greeks, Romans & Persians Used gold coins & passed through the mercantile era to the 19th centurythrough the mercantile era to the 19th century

No multinational agreement, but each country declared a par No multinational agreement, but each country declared a par value for its currency in terms of gold based on rule of games value for its currency in terms of gold based on rule of games or "Gold Standard"or "Gold Standard"

International Monetary SystemInternational Monetary SystemIMS-cont..IMS-cont.. Mercantilism of 19th CenturyMercantilism of 19th Century: Need for IMS:: Need for IMS:

Europe adapted the IMS in 1870 & the U.S.. in 1879Europe adapted the IMS in 1870 & the U.S.. in 1879

$20.67/Ounce of Gold, £4.274/Ounce:$20.67/Ounce of Gold, £4.274/Ounce:

$20.67/£4.2474=£4.8665/$$20.67/£4.2474=£4.8665/$

Limitation of gold reserve & supply of moneyLimitation of gold reserve & supply of money

Limit the flow of goods and gold & suspension of GSLimit the flow of goods and gold & suspension of GS

Inter War Years: 1914-1944:Inter War Years: 1914-1944:

Free Fluctuating of Exchange Rates with consideration of the gold and Free Fluctuating of Exchange Rates with consideration of the gold and par value of other currencies.par value of other currencies.

Short sell of week currencies, re-evaluation of £, the collapse of the Short sell of week currencies, re-evaluation of £, the collapse of the

Austrian banking system-total abandonment of GSAustrian banking system-total abandonment of GS

International Monetary SystemInternational Monetary SystemIMS-cont..IMS-cont..

The Bretton Wood Agreement: (1944): (1944) Dollar based Monetary System (par value based on $)Dollar based Monetary System (par value based on $)

Fixed value in term of $, but not required to convertFixed value in term of $, but not required to convert

Only $ remained convertible to gold: $35/OunceOnly $ remained convertible to gold: $35/Ounce

Only 1% of par allowed for fluctuationOnly 1% of par allowed for fluctuation

Devaluation was not allowed for purpose of high exportDevaluation was not allowed for purpose of high export

10% devaluation for week currency or approval of IMF10% devaluation for week currency or approval of IMF

IMF & World Bank were createdIMF & World Bank were created

Former Soviet Union did participate at Bretton Wood but chose not Former Soviet Union did participate at Bretton Wood but chose not to join IMF or World Bankto join IMF or World Bank

International Monetary SystemInternational Monetary SystemIMS-cont..IMS-cont..

International Monetary Fund IMF:: Mission:Rendering temporary assistance to currencies with cyclical, Mission:Rendering temporary assistance to currencies with cyclical,

seasonal or random fluctuation.seasonal or random fluctuation.

Help countries with a structural trade problemHelp countries with a structural trade problem

IMF is funded based on quota of expected post WWII tradeIMF is funded based on quota of expected post WWII trade

The Original quota were 25% in gold or $ (The Original quota were 25% in gold or $ (Gold trancheGold tranche), & 75% local ), & 75% local currency.currency.

A member country can borrow up to its original 25% in gold or convertible A member country can borrow up to its original 25% in gold or convertible currencies in any 12 month plus 100% of its total quota. A member country currencies in any 12 month plus 100% of its total quota. A member country can also borrow up to 120% of its quota in convertible currency or gold, can also borrow up to 120% of its quota in convertible currency or gold, even through it only paid 25% in convertible currency or gold.even through it only paid 25% in convertible currency or gold.

International Monetary SystemInternational Monetary SystemIMS-cont..IMS-cont..

International Monetary FundInternational Monetary Fund IMF IMF Cont..Cont..::

At the present time, each of the 151 member can borrow up to At the present time, each of the 151 member can borrow up to 150% annually of its quota or up to 450% during a three years 150% annually of its quota or up to 450% during a three years periodperiod

Cumulative access could be up to 600% of members quotaCumulative access could be up to 600% of members quota

Distribution of the quota is prelude to distribution of voteDistribution of the quota is prelude to distribution of vote

U.S. Vote:19.1%, UK:6.6%,Germany:5.8%, France:4.8%,Japan:4.5%,Canada:3.2%U.S. Vote:19.1%, UK:6.6%,Germany:5.8%, France:4.8%,Japan:4.5%,Canada:3.2%

General Agreement to Borrow: IMF ability to borrow from member General Agreement to Borrow: IMF ability to borrow from member countries, currently more than $180 billion.countries, currently more than $180 billion.

Special Drawing Rights (SDR): created according to Rio de Janeiro agreement (1967) to help Special Drawing Rights (SDR): created according to Rio de Janeiro agreement (1967) to help increase the global trade between nationsincrease the global trade between nations

SDR is distributed based on members quota and valued based on 16 then 5 currencySDR is distributed based on members quota and valued based on 16 then 5 currency

First $/SDR determined then value of other currencies are measured First $/SDR determined then value of other currencies are measured

International Monetary SystemInternational Monetary SystemIMS-cont..IMS-cont.. Monetary Development: (1944-1971)Monetary Development: (1944-1971)

EFTA (1957) & EEC (1959), rapid increase in world tradeEFTA (1957) & EEC (1959), rapid increase in world trade

U.S.. deficit of 1959 & International Monetary Reserve dilemma: U.S.. deficit of 1959 & International Monetary Reserve dilemma: BOP deficit to create more reserve for LDCsBOP deficit to create more reserve for LDCs

Doubt of convertibility of major reserve currenciesDoubt of convertibility of major reserve currencies

"Interest Equalization Tax"on foreign borrowing & creation of "Interest Equalization Tax"on foreign borrowing & creation of Euro-bondEuro-bond

Mandatory control of direct foreign investment ,control of foreign Mandatory control of direct foreign investment ,control of foreign lending by U.S banks,& high U.S deficitlending by U.S banks,& high U.S deficit

official Currency Swaps: Group of Ten Industrialized Nations as official Currency Swaps: Group of Ten Industrialized Nations as a interest credit between central banksa interest credit between central banks

International Monetary SystemInternational Monetary SystemIMS-cont..IMS-cont..

