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International Financial Management: Terry Fegarty Seneca College
International Financial Management: Terry Fegarty Seneca College
International Financial Management: Terry Fegarty Seneca College
Chapte
Currency Exchange
The Foreign Exchange Market Exchange Rates Changing Exchange Rates and Exchange Rate Risk Spot and Forward Rates Hedging with Forward Exchange Rates Supply and DemandThe Source of Exchange Rate Movement
2006 by Nelson, a division of Thomson Canada Limited
Multinational Corporations
Many Canadian companies are now multinational corporations (MNCs)
May set up or buy a foreign affiliate to produce goods in another country Wholly owned subsidiaryMNC owns 100% of foreign affiliate Together with partners, may set up a foreign joint venture
Currency Exchange
Companies operate and expect to be paid in currency of country in which theyre located
Anyone wanting to buy from firm in another country has to acquire some of that countrys currency For example, if a Canadian importer wants to buy from an American supplier, it has to pay the bill in U.S. dollars. May have to exchange some Canadian dollars for U.S. dollars (Canadian importer buys U.S. dollars with Canadian dollars)
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Exchange Rates
An exchange rate states the price of one currency in terms of another Direct quotenumber of Canadian dollars required to buy one unit of foreign currency Indirect quotehow many units of foreign currency it takes to buy one Canadian dollar The direct and indirect quotes are reciprocals of one another
2006 by Nelson, a division of Thomson Canada Limited
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Exchange Rates
Currency Swiss Franc U.S. Dollar Euro Code CHF USD EUR GBP C$/ 1 Unit 1.0042 1.3237 1.5518 2.2130 Units/ 1 C$ 0.9958 0.7555 0.6444 0.4519 Represents an indirect quotethe inverse of a direct quotehow many units $1 Cdn. will buy.
Example
British Pound
Japanese Yen
JPY
0.01215
82.28
Represents a direct quotehow many Cdn. dollars are required to buy one unit of foreign currency.
Q: If a Canadian company owed 35,000 U.S. dollars, how would this cost in Canadian dollars? A: 35,000 USD 1.3237 = $46,330
2006 by Nelson, a division of Thomson Canada Limited
much
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Exchange Rates
Cross Rates
It is possible to develop an exchange rate between any two currencies without going through Canadian dollars How many U.K. pounds will 1 U.S. dollar buy?
$1CAD = 0.4519 pounds $1CAD = 0.7555 USD 1 pound = (0.4519 / 0.7555=)0.5981 USD 1 U.S. dollar will buy about 0.6 pounds Example
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Fluctuating exchange rates give rise to exchange rate risk Exchange rate risk is chance of gain or loss from exchange rate movements that occur during a transaction
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Example
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When foreign currency is expected to become less (more) valuable in future, the forward currency said to be selling at a discount (premium) Terminology of Exchange Rate Movements
When a currency becomes more (less) valuable in terms of dollars, it is becoming stronger (weaker), or rising (falling) against the dollar
2006 by Nelson, a division of Thomson Canada Limited
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Governments set the rates and attempt to maintain them against market pressures by buying and selling in the foreign exchange market
2006 by Nelson, a division of Thomson Canada Limited
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Convertibility
Not all currencies are convertible to other currencies
Inconvertible currency has restrictions on trading currency in foreign exchange markets
For example, Russian ruble
For example, some currencies you can buy at official exchange rate, but can not sell at that rate Inconvertibility is impediment to international trade
2006 by Nelson, a division of Thomson Canada Limited
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For example, a Canadian company operating a subsidiary in the United Kingdom may borrow pounds sterling at a British bank to acquire inventory in the U.K. There is foreign exchange risk with such loans
2006 by Nelson, a division of Thomson Canada Limited
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Usually unsecured, made in multiples of $1 million, and for terms of one year or less Allow MNCs to arrange large loans quickly, confidentially, and at attractive interest rates Also available in Canadian dollars in foreign capital markets
2006 by Nelson, a division of Thomson Canada Limited
often the U.S. dollar (eurodollar loans) or the euro. If a British subsidiary borrowed U.S dollars in U.K., would constitute a eurodollar loan.
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High rates of inflation and volatile exchange rates in foreign countries If funds are left overseas, MNC may hedge net exchange exposure by currency through forward contracts or other mechanisms
2006 by Nelson, a division of Thomson Canada Limited
Parent presumably will want to move cash back to Canada, or to other low inflation, stable currency locations
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Foreign Receivables
Payments often received in foreign currency, particularly in U.S. dollars. To reduce foreign exchange risk, Canadian exporter may hedge receivables by selling currency in forward market To eliminate credit risk, Canadian exporter may ask foreign customer for letter of credit from customers bank Canadian exporter may accelerate receipt of cash by discounting guaranteed receivable at its own bank, or with a factor
2006 by Nelson, a division of Thomson Canada Limited
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Foreign Receivables
For sales not guaranteed by letter of credit, exporter may check potential customers credit with international credit agencies such as D&B Canada Credit insurance for non-payment of receivables due to credit problems available (at a price) from Export Development Corporation of Canada (EDC) EDC also provides financing to foreign customers to purchase equipment and other capital goods from Canadian companies
2006 by Nelson, a division of Thomson Canada Limited
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A third currency
2006 by Nelson, a division of Thomson Canada Limited
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Foreign government regulations on minimum levels of local ownership To increase loyalty of foreign employees towards firm To improve global image of the corporation Growing desire of investors to diversify their investment portfolios internationally
2006 by Nelson, a division of Thomson Canada Limited
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Many companies have set up operations in Europe to avoid European Union (EU) import tariffs on Canadian exports Reduce risks by diversifying internationally
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Political Risk
Political riskchance that foreign government will expropriate property or will impose rules and regulations that will impair operations
Examples include:
Raising taxes Limiting amount of profit that can be withdrawn from country Requiring key inputs to be purchased from local suppliers at arbitrary prices Limiting prices charged for product sold within the country Require part ownership by citizens of the host country
Terrorist activities, including kidnapping key executives, also included in political risk Risk smaller in industrialized countries
2006 by Nelson, a division of Thomson Canada Limited
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Political Risk
To minimize political risk:
Before investing in a country, investigate its political stability, and its governments rules, regulations, and incentives regulating incoming foreign direct investment Establish joint venture with local interests Buy political risk insurance from Export Development Corporation (EDC) Diversify operations among countries
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