GLOBAL DEBT AND EQUITY MARKETS

Capital Market

- need to access by MNEs to finance expansion

Finance

- integral to firm's international strategies

Chief Financial Officer (CFO)

- key member of the management team

- the one with the most important global finance - related responsibilities

- acquires financial resources, generates funds either internally or from external sources at the lowest
possible cost and allocates them among the company's activities and projects

Allocating Resources (investing)

- increasing stockholders' wealth through allocation of funds to different projects and investments
opportunities

CFO Job is more complex in global environment due to:

1. Foreign-exchange risk

2. Currency flows and restrictions

3. Political risk

4. Different tax rates and law determining taxable income

5. Regulations on access to capital in different markets

Financial Management
- role: maintain and create economic value or wealth by maximizing shareholder wealth (market value if
existing shareholders' common stock)

Corporate Finance Fubction

- acquires and allocates financial resources among the company's activities and projects

Key Function

1. Make financing decision

- capital structure

- long term financing

2. Make Investment Decisions

- capital budgeting

3. Manage short-term capital needs

- managing MNE's currency assets and liabilities

Controller

- overseeing activities in both accounting and financial management

Treasurer

- controlling the company's cash payments and related financial functioy

Role of CFO

1. Overall capital structure

2. Global capital markets

3. Taxation of foreign - source income and influence on capital markets

4. Offshore financing, offshore financial centers and tax havens

Capital Structure

- CFO must determine the proper mix between long-term debt and equity

Leverage

- the degree to which a firms funds the growth if busiyby debt

Leveraging

- often perceived as the most cost-effective route to capitalization because the interest that

companies pay on debt is a tax-deductible expense in most countries, whereas the divi-

dends paid to investors are not.

When is leveraging not the best option?

1. excessive reliance on long-term debt raises financial risk and thus requires a higher return for
investors.

2. foreign subsidiaries of an MNE may have

limited access to local capital markets, making it difficult for the MNE to rely on debt to fund

asset acquisition

Choice of capital structure depends on:

1. tax rates

2. degree of development of local equity markets

3. creditor rights
Multinational affiliates are financed with less external debt in countries with underdeveloped capital
markets or weak creditor rights, reflecting significantly higher local borrowing costs.

Instrumental variable analysis

- indicates that greater borrowing from parent companies substitutes for three-quarters of reduced
external borrowing induced by capital market conditions.

Multinational firms appear to employ internal capital markets

opportunistically to overcome imperfections in external capital markets

- different tax rates, dividend remission policies, and exchange controls may cause a company to rely
more on debt in some situations and more on equity in others.

Debt and Exchange Rates

Asian Financial Crisis 1997

- major cause: excessive dollar bank debt.

- lack of development of bond and

equity markets forced Asian firms to rely too much on debt, especially bank debt, for growth

Global crisis if 2007-2009

- highlighted foreign exchange risk

Iceland

- currency: the Krona

- Central Bank kept interest rates high, attracting lots of foreign investment and keeping the krona
strong.
People’s standards of living, among the highest in the world, were supported by the strong currency
and

the ability to import products. They sustained their high consumption by financing houses

and other purchases through borrowing in cheaper currencies.

- When the crisis hit, however, the krona plunged in value, the banks failed, and consumers could not
afford to service their

debts.

- The lower foreign interest rates were replaced by exchange-rate risk

The economic crisis in Europe

(2010 - 2011)

- due: more to sovereign

liquidity than exchange rate risk.

Regulatory Risk

- regulatory reform has complicated access to debt financing

The Basel Committee on

Global Banking Supervision

- a part of the Bank for International Settlements

- comprised of some of the world’s top regulators and central bankers

- worked hard

to put together rules to ensure that banks will be able to withstand future economic crises.

The basic idea is to set standards for stronger capital positions and increased liquidity.

- The

most recent agreement is called Basel III.8

1. the world should be better off as banks comply with Basel III and increase their capital positions

2. higher capital requirements also mean lower funds available to lend to companies that might not
be able to raise capital through an IPO or by floating a bond issues.