Floating Exchange Rate-Crises of 1971:Floating Exchange Rate-Crises of 1971:

U.S. BOT had reached to all-time high in 1971U.S. BOT had reached to all-time high in 1971

U.S lost one-third of her official gold & president Nixon suspended U.S lost one-third of her official gold & president Nixon suspended convertibility of $ to goldconvertibility of $ to gold

U.S.imposed 10%surcharge on imports & freezed P&WU.S.imposed 10%surcharge on imports & freezed P&W

Most European currencies gained against $Most European currencies gained against $

Smithsonian agreement: : December of 1971December of 1971

Group ten Industrialized Nations signed on Dec, 17 1971Group ten Industrialized Nations signed on Dec, 17 1971 $ devaluated to $38/Ounce, Yen evaluated against $ :16.9%,Canada 7.4%$ devaluated to $38/Ounce, Yen evaluated against $ :16.9%,Canada 7.4%

Floatation of 2.25% (Max 4.5%) is allowedFloatation of 2.25% (Max 4.5%) is allowed $ lost its value sharply: $42.22 in free market, $70 in official London market$ lost its value sharply: $42.22 in free market, $70 in official London market

International Monetary SystemInternational Monetary SystemIMS-cont..IMS-cont..

Jamaican Agreement: January 1976

Floating Rate has been established ( has continued today)Floating Rate has been established ( has continued today)

Gold was demonetarized as a reserved assetGold was demonetarized as a reserved asset

IMF agreed to sell $25 million ounces of gold to its members and IMF agreed to sell $25 million ounces of gold to its members and used the proceeds to help the poor nationsused the proceeds to help the poor nations

IMF quota increased to $41 and then to $180 billionIMF quota increased to $41 and then to $180 billion

10% of the voting power given to OPEC members10% of the voting power given to OPEC members

Non-oil producing countries have more access to IMFNon-oil producing countries have more access to IMF Floating Exchange Rate System has officially adopted & continued until Floating Exchange Rate System has officially adopted & continued until

present timepresent time

International Monetary System IMS-cont..International Monetary System IMS-cont..

• Plaza Agreement

• Louvre Agreement

http://www.econ.iastate.edu/classes/econ355/choi/cur.htm

Gravurev.ppt

Balance of Payments (BOP) Balance of Payments (BOP) Definition of BOP: Record of transactions between

residents of one country & rest of the world Functions of BOP:

• Helps force market potential of a country

• Helps to understand the currency fluctuation of a country

• It is a poor description of National Economy

• Useful in measuring economic performance if there is FER

$ was indexed at 100 at 1970: If index is greater than 100,$ gain Vs other countries currencies.

Accounts of BOP:• Trade Balance : Net balance in merchandise traded

• Current Account: Trade account+earning & expe on services

• Performed service: travel, shipping, banking, insurance, etc

• Debt service: interest, dividend received or paid abroad.

Gravurev.ppt

Balance of Payments (BOP) Con.. Balance of Payments (BOP) Con..• Basic Balance: Current account+long term capital (such as direct

investment)

• Overall Balance: basic Balance+short term capital +Error & Omission

• Unilateral Transfer: no corresponding flow of G&S-non military goods, grants, foreign aids, donation, inheritance

• Capital account: record of investment & payments

Macro Modeling of BOP: Aggregates Income: Y=C+S, Where, C=Agg Consumption & S=Agg Saving Aggregate Expenditure: E=C+Id, where Id=Domestic investment Y-E=S-Id

If Y is greater than E, S is greater than Id

Gravurev.ppt

Balance of Payments (BOP) Con.. Balance of Payments (BOP) Con..Coping with Current account deficit (CAD):

Relationship between CAD & currency depreciation According to General Equilibrium View : not a simple one

1976-1980: $ depreciate, CAD decreased 1980-1985 $ appreciate, CAD increased

Impose high tariffs & quotas: Since S-Id=X-M, (unless S & Id changes), if M decline, X must

decline : less import means less demand for foreign currency, less supply of domestic currency, and an increase in value of domestic goods, which mean less export.

End Foreign ownership of domestic assets No capital account surplus means interest rate will increase &

investment & income will decline

Stimulate savings: If S is greater than Id, we will have capital outflow, causing deficit to decrease in both Government budget & Current Account.

Foreign Exchange Market(FEM)

FF

The Functions of FEMThe Functions of FEM

1. Transfer of Purchasing Power.

2. International Credit such as L.C.

3. Minimize Exposure to Foreign Exchange Risk

4 Market for Hedging & Arbitrageur

5 Market for currency Swaps, futures &

forward/Spot Transactions

1. Transfer of Purchasing Power.

2. International Credit such as L.C.

3. Minimize Exposure to Foreign Exchange Risk

4 Market for Hedging & Arbitrageur

5 Market for currency Swaps, futures &

forward/Spot Transactions

Participants in FEM1. Banks & Non-banks2. FEM Dealers- benefited from bid-ask spread3. Market Makers-Position on certain Currencies4. FEM Brokers (56%)5. Exporter, Importer, Tourists MNCs, Portfolio Managers6. Speculators & Arbitrageur7. Central Banks

Types of FEM Transactions Spot Transactions: one day settlement (63% of market) Forward Transactions: one, two, six & 12 month (6%) Swaps Transactions: Simultaneous purchase or sale of FE,

with two value dates: spot-forward, forward-forward

Spot Transactions

Forward Transactions

Swaps TransactionsExample: sell £20 mil forward for $ deliver in two monthsat $1.4870/£ & simultaneouslybuy back £20 mil forward fordelivery in three month at$1.4820/£.

Types of QuotationsTypes of Quotations Direct Quotation : Direct Quotation :

Home currency in terms of foreign currency.Home currency in terms of foreign currency. $/ff=$.1265/ff: American Way$/ff=$.1265/ff: American Way

Indirect Quotation:Indirect Quotation: Foreign currency in terms of home currencyForeign currency in terms of home currency ff/$=ff7.9045/$.ff/$=ff7.9045/$.

Bid & ask spread:Bid & ask spread: buy(bid) at ff7.9030/$ & ask(offer) at ff7.9070/$buy(bid) at ff7.9030/$ & ask(offer) at ff7.9070/$ Difference between bid-ask is dealerDifference between bid-ask is dealer

premium=transaction costpremium=transaction cost

Cross Rates:Cross Rates: Dutch Guilder/$ over Danish KoranDutch Guilder/$ over Danish Koran

DF3.0245/DK9.7215=DG.3111/KoranaDF3.0245/DK9.7215=DG.3111/Korana

Point Quotation:Point Quotation: Difference between forward rate & spot rate (swap rate).Difference between forward rate & spot rate (swap rate).

TRIANGULAR ARBITRAGEURTRIANGULAR ARBITRAGEUR

U.S $U.S $ UK £UK £ DMDM

$$ 1 1 S($/£)=1.8930 S($/DM)=0.453 S($/£)=1.8930 S($/DM)=0.453

££ S(£/$)=0.526 1 0.239 S(£/$)=0.526 1 0.239

DMDM 2.205 4.190 1 2.205 4.190 1

If S(DM/$)*S(£/DM)*S($/£) is greater than one, successful arbitrageur.

