Lecture Jan 24, 2011

Financial Forces in International Business

Fluctuating Currency Values

I.

Fluctuating Currency Values A. Uncontrollable financial forces are those that originate outside the business firm B. Among these are "sovereign debt" or the debt of a government of a sovereign nation C. Most world currencies are allowed to float in value relative to other currencies D. Sometimes these fluctuations can be quite large requiring conscious action to repair

II.

Foreign Exchange Quotations A. Foreign exchange quotations are periodic quotations of the price of one currency in terms of another B. Reasons that the US$ continues to dominate in world currency
   

The US$ serves as a central reserve asset for many countries It is the most often used vehicle currency for international trade And it serves as an intervention currency in efforts to stabilize currencies Many see the US dollar as a safe haven investment because of its long-term value and stability 2

Exchange rates
Exchange Rates


Sources, such as the Wall Street Journal will detail the values of currencies bought and sold against one another.

 

Currencies can exchange without the intermediary position of the US$ Spot Rates 1. The exchange rate between two currencies for their immediate exchange (delivery within two days)

Forward rates 1. The cost today for a commitment by one party to deliver or take from another party and agreed upon amount of a currency at a fixed, future date 2. May be for 30-, 60-, 90, 180-day commitment 3. A currency is trading at a premium when the forward rates exceed the sport rate. 4. A currency is trading at a discount when the forward rate is less than the sport rate
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Relative strengths of currencies

So many yen, so few pounds.

 

The rates quoted do not represent relative strengths of currencies Other factors must be reviewed to determine the strength of a currency against another currency

The forward condition, either premium or discount, is determined by the exchange traders' expectations for the currencies

Bid and Ask prices 1. The bid/ask prices reflect whether the currency is being bought or sold 2. Usually bid/ask prices shown in publications are for large amounts of currency in exchange.

Rates

Cross rates


Expectations are that the Euro will become as popular as the US$ as an exchange currency

As listed in financial publications, currencies can also be traded directly without the need to use the US$ or the Euro as an intermediary currency

 Fluctuating Exchange Rates Create Risk

Currency Exchange Controls

Currency Exchange Controls  These limit or prohibit the legal use of a currency in international transactions  Typically this situation occurs when a currency is fixed at an exchange rate higher than suggested in free market conditions  Official rates for currencies are consider currency exchange controls  Efforts to exchange controlled currency may lead to mad decisions and extreme actions.
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Balance of Payments

Balance of Payments  A major force in the financial environment of international business  Trends in the BOP can provide a business with hints about direction of exchange  Under the right conditions a firm might shop of export incentives such as tax breaks, foreign aid, or other advantages allowed by a government to foster exporting

Tariffs or Duties
Tariffs or Duties A. These words are used interchangeably and refer to taxes collected on import goods B. Trade groupings have worked to reduce these taxes among group members Taxation A. Corporations and business pay taxes B. Different taxes in different countries


Almost every country views taxes as big revenue earners for government Tax laws and amounts vary widely from country to country
8 Tax liabilities become a priority decision criterion for many businesses

Inflation
Inflation A. General increase of prices to the domestic consumer B. Inflation's effect on interest rates
 

Businesses must borrow money Real interest rate or cost of money is calculated by subtracting the inflation rate from the nominal interest rate

When borrowed money is repaid at a later date, the effect of inflation is to make the future value less

C. Monetary and fiscal policies affect inflation

  

Monetary policies control the amount of money in circulation Fiscal policies address collection and spending of money by governments Successful policies have two commonalities 1. the remove artificial economic controls 2. the apply fiscal and monetary restraint
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Inflation cont
A. Importance of inflation to business
 

Inflation affects decisions on how to raise capital, by dept or equity Variable interest rates are used by some lenders to offset the effect of inflation on the future value of money

 

High inflation makes capital spending more difficult to plan Inflation and the international company 1. Inflation rates differ among countries 2. Comparative inflation rates will effect comparative currency exchange rates 3. Higher inflation rates cause prices of goods and services to rise
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Accounting Practices

I.

Accounting Practices A. Accounting practices vary widely among countries B. Most often host country accounting practices are primary and results are converted to the home country accounting practice

II. Household Savings A. A percentage of disposable income that is a good measure of the savings rate in a country B. High savings rate countries may have an advantage of increased capital resource pools resulting from the higher savings rate
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ational Bankruptcy
Countries Went Bust A. For a long time it was thought that a country could not go "bust" B. Sovereign debt proved this adage wrong C. During the 1970s many developing nations found themselves unable to pay the interest on their debt much less against the principal D. Causes of increased indebtedness in developing countries
   

One of the immediate causes is the jump in oil prices Inflation in the 1970s was compounded by the rise in oil prices Interest rate increases also placed burden on developing countries Strength of the US$, in which many of the developing countries loans are made, created the need to earn more to cover the increasing exchange rate gap
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Debt problem solution

A. Debt problem solution


Short-term solutions 1. Rescheduling dept repayment 2. Debtor nations are balking at stringent austerity programs sought by lenders 3. Debtors have reduced imports causing exporting nations to experience lower export volume and the attendant loss of jobs 4. Debtors have increased reliance on private sources

Long-term solutions 1. First phase saw stringent austerity programs as a condition of loans 2. Second phase saw awareness that short-term adjustment would not work 3. Baker plan called for market approach to encourage growth in debtor countries 4. Brady plan built on baker plan and allowed debt relief based on a debtor's efforts to comply with IMF conditions 5. Brady provided a. Exchange of old debt for new at a discount b. Exchange of old debt for new at lower interest rate c. Buying back of debt from creditor at a discount 13

Debt Markets of developing country

Growing developing country debt market 1. The last provision of the Brady plan has a debtor nation buying its own debt and retiring it 2. Some banks have sold debt to other financial groups into a secondary market

200-year history of sovereign debt defaults 1. Investment banks are preparing a new generation of sovereign credits 2. This allows credit-risk countries to enter the market 3. In the past 200 years sovereign defaults have been rampant

Some positive developments 1. Some debt forgiveness is occurring as a way to clear debt 2. The World Bank, IMF and others have moved to reduce the debt load of poorer developing nations 14

Debt Markets of developing country

Long-term solutions (see the text for more detail) 1. Borrowing countries will have to ensure policies are to pursue money for economic growth rather than for consumption 2. Borrowers should build reserves in good years to help them sustain poorer years 3. Developed countries must accept greater responsibility for their economic growth 4. The IMF and other creditors must not force austerity conditions of developing nations. 5. The IMF, World bank, and other agencies must be assured of sufficient funding that they can take long-term views 6. Parts of huge developing country debt must be exchanged for other types of equity 7. Developing countries must relax their restrictions on foreign investment 8. No one should be "blamed " for the debt crisis 15

Debt Markets of developed countries

A. The United States in debt


US Debt defined 1. The US Foreign Debt-net negative international investment position-is the difference between the value of assets owned by Americans overseas and the value of US assets owned by foreigners

Differences between US and developing country debt 1. Most of the US debt is obligations of the US Treasury with values that change daily rather than fixed face value of developing countries' debt 2. Most foreign assets are valued at book value or the value when bought resulting in under valuation of value 3. US assets abroad earn more interest and dividend per dollar of investment than foreign investment in the US 4. US liabilities are huge in absolute terms but are relatively small compared to other economic factors 16