- new requirements should make the banking system more secure and less prone to financial collapse.

Debt Markets As A Means Of Expansion

interbank market

- the

market for exchanges between dealer banks—money center banks either deal directly with

each other or operate through foreign-exchange brokers.

- placed to provide services in offshore financing.

Companies can use local

international debt markets to raise funds.

MNEs have an advantage because they can tap local and foreign debt and equity markets (such as the
Eurodollar, Eurobond, and Euroequity markets).

Two major sources of funds external to the MNE’s normal operations:

1. Debt markets

2. Equity markets.

Eurocurrency
- or offshore currency

- any currency outside its country of origin

- but it is primarily dollars banked outside the United States.

- exist partly for the convenience and security of the user and partly because of cheaper lending rates
for the borrower and better yield for the lender.

Eurocurrency market

- an important source of debt financing to complement what MNEs can find in their domestic markets.

- euroyen / eurosterling

- a wholesale (companies and other institutions) rather than a retail (individual) matket

- major player: government, central bank, public sector corporation

- characteristics: both short- and medium-term

- interest rates: major attraction for its difference compared to those domestic market

Short-term borrowing

- composed of maturities of less than one year.

Eurocredit

- anything from one to five years

- which may be a loan, a line of credit, or another form of medium- and

long-term credit.

syndication

- in which several banks pool resources to

extend credit to a borrower and spread the risk.

Eurocommercial Paper

- Short-term borrowings

- unsecured loans issued by a bank or corporation in the offshore money market and typically in the
currency that is different from the corporation’s domestic currency.

- Maturities are less than one year.

Domestic rates

- function of the monetary policies adopted by the Central Banks of each country.

- therate a company must pay to get loans or issue bonds depends not only on benchmark rates

but also its creditworthiness. The better the creditworthiness, the lower the rate compared to other
borrowers

Eurodollar market

- the most significant eurocurrency market.

- major advantage: not regulated by the U.S. Federal Reserve Bank

- started with the deposit of U.S. dollars in London banks during the Cold War by the Soviet

Union to avoid the possibility that their accounts could be frozen in the United States.

Eurodollar

- a certificate of deposit in U.S. dollars in a bank outside the United States.

- constitute a majority of the Eurocurrency market.

Major Sources of Eurocurrencies

1. Foreign governments or individuals who want to hold dollars outside the United States

2. Multinational enterprises that have cash in excess of current needs

3. European banks with foreign currency in excess of current needs

4. Countries such as China, Japan, the EU, Saudi Arabia, Russia, and Taiwan that have large

foreign exchange reserves

LONDON INTER-BANK OFFERED RATE (LIBOR)

- a short-term interest rate for dollars held in the Eurodollar market.

International Bonds

Bond (and stock) markets in the United States are so influential reason:

the companies of continental Europe still rely disproportionately on banks for finance. However, that
began to change due to the economic crisis in Europe and the drop

in available bank funding.

There are two types of international bonds:

1. foreign bonds - one sold

outside the country of the

borrower but denominated

in the currency of issue

2. Eurobonds

- bond issue sold

in a currency other than that of

the country of issue

- way to get access to international capital

- may provide currency options, which enable the creditor to

demand repayment in one of several currencies, thus reducing the exchange risk inherent in single-
currency foreign bonds

- both interest and principal on Eurobonds are payable to the

creditor in U.S. dollars

international

bond market

- primarily a wholesale market

- bond holders: institutional investors

- issuers: large companies, governments, and international organizations.

- a desirable place to borrow money

- it allows a company to diversify its funding sources from the local banks and the domestic bond market
and borrow in maturities that might not be available in the domestic markets

- tends to be less expensive than local bond markets and attracts investors from around the world,

bearer bond

- entitled to receive the principal and interest payments

registered bond

- more typical in the United States, the investor is required to be

registered as the bond’s owner to receive payments.