(2.205*0.239*1.893)=$0.9979, not successful arbitrageur

Buying & selling of one currency for another & returning to the original one.

The Interest Rate Parity The Interest Rate Parity TheoryTheory

DEF:DEF: Except for transaction costs, Except for transaction costs, the differences in the differences in national interest rate,national interest rate, for security of similar risk & for security of similar risk & maturity maturity should be equal should be equal but opposite in sign, to but opposite in sign, to forward exchange rateforward exchange rate discount or premium for foreign discount or premium for foreign currency.currency.

It links National Monetary Market Rate to Foreign It links National Monetary Market Rate to Foreign Exchange Rate.Exchange Rate.

Forward Exchange Rate Discount & Premium:Forward Exchange Rate Discount & Premium:

(Forward Rate-(Forward Rate-Spot RateSpot Rate))/(Spot Rate)*12/n*100/(Spot Rate)*12/n*100

((Spot RateSpot Rate--Forward RateForward Rate)/(Forward Rate)*12/n*100 )/(Forward Rate)*12/n*100

DM2.5885-2.5639/2.5639*12/3*100=+3.8379 per year:DM2.5885-2.5639/2.5639*12/3*100=+3.8379 per year:

It means DM is in 3.8379%, 3-month forward It means DM is in 3.8379%, 3-month forward premium or the U.S. $ is in 3.8379%, 3-month premium or the U.S. $ is in 3.8379%, 3-month forward discountforward discount..

Test for ParityTest for Parity– UK 3-Month Interest Rate=12% per year UK 3-Month Interest Rate=12% per year

– U.S. 3-month Interest Rate=7% per yearU.S. 3-month Interest Rate=7% per year

– Transaction Cost=.15% should be calculated at the beginning of Transaction Cost=.15% should be calculated at the beginning of transactiontransaction

– Size of Transaction=$2,800,000.00Size of Transaction=$2,800,000.00

Covered Interest Arbitrageur actions:Covered Interest Arbitrageur actions:– Step 1. Borrow $2.8mil at 7%/year for 3-monthStep 1. Borrow $2.8mil at 7%/year for 3-month

– Step 2. Exchange $2.8 mil for £ at spot rate of $1.4000/£ & receive Step 2. Exchange $2.8 mil for £ at spot rate of $1.4000/£ & receive £2mil.£2mil.

– Step 3. Invest £2mil for 3-month in UK at 12%/year or 3%/Quarter.Step 3. Invest £2mil for 3-month in UK at 12%/year or 3%/Quarter.

– Step 4. Sell £2.06mil forward at 3-month forward rate of $1.3860/£: Step 4. Sell £2.06mil forward at 3-month forward rate of $1.3860/£: which include £2mil principal & £60,000 interest for the 3-month which include £2mil principal & £60,000 interest for the 3-month (3%*2mil=$60mil (3%*2mil=$60mil

– Step 5. Pay transaction cost of $4,200 ($2.8*.15)Step 5. Pay transaction cost of $4,200 ($2.8*.15)

The operation of Covered Interest The operation of Covered Interest ArbitrageurArbitrageur

Covered Interest Arbitrageur actions-con..:Covered Interest Arbitrageur actions-con..:– Step 6. Three month after, redeem UK investment of Step 6. Three month after, redeem UK investment of

£2,06mil£2,06mil

– Step 7. Fulfill forward contract by selling £2060mil at Step 7. Fulfill forward contract by selling £2060mil at $1.3860/£ forward rate & receive $2.855160.$1.3860/£ forward rate & receive $2.855160.

– Step 8. Repay loan of $2.8mil plus 3-month interest at Step 8. Repay loan of $2.8mil plus 3-month interest at 1.75%/Quarter ($2.8*1.75%=$49000).1.75%/Quarter ($2.8*1.75%=$49000).

Profit Calculation:Profit Calculation:– Proceed from investment in UK=$2,855,160.Proceed from investment in UK=$2,855,160.

– Principal+interest from borrowing=$2,849,000Principal+interest from borrowing=$2,849,000

– Transaction cost=$4200Transaction cost=$4200

– Net profitNet profit=$2,855160-2,849000-4200==$2,855160-2,849000-4200=$1,950.00$1,950.00

The operation of Covered Interest The operation of Covered Interest Arbitrageur-Con...Arbitrageur-Con...

Speculation in FEMSpeculation in FEM Spot Market Speculation:Spot Market Speculation:

•Spot rate:DG2.9000/$,Forward Spot rate:DG2.9000/$,Forward Rate=DG2.8000/$Rate=DG2.8000/$

• 6-month expected spot rate=DG2.700/$6-month expected spot rate=DG2.700/$•With $40,000, buy:$40,000*DG2.9=DG116000With $40,000, buy:$40,000*DG2.9=DG116000•Sell at DG2.7/$ for $42965 (116000/2.7)Sell at DG2.7/$ for $42965 (116000/2.7)•Make profit of 2965 or14.82%/YearMake profit of 2965 or14.82%/Year

Forward Market SpeculationForward Market Speculation BBuy $40,000*DG2.8=DG112000uy $40,000*DG2.8=DG112000

BBuy back $ at DG2.7=$41,481uy back $ at DG2.7=$41,481

Profit=$1,481Profit=$1,481

Factors to be considered in forecasting the ER

Factors to be considered in forecasting the ER

1. Expected changes in spot rate,

2. Inflation rate differential,

3. Interest rate differential,

4. BOP problems,

5. Growth of Money supply

6. Business Cycle,

7. Change in International Monetary Reserve,

8. Increase in official-nonofficial rate spread

9. FE policies such as , FE. control, ceilings on interest rate, high import

duties, export subsidies, excess G-Spending,

10. Elasticity of demand for exchange rate, Forward rate discount or premium

1. Expected changes in spot rate,

2. Inflation rate differential,

3. Interest rate differential,

4. BOP problems,

5. Growth of Money supply

6. Business Cycle,

7. Change in International Monetary Reserve,

8. Increase in official-nonofficial rate spread

9. FE policies such as , FE. control, ceilings on interest rate, high import

duties, export subsidies, excess G-Spending,

10. Elasticity of demand for exchange rate, Forward rate discount or premium

Foreign Change Market Foreign Change Market Cont..Cont.. Purchasing power Parity (PPP)Theory :Purchasing power Parity (PPP)Theory :

Def: If the Def: If the spot ratespot rate between two countries starts in equilibrium, any between two countries starts in equilibrium, any change in the difference of change in the difference of rate of inflationrate of inflation between them tends to be between them tends to be offset over the long run by equal, but opposite change in spot offset over the long run by equal, but opposite change in spot exchange rate. exchange rate.

