chapter 17 - multinational financial management Flashcards
What are various risk factors for multinational
corporation?
* How do companies hedge currency risk?
What is a multinational corporation?
A corporation that operates in two or more countries.
Decision making within the corporation may be centralized in the home country or may be decentralized across the countries in which the corporation does business.
Often headquarters in the home country will make major company-wide decisions while smaller, local decisions will be made in the subsidiary/local office branches
they expand to other countries/diversify
what is exchange rate risk?
* Why do companies care about this risk?
* How to companies mitigate this risk?
Exchange rate risk
The risk that the value of a cash flow in one currency translated to another currency will decline due to a change in exchange rates.
For example, if you are a US company selling goods in Australia,
The company receives Australian dollars than need to be converted into US dollars
If the US dollar appreciates, you exchange Aust $ into fewer US $, have less US profit than anticipated.
If the US dollar depreciates, you exchange Aust $ into more US $, have more US profit than anticipated.
can lose money
to mitigate this risk, they convert the currency when appreciating or depreciating
What is the international monetary system?
* What is the difference between devaluation
and depreciation?
* Revaluation and appreciation?
International monetary system
The framework within which exchange rates are determined
Devaluation and revaluation
When the government increases or decreases the value of the currency
Depreciation and appreciation
When market forces cause currencies to increase or decrease in value
What are the five different types of currency
regimes?
* Which regimes are most common?
freely floating (us) market forces
managed float (switzerland and japan)
no local currency (ecuador and eu)
currency board (argentina 2002)
fixed peg/crawling peg (china)
what are the pros and cons of joining the Euro
currency?
No local currency
The country uses either another country’s currency as its legal tender (like the U.S. dollar in Ecuador) or else belongs to a group of countries that share a currency (like the euro).
floating
Freely floating
Exchange rate determined by the market’s supply and demand for the currency. Governments may occasionally intervene and buy or sell their currency to stabilize fluctuations.
Managed floating
Significant government intervention manages the exchange rate by manipulating the currency’s supply and demand. The target exchange rates are kept secret to limit speculation.
fixed
No local currency
The country uses either another country’s currency as its legal tender (like the U.S. dollar in Ecuador) or else belongs to a group of countries that share a currency (like the euro).
Currency board agreement
The country technically has its own currency but commits to exchange it for a specified foreign currency at a fixed exchange rate (like Argentina before its January 2002 crisis).
What is interest rate parity?
What is interest rate parity?
Interest rate parity holds that investors should expect to earn the same return in all countries after adjusting for risk.
ft = t-period forward exchange rate
e0 = today’s spot exchange rate
rh = periodic interest rate in home country
rf = periodic interest rate in foreign county
What is purchasing power parity? Does PPP hold
in real life?
Purchasing Power Parity:
Purchasing power parity implies that the level of exchange rates adjusts so that identical goods cost the same amount in different countries.
Ph = PfEo
Price in home currency = Price in foreign currencyexchange rate
What is multinational financial management?
in foreign countries
Know reasons why firms move internationally
* Boost sales, better serve customers, low labor
costs, etc.
cb
What impact does relative inflation have on
interest rates and exchange rates?
If you are a company and have 2 choices:
1. Borrow in a low-interest currency/country.
Low-inflation/low interest rates, so currency will likely appreciate and make the loan more expensive
2. Borrow in a high-interest currency/country.
High-inflation/high interest rates, so currency will likely depreciate and make the loan less expensive
Should have the same return for both choices:
Borrow 3%, appreciate by 2%, total cost of 5%
What are Eurobonds, Eurocredits, and ADRs?
* Why do companies issue ADRs?
Eurobonds
Eurobonds are bonds underwritten by international banks and sold to investors in countries other than the one in whose currency the bond is denominated.
Example: Japanese investors purchase US bonds
Example: US investors by Japanese bonds
Can be fixed or floating rate debt
Eurocredits
Eurocredits are fixed term or floating-rate bank loans (with no early repayment) made by international bonds
An example: eurodollar deposits, which are U.S. dollars deposited in banks outside the United States.
ADRs
What if foreign companies want to list on American stock exchanges?
Solution is ADRS
ADRs are certificates representing ownership of foreign stock held in trust
About 1,700 ADRs are now available in the United States
Most of them traded on the over-the-counter (OTC) market.
Examples: Nintendo, BP, Nestle, Alibaba
Allows US investors to directly invest in foreign stocks
Lowers cost of equity for foreign companies