OTC bond

- traded with or through an investment bank rather than on a securities exchange, such as the London
Stock Exchange

Equity Securities
- an investor takes an ownership position in return for shares of stock in the company and the promises
of capital gains and

dividends.

- raise quity capital to:

1. fund operations

2. may work with private investors who want to take an equity interest in the company

rather than just loan money to the company

3. through an Initial Public Offering where it goes directly to a stock market.

Access to Equity Capital

1. private placement with an angel investor (a wealthy individual who wants to invest in a small private
firm)

2. a venture capital firm (which invests funds of a group of private investors)

3. institutional investors (a pension fund, insurance company)

Sovereign wealth funds (SWFs)

- also an important source of capital

-a

state-owned investment fund that generates its resources from a variety of places, including revenues
from the exports of natural resources such as oil

- top five SWFs in terms of assets:

1. Government Pension Fund (Norway)

2. Abu Dhabi Investment Authority

3. SAFE Investment Company (China)

4. SAMA Foreign Holdings (Saudi Arabia)

5. China

Investment Corporation
equity-capital market

- more commonly known as the stock market

- can raise new capital known as an Initial Public Offering, or IPO by listing their shares on a stock
exchange, either home-country or foreign.

Size Of Global Stock Markets

market capitalization

- the total number of shares of stock listed times the market price per share.

three largest stock markets in the world:

1. New York

2. Tokyo

3. London, with the U.S. markets controlling nearly half of

the world’s stock market capitalization.

emerging markets seem to benefit from a flight to risk seeking higher returns and a rise in commodities
prices. However, the markets also fall fairly quickly if there is a flight to safety.

Euroequities

- shares

listed on stock exchanges

in countries other than the

home country of the issuing

company.

American Depositary Receipt (ADR)

- a negotiable certificate issued by a U.S. bank in the United States to represent the underlying shares of
a foreign corporation’s stock held in trust at a custodian bank in the foreign country

- traded like stock shares, with each one representing some number of shares of the underlying stock.

Most foreign companies that list on the U.S. stock exchanges do so through American Depositary
Receipts, which are financial documents that represent a share or part of a share of stock in the foreign
company.

OECD

- concerned about

a broader range of activities

that involve cross-border operations.

- Guidelines

for MNEs includes a code of

conduct for MNEs engaged

in cross-border operations.

offshore financing has proved conducive to such

misbehavior as: 1. tax avoidance

2. the OECD and several other multilateral organizations have

made efforts to strengthen ethical practices in offshore

transactions.

Tax planning
- a crucial responsibility for a CFO because taxes can profoundly affect profitability and cash flow.

- international tax specialist must be familiar with both the home country’s tax policy on foreign
operations and the tax laws of each country in which the MNE operates.

Taxation has a strong impact on several choices:

• Location of operations

• Choice of operating form, such as export or import, licensing agreement, or overseas

investment

• Legal form of the new enterprise, such as branch or subsidiary

• Possible facilities in tax-haven countries to raise capital and manage cash

• Method of financing, such as internal or external sourcing, and debt or equity

• Capital budgeting decisions

• Method of setting transfer prices

Problems with different

countries’ tax practices arise

from

• Lack of familiarity with laws.

• Loose enforcement.

With a value-added tax, each

company pays a percentage of

the value added to a product

at each stage of the business

process.
International Tax Practices

1. Differences in Types of Taxes

- differ in types of taxes they have

(income versus excise), the tax rates applied to income, the determination of taxable income, and the
treatment of foreign-source income

- VAT: percentage levied on products at the point of sale in every stage of the value chain, and is
included in the final price of the product rather than added to the price at the final point of sale

2. Differences in Generally Accepted Accounting Principles (GAAP)

3. Differences in Tax Rates

Two Approaches to Corporate Taxation

1. separate entity

approach - governments tax

each taxable entity when it

earns income.

2. integrated system approach - tries

to avoid double taxation of

corporate income through split tax rates or tax credits.