If inflation rate in China increases by 4%, Chin's Ys deprecate by 4%If inflation rate in China increases by 4%, Chin's Ys deprecate by 4% Current Account Balances are very sensitive to change in inflation Current Account Balances are very sensitive to change in inflation

RateRate

International Fisher Effect (Fisher Open):International Fisher Effect (Fisher Open): Difference in Difference in interest rateinterest rate between two countries is equal, but between two countries is equal, but

opposite in sign to the opposite in sign to the spot exchange ratespot exchange rate of foreign currency to of foreign currency to home currencyhome currency

Fisher Effect (Irving Fisher):Fisher Effect (Irving Fisher): Differences in Differences in inflation rateinflation rate between countries is equal to the between countries is equal to the interest interest

raterate differential between them. differential between them.

Foreign Change Market Foreign Change Market Cont..Cont.. Foreign Currency Option (FCO) :Foreign Currency Option (FCO) :

DefDef: FCO is a contract that gives buyers the: FCO is a contract that gives buyers the right right to buy or sell a to buy or sell a given given amount of foreign exchangeamount of foreign exchange at a at a fixed price fixed price (exercise price or strike price) (exercise price or strike price) per unit for a specific period of time.. per unit for a specific period of time..

Types of FCOTypes of FCO: : American OptionAmerican Option: Right to exercise on any day before the : Right to exercise on any day before the expiration date, expiration date, European Option: European Option: only on the expiration date.only on the expiration date.

In-the Money Option: In-the Money Option: When you make profit, When you make profit, At-the-money option:At-the-money option: when when profit is zero, andprofit is zero, and Out of-the money option: Out of-the money option: when you have a losswhen you have a loss

FCP is a flexible transaction of over 1 mil in major trading currencies for FCP is a flexible transaction of over 1 mil in major trading currencies for any time period up to one year, tailored to the customer's need. any time period up to one year, tailored to the customer's need.

This is a good alternative to the forward market. This is a good alternative to the forward market.

FCP Premium: A percentage of transaction:FCP Premium: A percentage of transaction: paid advance & according to following factorspaid advance & according to following factors

1. Strike price relative to spot rate1. Strike price relative to spot rate 2. Supply & demand for option2. Supply & demand for option 3. Relative interest rate between countries3. Relative interest rate between countries 4. Relative currency risk, and4. Relative currency risk, and 5. Maturity of the option.5. Maturity of the option.

Foreign Exchange Market Foreign Exchange Market Cont..Cont.. Maturity dates & size of FCO:Maturity dates & size of FCO:

Saturday proceeding the third Wednesday of expiration MonthSaturday proceeding the third Wednesday of expiration Month March March, , June,June, September, September, and and December.December.

Contract size:Contract size: Cited as fixed contract per unit, such as DM62,500/per unit of Cited as fixed contract per unit, such as DM62,500/per unit of option: with one mil$ one can buy:$ one mil/¨DM62,500=16 FCP contractoption: with one mil$ one can buy:$ one mil/¨DM62,500=16 FCP contract

Price of FCP: Price of FCP: No of cents per unit: £12,500*.02=$250.No of cents per unit: £12,500*.02=$250.

An Exercise on FCP:An Exercise on FCP: March $1.45 call option payees $.02 per £ ( purchase £12,500 at $1.45 March $1.45 call option payees $.02 per £ ( purchase £12,500 at $1.45

option with expiration date of March.option with expiration date of March. If price of £ increase to $1.5100, buy £ at £1.4500 & sell £ 1.5000 & make If price of £ increase to $1.5100, buy £ at £1.4500 & sell £ 1.5000 & make

$1.5100-1.4500=.06 per £ or 12500*.06=$750. $1.5100-1.4500=.06 per £ or 12500*.06=$750. Subtract transaction cost of 250, & make a net profit of $750-250=$500.Subtract transaction cost of 250, & make a net profit of $750-250=$500.

Currency Future Market (CFM):Currency Future Market (CFM): Def of CFM: CF are contract between the future dealers & client.Def of CFM: CF are contract between the future dealers & client. It does not involve commercial banks & tradersIt does not involve commercial banks & traders Difference between CFM & Forward Exchange Market, as inflation, Difference between CFM & Forward Exchange Market, as inflation,

contract is drawn up between banks & client;contract is drawn up between banks & client; Major Participants in CFM are: Importer & Exporter, Speculators & Major Participants in CFM are: Importer & Exporter, Speculators &

Arbitrageur, and those who invest abroad. Arbitrageur, and those who invest abroad.

Multinational Capital BudgetingMultinational Capital Budgeting

DEF: Selecting multinational assets & allocating the DEF: Selecting multinational assets & allocating the required funds with consideration of the following:required funds with consideration of the following:

• Cheap loan from foreign governmentCheap loan from foreign government

• Foreign Exchange rate risk.Foreign Exchange rate risk.

• Multiple ties of taxation of different countriesMultiple ties of taxation of different countries

• Restrictions on repatriation of income.Restrictions on repatriation of income.

NPV=-CO+CFl (1+t)/(1+i)*t, where:NPV=-CO+CFl (1+t)/(1+i)*t, where:• NPV=Net Present ValueNPV=Net Present Value

• Co=cost of projectCo=cost of project

• E=Market value of equityE=Market value of equity

• CFl=Before tax expected cash flowCFl=Before tax expected cash flow

• t=tax ratet=tax rate

• I=WACC=interest rateI=WACC=interest rate

Multinational Capital Budgeting Multinational Capital Budgeting cont..cont..

Factors Affecting Inventories Cash Flow: Factors Affecting Inventories Cash Flow: • Blocked Funds: Limitation of transfer of foreign exchange for trade or Blocked Funds: Limitation of transfer of foreign exchange for trade or

currency non-convertibility, if used for financing of the project, it alters currency non-convertibility, if used for financing of the project, it alters the cost of capital for the firm.the cost of capital for the firm.

• Remittance restriction: only remitted cash flow is relevant.Remittance restriction: only remitted cash flow is relevant.

• Differences in tax structure.Differences in tax structure.

• Concessionary loan.Concessionary loan.

• Effect on the sales of other divisionsEffect on the sales of other divisions

NPV=-CO+CFl (1+t)/(1+i)*t, where:NPV=-CO+CFl (1+t)/(1+i)*t, where:• NPV=Net Present ValueNPV=Net Present Value

• Co=cost of projectCo=cost of project

• E=Market value of equityE=Market value of equity

• CFl=Before tax expected cash flowCFl=Before tax expected cash flow

• t=tax ratet=tax rate

• I=WACC=interest rateI=WACC=interest rate

Multinational Capital Budgeting Multinational Capital Budgeting cont..cont..

