Chapter 17- Financial Management

Question 1

What is a draft?

Answer 1

A document that requires payments from the buyer for goods, used in international trade.

Question 2

What is a bank draft?

Answer 2

A financial document drawn against a bank.

Question 3

What is a trade draft?

Answer 3

a withdrawal document against a company.

Question 4

What is NPV?

Answer 4

Net present value- the sum of the present value of all cash inflows and outflows from an investment project, discounted at the cost of capital.

Question 5

What is a capital budget?

Answer 5

The financial evaluation of a proposed investment to determine whether expected returns are sufficient enough to justify the investment.
contains three main cash flows:
1) initial expenses and capital outlays- the largest cash outflow–> the big investment needed to get the project started.
2) Operating expenses- expenses required to maintain the project, keep it running.
3) Terminal cash flows- salvage/resale value of the project at its end.

Question 6

What is cash management?

Answer 6

the management of cash balances owed by the firm, held by banking and other financial institutions.

Question 7

Financing cash flows?

Answer 7

the cash flows of a firm needed to fund its operations; debt and equity related cash flows.

Question 8

Transfer prices?

Answer 8

The price set to subsidiaries of a company and affiliates. • Theoretically are equivalent to what the same product would cost if purchased on the open market. Often impossible to find the same product on the open market→ price is internally set and may result in the subsidiary (of the parent company) being more or less profitable. Impacts taxes paid in host countries.

Question 9

What is netting?

Answer 9

Cash flow coordination between a corporations global units, so that instead of multiple transactions having to be made, only one smaller transaction is made.

Question 10

What is cash pooling?

Answer 10

Used by multinational corporations, all individual units’ cash is pooled together into one location to reduce spending or foregone interest on unnecessary cash balances.
• All the money is in one central location, i.e. New York, and then the parent firm is in a better position to negotiate financial services, reduce currency exposure of individual units etc.

Question 11

What are two ways that companies time their payments to take advantage of exchange rates?

Answer 11

Lead - pay a debt early

Lag- pay a debt later

Question 12

What is reinvoicing?

Answer 12

the policy of buying goods from one unit and selling them to a second unit and reinvoicing the sale to the next unit, to take advantage of favorable exchange rates.

Question 13

What is an internal bank?

Answer 13

A multinational firm’s financial tool that actually acts as a bank to coordinate finances among its units.

Question 14

What are the 3 types of foreign currency exposure?

Answer 14

Transaction, economic and translation.

Question 15

Describe transaction exposure.

Answer 15

the potential for currency losses or gains during the time when a firm completes a transaction denominated in a foreign currency.
o Associated with a contractual payment of foreign currency. If any cash flow is denominated in a foreign currency, the firm will run this risk.

Question 16

What is economic exposure?

Answer 16

the potential change in the VALUE of a firm from unexpected changes in exchange rates. Also called “operating exposure” and “strategic exposure”
o Long-term cash flows will be affected by unexpected future exchange rate changes.

Question 17

What is translating exposure?

Answer 17

the potential effect of a change in currency values of a firm’s financial statements.
o Legal requirement that all firms consolidate their financial statements of all worldwide operations annually (problem that arises from accounting, not a “true exposure” like the other two.)
o Only two conditions needed: 1) cash flow in a foreign currency and 2) cash flow that will occur at a future date.

Question 18

What are some transaction exposure management tactics?

Answer 18

Hedging and Bartering

Question 19

What is natural hedging?

Answer 19

the structuring of a firm’s operations so that cash outflows are matched by cash inflows.

Question 20

What is contractual hedging?

Answer 20

a multinational’s firm’s use of contracts to minimize its transaction exposure.

Question 21

What is a forward contract?

Answer 21

A type of contract commonly used as part of contractual hedging.
-Allows the firm to be assured a fixed rate of exchange between the desired two currencies at the precise future date (most common).

Question 22

What is a hedge?

Answer 22

an asset or position that moves in equal but opposite direction of the exposure (balancing out the risk).
-It is meant to counterbalance a present sale or purchase with a sale or purchase for future delivery as a way to minimize loss due to price fluctuations’ to make counterbalancing sales or purchases in the international market as protection against adverse movements in the exchange rate.

Question 23

What is bartering?

Answer 23

The exchange of goods with approximately equal value, involving no money
• Conditions to encourage countertrade: lack of money, lack of value of or faith in money, lack of acceptability of money as an exchange medium, greater ease of transaction by using goods.
• World financial crisis has made ordinary trade financing very risky. Heavily indebted countries may not be able to afford imports at all, and hasten to use countertrade to at least get some product inflow.
• Does not reduce commercial risk, in fact studies show that the more creditworthy a country is, the more likely they are to participate in unconventional trading practices.
• Excellent method gain entry into new markets.
• Can also provide stability for long-term sales.
• Main arguments- not efficient, need to find someone who wants something you have and you have to want what they have.
o Uncompetitive goods made be traded

Question 24

What are 4 different types of tax?

Answer 24

• Direct taxes- taxes applied directly to income
• Indirect taxes- taxes applied to non-income items, such as sales tax, value-added taxes, excise taxes, tariffs, and so on.
• Value-added tax (VAT)- a tax on the value contributed at each stage of production and distributions process; a tax assessed in most European countries and also common among Latin American countries.
• Withholding taxes- taxes applied to the payment of dividends, interest, or royalties by firms.