Taxing Branches And Subsidiaries

1. Foreign Branch - income (or

loss) is directly included in the

parent’s taxable income.

2. Foreign subsidiary - When an MNE purchases a foreign corporation or sets up a new one in a foreign
country. Income earned by the subsidiary is either reinvested in the subsidiary or remitted as a dividend
to the parent company.
Tax deferral

- that income is not taxed until

it is remitted to the parent

company as a dividend.

controlled foreign corporation (CFC)

- a technical term in the U.S.

tax codeand whether the income is active or passive.

- shareholders

hold more than 50 percent of

the voting stock.

Active income

- derived

from the direct conduct of

a trade or business.

Passive income (also called Subpart

F income)

- usually derived

from operations in a tax-haven

country.
Other Sources of Income

• Holding company income—income primarily from dividends, interest, rents, royalties, and

gains on sale of stocks.

• Sales income—income from foreign sales corporations that are separately incorporated

from their manufacturing operations. The product of such entities is manufactured and

sold for use outside the CFC’s country of incorporation, and the CFC has not performed

significant operations on the product.

• Service income—income from the performance of technical, managerial, or similar services

for a company in the same corporate family as the CFC and outside the country in which

the CFC resides.

transfer price

- a price

on goods and services one

member of a corporate family

sells to another.

arm’s-length price

- a price between two companies that

do not have an ownership interest in each other.

The IRS allows a tax credit for

corporate income tax U.S.

companies pay to another

country.
A tax credit is a dollar-

for-dollar reduction of tax

liability and must coincide with

the recognition of income

The purpose of tax treaties is

to prevent double taxation or

to provide remedies when it

occurs.

Dodging Taxes

Two things will always be true: governments will always try to figure out how to collect

as much in taxes as they can and companies (and individuals) will try to avoid paying as

much in taxes as they can.

Offshore financing—the

provision for financial services

by banks and other agents to

nonresidents

Offshore financial centers

(OFCs)

- cities or countries
that provide large amounts of

funds in currencies other than

their own

- OFCs offer low or zero

taxation, moderate or

light financial regulation,

and banking secrecy and

anonymity.

- Offshore financial centers

can be operational centers or

booking centers.

characteristics:

• A large foreign-currency (Eurocurrency) market for deposits and loans (in London, say)

• A market that functions as a large net supplier of funds to the world financial markets

(such as in Switzerland)

• A market that functions as an intermediary or pass-through for international loan funds

(e.g., the Bahamas and the Cayman Islands)

• Economic and political stability

• An efficient and experienced financial community

• Good communications and support services

• An official regulatory climate favorable to the financial industry, in the sense that it pro-

tects investors without unduly restricting financial institutions

Operational centers have extensive banking activi-

ties involving short-term financial transactions; booking centers have little actual banking

activity taking place but transactions are recorded to take advantage of secrecy and low

(or no) tax rates.

two approaches that

companies can take to forecast

exchange rates: fundamental

forecasting (which bases

external or internal decisions

on a range of economic

variables) and technical

forecasting (which depends on

specialists to analyze trends in

exchange rates themselves).

The OECD is trying to

eliminate the harmful tax

practices in tax-haven

countries.

OFCs as “Tax Havens” A major concern with OFCs is the tax avoidance dimension of

their activities. The OECD has been working closely with the major OFCs to ensure that they

are engaged in legal activity. It uses the following key factors in identifying tax havens: (1) no
or only nominal taxes, (2) lack of effective exchange of information (especially bank secrecy),

(3) lack of transparency, and (4) no substantial activities.45 Although not trying to tell the

sovereign countries what their tax rates should be, the OECD is trying to eliminate harmful

tax practices in these four areas:

1. The regime imposes low or no taxes on the relevant income (from geographically mobile

financial and other service activities).

2. The regime is ring fenced (i.e., separated) from the domestic economy.

3. The regime lacks transparency; for example, the details of it or its application are not

apparent, or there is inadequate regulatory supervision or financial disclosure.

4. There is no effective exchange of information with respect to the regime.46