Calculation of Incremental Cash Flow: Calculation of Incremental Cash Flow: • Cash Flow associated with the projectCash Flow associated with the project

• Cost of CapitalCost of Capital

• Cash flow during the life of the project BCash flow during the life of the project B

Incremental Cash flow is different from total cash flow: Incremental Cash flow is different from total cash flow: • Cannibalization: new product taking sales away from existing productCannibalization: new product taking sales away from existing product

• Sales creation-opposite of cannibalizationSales creation-opposite of cannibalization

• Opportunity cost_windfall profit taxOpportunity cost_windfall profit tax

• Sunk costSunk cost

• Transfer pricingTransfer pricing

• National inflation difference, unexpected exchange rate, interest rate National inflation difference, unexpected exchange rate, interest rate difference, political & economical environment, anddifference, political & economical environment, and

• Difficulty in estimating terminal value.Difficulty in estimating terminal value.

Financing the International Trade Financing the International Trade Export-Import FinancingExport-Import Financing

Functions of Financing the trade:Functions of Financing the trade:

Managing the risk of completion of the transaction.Managing the risk of completion of the transaction.

Protection against foreign exchange rate risk.Protection against foreign exchange rate risk.

A measure of financing the transaction.A measure of financing the transaction.

Solve the dilemma of Solve the dilemma of seller maintaining the legal right to seller maintaining the legal right to titletitle until paid & until paid & buyer reluctant to paybuyer reluctant to pay until receiving the until receiving the merchandise .merchandise .

Financing the International Trade Financing the International Trade Export-Import Financing (con...)Export-Import Financing (con...)

Types and Mechanisms of Financing:Types and Mechanisms of Financing:

Letter of Credit (L/C):Letter of Credit (L/C):Issued by a Issued by a importer bankimporter bank at the at the request of an request of an importerimporter. . Importer bankImporter bank promises to pay promises to pay the the exporterexporter upon receiving of required document upon receiving of required document specified in L/C.specified in L/C.

Types of L/C:Types of L/C:

IrrevocableIrrevocable (can not be canceled without consent of all (can not be canceled without consent of all parties) v.s. parties) v.s. RevocableRevocable (can be canceled or amended (can be canceled or amended before payment).before payment).

Export-Import Financing (con...)Export-Import Financing (con...)ConfirmedConfirmed (both banks of importer and exporter have (both banks of importer and exporter have

obligated to pay) v.s. obligated to pay) v.s. Unconfirmed Unconfirmed (only obligation of (only obligation of issuing banks).issuing banks).

Revolving (valid for more than one transaction) v.s. non-Revolving (valid for more than one transaction) v.s. non-revolving (only good for one transaction).revolving (only good for one transaction).

Cumulative revolving (amount that is not used can be Cumulative revolving (amount that is not used can be added together) v.s. non-cumulative (amount which is not added together) v.s. non-cumulative (amount which is not used can not add together).used can not add together).

Issuers of L/C: L/Cs can be issued by foreign bank and Issuers of L/C: L/Cs can be issued by foreign bank and confirmed by local bank or confirmed by third party. confirmed by local bank or confirmed by third party.

Export-Import Financing (con...)Export-Import Financing (con...) It can be issued only by local bank or issued by foreign It can be issued only by local bank or issued by foreign

bank with no confirmation from domestic bank.bank with no confirmation from domestic bank.

Draft: Bill of Exchange (B/E): Draft: Bill of Exchange (B/E): Order written by an Order written by an exporterexporter to be paid a specific amount of money by the to be paid a specific amount of money by the importerimporter or importer bank at a specific period of time. or importer bank at a specific period of time.

Party who initiates the draft is called Party who initiates the draft is called DrawerDrawer or or Originator (Usually exporter).Originator (Usually exporter).

Party the draft being written for is Party the draft being written for is DraweeDrawee (usually (usually importer). If drawee is buyer, draft is called trade draft, importer). If drawee is buyer, draft is called trade draft, if it is bank, it is called bank draft.if it is bank, it is called bank draft.

Export-Import Financing (con...)Export-Import Financing (con...)Conditions for Draft:Conditions for Draft:

It must be in writing and signed by a drawer.It must be in writing and signed by a drawer.

It must contain an unconditional promise to pay a definite It must contain an unconditional promise to pay a definite sum of money to drawer at a specific time.sum of money to drawer at a specific time.

It could be written to order or bearer with receiving bank It could be written to order or bearer with receiving bank or person being a holder in due course.or person being a holder in due course.

Types of draft:Types of draft: Sight DraftSight Draft, , Time DraftTime Draft, Clean Draft, , Clean Draft, Documentary DraftDocumentary Draft

Bill of Lading (B/L): Bill of Lading (B/L): Composed of merchandise receiptComposed of merchandise receipt, , contract (obligation of career)contract (obligation of career), , documents of titledocuments of title

Export-Import Financing (con...)Export-Import Financing (con...)Types of B/L:Types of B/L:

Straight B/LStraight B/L: Carrier delivers the merchandise to the : Carrier delivers the merchandise to the designated person when paid in advance or designated person when paid in advance or Order B/LOrder B/L; ; grant the title to the specified person.grant the title to the specified person.

Clean B/L:Clean B/L: Merchandise received by the carrier must be Merchandise received by the carrier must be in a good condition v.s in a good condition v.s Foul B/LFoul B/L merchandise could have a merchandise could have a margin of damage.margin of damage.

Other Financing related Documents:Other Financing related Documents:

Commercial Invoice: Price , financial terms, shipping Commercial Invoice: Price , financial terms, shipping condition such as FOB, FAS, C&F and CIF.condition such as FOB, FAS, C&F and CIF.

Export-Import Financing (con...)Export-Import Financing (con...) Public and Private Financing agencies:Public and Private Financing agencies:

Export Credit Insurance: Credit for export and insurance for default importer.

Foreign Credit Insurance Association (FCIA)

Export Import Bank

Private Export Funding Corporation (PEFCO)

Overseas Private Insurance Corporation. (OPIC)

www.freetradeat10.com

www.mexonline.com/nafta.htm

http://www.usmcoc.org/naftafor.html

The Fundamentals ofThe Fundamentals of Counter Trading Counter Trading

Def:Def: Financing the international trade with exchange of Financing the international trade with exchange of goods and creditgoods and credit

Types of Counter tradingTypes of Counter trading

Barter TradingBarter Trading: Goods for Goods - Pepsi for Vodka: Goods for Goods - Pepsi for Vodka

Counter purchaseCounter purchase : Partial payment in cash and : Partial payment in cash and merchandise. German Car to Iran for Oil and Cash.merchandise. German Car to Iran for Oil and Cash.

Compensation arrangementCompensation arrangement or or Buyback:: Buyback:: Buyback Buyback the output of capital invested: Russia buys gas from the output of capital invested: Russia buys gas from a gas pipeline built for Iran.a gas pipeline built for Iran.

Switch Trading:Switch Trading: Exchange the blocked currency for Exchange the blocked currency for hard currency by switching the trade: Blocked funds hard currency by switching the trade: Blocked funds of Canada can be traded at a discount for other of Canada can be traded at a discount for other currency for trading with Romania.currency for trading with Romania.

www.countrywatch.com

Working Capital ManagementWorking Capital ManagementDef: Managing of Current Assets & Liabilities :Def: Managing of Current Assets & Liabilities :

Flow Prospective:Flow Prospective: Managing the location of liquid Managing the location of liquid funds to find both the funds to find both the currencycurrency in which liquid funds in which liquid funds are held and are held and countrycountry where such funds are placed where such funds are placed Tax StructureTax Structure Exchange RateExchange Rate Liquidity considerationLiquidity consideration Import RestrictionsImport Restrictions Political and social considerationPolitical and social consideration Rate of return for excess cash investmentRate of return for excess cash investment Inconvertibility of the fundInconvertibility of the fund Exchange controlExchange control Conversion BlockageConversion Blockage Heavy withholdingHeavy withholding TAX ON FOREIGN INCOME, TAX ON FOREIGN INCOME,

DIVIDEND,ROYALTY, AND OTHER RESTRICTION FOR DIVIDEND,ROYALTY, AND OTHER RESTRICTION FOR REMITTANCE OF THE FUND.REMITTANCE OF THE FUND.

International Fund TransferInternational Fund Transfer Recovering funds from affiliate without piquing host country’s Recovering funds from affiliate without piquing host country’s

sensitivity with a sensitivity with a large Dividend drainlarge Dividend drain

Allocation of a large Allocation of a large overheadoverhead from parent to an affiliate from parent to an affiliate

Facilitate the entry of local capital toFacilitate the entry of local capital to joint venture joint venture

FUND TRANSFER STRATEGIES:FUND TRANSFER STRATEGIES:

If foreign exchange losses are expected, speed up the transferIf foreign exchange losses are expected, speed up the transfer

Consideration for the age and size of the affiliateConsideration for the age and size of the affiliate

Availability of the fund to the affiliateAvailability of the fund to the affiliate

Availability of the joint ventureAvailability of the joint venture

Transferability of royalty fees and other foreign incomeTransferability of royalty fees and other foreign income

Consideration for transaction, speculative and precautionary Consideration for transaction, speculative and precautionary balancesbalances

Managing International Receivables & Managing International Receivables & InventoryInventory

Receivable: Lead and Lag Techniques:Receivable: Lead and Lag Techniques:

Provide funds to affiliate in exchange for equitiesProvide funds to affiliate in exchange for equities

Sell in and provide credit in long run from one Sell in and provide credit in long run from one affiliate to othersaffiliate to others

Re-invoicing centers: separate subsidies to Re-invoicing centers: separate subsidies to manage intercompany transactions when the manage intercompany transactions when the title passes to re-invoice center but goods are title passes to re-invoice center but goods are directed to the affiliate.directed to the affiliate.

Inventory:Inventory:

Taking advantage of free trade zoneTaking advantage of free trade zone

Consideration for inflation rateConsideration for inflation rate

Consideration for currency devaluation, price Consideration for currency devaluation, price freeze, import restrictions etc..freeze, import restrictions etc..

MNC’s Strategy & Direct InvestmentMNC’s Strategy & Direct Investment

1. Theory of MNC1. Theory of MNC• Most MNC’s are oligopoliesMost MNC’s are oligopolies..

• They operate in product and factor market imperfection.They operate in product and factor market imperfection.

• They have intangible capital in the form of trade markets, patents, They have intangible capital in the form of trade markets, patents, general marketing skills, organizational abilities to raise the market general marketing skills, organizational abilities to raise the market and introduce new products, quality control, advertising, distribution, and introduce new products, quality control, advertising, distribution, after-the-sale service and ability to forecast exchange markets.after-the-sale service and ability to forecast exchange markets.

2. Investment Strategy2. Investment Strategy• Vertical Integration - diversification across the industry.Vertical Integration - diversification across the industry.

• Horizontal Integration - investment within the industry.Horizontal Integration - investment within the industry.

• Trade innovation and barriers prohibit market entry by continuous Trade innovation and barriers prohibit market entry by continuous introduction of new products, different services and product introduction of new products, different services and product differentiation.differentiation.

3. Follow-the-Lead Behavior• Cost reduction and economy of scale; low cost production site with Cost reduction and economy of scale; low cost production site with

low price -- oligopoly price leadership and cost minimizer.low price -- oligopoly price leadership and cost minimizer.

MNC’s Strategy & Direct MNC’s Strategy & Direct Investment (con...)Investment (con...)

4. Joint Venture4. Joint Venture

5. Pricing Conversion5. Pricing Conversion High prices in home country High prices in home country

to compensate for low prices to compensate for low prices overseas.overseas.

6. Investing in Each Other’s Market

• “if you undercut me in my home market, I will do the same thing in your market.”

Process Classification

MaterialSavings 19% 54% 48%

LaborSavings 61% 18% 16%

CapitalSavings 19% 24% 28%

MultipleFactors 1% 4% 8%

Process U.S. E.C. Japan

Swaps - A Brief OverviewSwaps - A Brief Overview• Interest Rate Swaps:

– No Principal ever changes hands.

– Maturity varies from under one year to over 15 years.

– Types:

» Coupon Rate Swap -- fixed rate to float rate.

» Basis Swap -- float rate to float rate.

• Currency Swaps:– to receive one currency for another

currency at a fixed or flexible rate.

• Interest Rate Swaps:– No Principal ever changes hands.

– Maturity varies from under one year to over 15 years.

– Types:

» Coupon Rate Swap -- fixed rate to float rate.

» Basis Swap -- float rate to float rate.

• Currency Swaps:– to receive one currency for another

currency at a fixed or flexible rate.

International Financial MarketInternational Financial Market

Sources of Capital

• International Market: business operation

• External Market:– A. Domestic Market: domestic funds for domestic use.

– B. International Market: domestic funds for foreign use.

– C. International Market: foreign funds for domestic use.

– D. Offshore Market: foreign funds for foreign use

ie. London, N.Y., Tokyo, Zurich, Singapore, Bahrain, Bahamas.

Eurodollar vs Eurocurrencies Market

• U.S. Dollar time deposits in a bank outside the U.S.A.

• Bank may be foreign bank or overseas branch of a U.S. bank.

• Deposits could be in: Call Money, Overnight Draft, 3-month CD.

Eurodollar deposits are not demand deposit and can’t be transferred by a check drawn on the bank having the deposit. It can be transferred by a wire or cable from a balance-hold in a corresponding bank located in the U.S.

Banks in which Eurodollar or Eurocurrencies are deposited are generally called Eurobanks.

1. Convenient money market1. Convenient money market

2. Major source of short-term bank loans2. Major source of short-term bank loans

3. Arbitrage purpose3. Arbitrage purpose

4. U.S. long-time trade deficit4. U.S. long-time trade deficit

5. Money regulation in the U.S.5. Money regulation in the U.S.

6. Military expenses of the 1960’s and 1970’s6. Military expenses of the 1960’s and 1970’s

7. Freezing of foreign assets in the U.S. in the 1970’s and 7. Freezing of foreign assets in the U.S. in the 1970’s and 1980’s1980’s

Reasons for Existence of Eurodollar Reasons for Existence of Eurodollar MarketMarket

Size of the MarketSize of the Market

• According to the report by Bank for International Settlement, the size of the market has increased 4 times since the 1970’s to $2,056 billion.

• A Majority of the dollar deposits are in Europe (60%), and the rest are in Asia -- mainly in Japan and Singapore.

• The Expansion of the market is very similar to the money creation principle of a commercial bank.

• Money Market (Euro-Line of Credit, Money Market (Euro-Line of Credit, Revolving Credit, Syndicated Short-term Revolving Credit, Syndicated Short-term and Medium-term loans) and Medium-term loans)

• Euro-CD, such as Spot Rate CD, Roll-over Euro-CD, such as Spot Rate CD, Roll-over Credit where the interest is paid in Credit where the interest is paid in floating rate and TAPS, CD’s for less than floating rate and TAPS, CD’s for less than a year with min $25,000 denomination a year with min $25,000 denomination which could be in a series of identical CD’s which could be in a series of identical CD’s (Tranche) or single issue, and Five-(Tranche) or single issue, and Five-currency CD (denominated in a basket of currency CD (denominated in a basket of five different currencies).five different currencies).

Euro-capital MarketEuro-capital Market

Eurobonds1. The Euronote Market: short to medium-term 1. The Euronote Market: short to medium-term

debt instruments (negotiable promissory debt instruments (negotiable promissory notes) sold in the Eurocurrency market.notes) sold in the Eurocurrency market.– They are underwritten by different facilities, such as

Revolving Underwriting Facilities (RUF), Note Insurance Facilities (NIF) and Standby Note Issuance Facilities (SNIF).

2. Euro-commercial Papers (ECP) - one, three and six-month maturities.

3. Euro Medium-term Notes (EMTN): bridges maturity gap between ECP and Eurobond.

4. Euro-bond Market– Straight Fixed Rate Issue -fixed CR, specified maturity date and full

principal repayment upon final maturity.

– Floating Rate Notes (FRN) - semiannual coupon, variable rate, fixed maturity or perpetuities.

– Euro-Equity Convertibles - similar to straight bond with added feature to convert to a certain number of stocks prior to maturity.

Eurobonds Eurobonds 4. Euro-bond Market (con...)

– Dual currency Bonds - purchase price and coupon denominated in one currency and the principal redemption value fixed in a second currency.

– Currency Cocktail Bond - denominated in one of several currency baskets such as SDR or ECU; stable interest and principal payments.

– Stripped Bond - deep discounted bond issued in bearer form in order to sell them to non-residents; Certificate of Accrual on Treasury Securities (CATS).

5. Yankee Bond - issued by non-residents in U.S. Dollars sold in the U.S.

6. Foreign Bond - issued by non-residents in non-Dollars sold in the U.S.

Eurobonds Eurobonds

• 7. Treasury Bond - long-term obligation of federal government (U.S.)

• 8. Corporate Bond (General, Debenture, Jr, Subordinate) - long-term obligation of corporation.

• 9. Municipal Bond - long-term obligation of state and local government.

• 10. Interest and Currency Swaps

Cost of CapitalizationCost of Capitalization

Taking advantage of the capital market Taking advantage of the capital market imperfection M>N>C can lower the cost of imperfection M>N>C can lower the cost of capitalization.capitalization.

WACC = KeE/E+D + KdD/E+DWACC = KeE/E+D + KdD/E+D Cost of Equity = Ke = d/p+gCost of Equity = Ke = d/p+g Capital Asset Pricing Model = Ke = Rf + B*(Rm-Rf)Capital Asset Pricing Model = Ke = Rf + B*(Rm-Rf) Cost of Debt: Cy, Y-T-M, H.P.Y. W.A.Y.T.M. , ...Cost of Debt: Cy, Y-T-M, H.P.Y. W.A.Y.T.M. , ...

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MNC Influences Cost of MNC Influences Cost of Capitalization by:Capitalization by:

1. Availability of capital from domestic as well 1. Availability of capital from domestic as well as from international as from international

– MNC have higher capacity to raise funds as extensions of the MC curve making it easier to borrow more at a lower rate.

2. Market segmentation2. Market segmentation– if the required rate on a security in a market is different

from the required rate on a comparable security in an efficient capital market, the cost of capitalization will be lower if MNC has access to fully-integrated markets as it shifts the MC curve further down.

– Cost of capital varies as the amount of employed TD/TA increases; an after tax cost of capital decrease reduces the overall cost of capital after a certain level of perceived risk by the investor increases the cost of capital.

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3. Investor’s Premium for International 3. Investor’s Premium for International DiversificationDiversification

– reduces the perceived risk by the investor and reduces the cost of capitalization.

4. Managing Foreign Exchange Rate Risk and 4. Managing Foreign Exchange Rate Risk and Political RiskPolitical Risk

5. Taking Advantage of Tax Treaties5. Taking Advantage of Tax Treaties– MNC could be subject to taxation both home and abroad.– Retained earnings in foreign affiliate are not subject to

U.S. tax until they are reported, so it could reduce the cost of equity. Transfer pricing also affects the tax liability of MNC.

MNC Influences Cost of Capitalization by (con...):

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6. Disclosure of International Financial 6. Disclosure of International Financial StatementsStatements

– improved financial disclosure will tend to increase the relative weighting which investors place in favorable firm’s statistics relative to others, especially in capital formation from Eurocurrency Market.

– Rating of foreign bonds by Moody and S&P as asked by Japanese to help reduce risk for the investor.

7. Financial Structure of Different Countries7. Financial Structure of Different Countries– country debt ratio is different for different countries.

MNC Influences Cost of Capitalization by (con...):

ExampleExampleWhen MNC issues foreign currency-dominated debt, its cost

of repaying the principal and interest in terms of patent’s own currency will be affected as follows:

If U.S. MNC borrows Deutschemarks for one year at 6% and the Mark increases interest of $ by 8%, the before tax cost of capital:

° Kc = interest on DM*additional interest to exchange rate change + additional principal due to exchange rate.

° If the interest rate in Germany = [(1.06*1.08)-1]*100 = 14.48% and if the tax rate is 54%, then the after tax cost of capital = 14.48%(1-.54) = 7.82%.

After tax expected dollar cost to foreign affiliate of one year foreign currency loan = r = (1-d)(1-t)-d, where r = interest rate, d = expected foreign currency devaluation to dollar and t = local tax.

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Advice on Avoidance of Excess Cost of Capitalization for MNCAdvice on Avoidance of Excess Cost of Capitalization for MNC

Under no condition should a firm borrow long-term in a foreign currency which has been eliminated.

Borrow long-term in foreign currency if you anticipate cash outflow on principal and interest is matched by anticipated operating receivable in the same currency.

Borrow for the purpose of diversifying long-term currency commitments.

Short Term FinancingShort Term Financing

Definition: financing for less than a year.

Two sources of short-term financing: Unsecured short-term financing

Secured short-term financing

Categories of unsecured short-term financing Trade Credit

Line of Credit

Bank Loan

Commercial Papers

Short Term Financing (con...)Short Term Financing (con...)

Categories of Secured Short-term Financing• Pledging the Account Receivable

• Factoring the Account Receivable

• Inventory Loans:

» 1. Floating Lien (Blanket Lien)

» 2. Trust Receipt (Chattel Mortgage)

• Field warehousing

• Public warehousing (Terminal Warehouse Agreement)

International Short Term International Short Term FinancingFinancing

1. Intercompany financing

2. Local currency financing

3. Euronotes and Euro-commercial papers

4. Funds from parent company

5. Funds from operation

6. Loan from sister subsidiary

7. Loan from local and international banks

8. Currency swaps

9. Link financing (third strong currency company

guarantees loan)

International Short Term International Short Term Financing (con...)Financing (con...)

10. Edged Act and agreement banking

11. International Banking Facilities

12. Joint Venture

13. World Bank and IMF

14. Regional Development Bank, such as Inter-American

Development Bank

15. Export / Import Bank

16. Agency for International Development (AID)

17. OPIC

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International Banking International BankingMotivations: Access to dollar and Eurocurrency

deposits and international saving markets. Tasks of International Banking:

• Financing exports and imports

• Trading foreign exchange

• Underwriting both Euro-bonds and foreign bonds

• Borrowing and lending in Euro-currency market

• Participate and organize foreign exchange market

• Project financing

• International cash flow management & fund transfer

• Solicitation for local currency deposits to operate as full-service banks

• Serve as consultant for MNC

Risks in International Risks in International BankingBanking

1. Commercial Risk•Facing difficulties in receiving the repayments of principal and interest on due date.•Lack of financial and economic information about the clients and host countries and differences in accounting disclosure practices and legal procedures.

2. Country Risk•Sovereign Risk: political, jurisdictional and cultural differences.•Exchange Rate Risk: shortage of foreign exchange reserves; change in repayment schedules.

Advantages and Disadvantages of Advantages and Disadvantages of International BankingInternational Banking

Advantages• High rate of return for investment and relatively low loss ratio• Ability to diversify loan portfolio.• Excess demand for international loans, especially for development

programs.• Usually international loans are safeguarded by official and non-official

insurance agencies, such as export credit insurance.

Disadvantages• Unfamiliar political and social environments and rapidly changing

macroeconomic and financial variables.• Unexpected events and regulators.• Weak demand for domestic loans has relaxed standards for

international loans.• Only a few credit-worthy countries are available.• External debt problems of many foreign international countries,

especially Latin American countries and major international loan loss by many international banks.

Types of International Bank Types of International Bank OfficesOffices

Correspondent BankingCorrespondent Banking Two way link between banks (home and foreign bank); services offered Two way link between banks (home and foreign bank); services offered

include, but not limited to: accepting drafts, honoring L/C, and furnishing include, but not limited to: accepting drafts, honoring L/C, and furnishing credit information.credit information.

Representative OfficesRepresentative Offices• Cannot accept deposits, make loans, accept L/C or cash checks; just help

and advise parent bank clients when they are doing business in host country.

Agencies RelationshipAgencies Relationship• Like branch banking without having authority to accept deposit from the

public; may accept deposits from other banks; can arrange loans, L/C and trade foreign exchange.

Bank Subsidiaries and AffiliatesBank Subsidiaries and Affiliates• Can be a separately incorporated bank or owned and control by bank

(partially-owned or entirely-owned subsidiaries).

Types of International Bank Types of International Bank Offices (con...)Offices (con...)

Branch BankingBranch Banking Extension of parent bank; can be full-service bank.Extension of parent bank; can be full-service bank.

International Banking Facilities (IBF)International Banking Facilities (IBF)• An accounting entity as well as a legal entity of a bank to capture a segment of the

Euromarket.• They are not subject to FDIC rules or Fed’s Required Rate Ratio.• Deposits limited to non-residents only and size limitation.• They are exempt from state and local tax.• They could be U.S.-owned IBF (exempt from federal tax) or foreign-owned IBF, such

as Japanese IBF and Italian IBF.

Edged Act BanksEdged Act Banks• Subsidiary of U.S. bank incorporated in U.S. under section 25 of federal banking law

to engage in international banking functions and finance all types of the loans in the world.

• They are physically located in states other than their own within the U.S. (inter-state banking).

• If they are state chartered - called Agreement Corporation, if nationally chartered - called Edged Act Bank.

Decoratv.ppt

Professor VAZIRI Professor VAZIRI WISHS YOU:WISHS YOU:

GOOD LUCK WITHGOOD LUCK WITH"Final Exam""Final Exam"

Professor VAZIRI Professor VAZIRI WISHS YOU:WISHS YOU:

GOOD LUCK WITHGOOD LUCK WITH"Final Exam""Final Exam"

Exam will cover the materials discussed in the classReview the notes and thebook.Have your calculater readyHave your formulas readyAsk questions if you are confused.Leave a self stamt and adressed envelope for your grade reporting.

CFP Diploma

Finance Diploma

Lgnbleuv.ppt

ISEFI IN THE MOVE TOWARD INTERNATIONAL CFP COUNCIL

0.0 0.4 0.8 1.2 1.6 2.0 0.0 0.4 0.8 1.2 1.6 2.0

Allemagne

France

Espagne

Pays-Bas

Italie

Royaume-Uni

Suède

Danemark

Norvège

Finlande

Suisse

Autriche