global financial management

• TODO global fin man notes 🔼 📅 2024-03-26

• Syllabus

  • Students learn to: Compare the risks involved in domestic and global financial transactions

Exchange rates

• Exchange rates are :: the value of one country’s country in terms of another currency.

• A Foreign exchange market (forex, fx): determines the price of one currency relative to another.

• Exchange rates often fluctuate

  • posing risks for global businesses (may impact profitability)

• Appreciation in (AUD):

  • reduces the international competitiveness of Australian export businesses.
    • increases price of exports (→ decreases demand)
    • decreases price of imports (→ increases demand)

• Depreciation in (AUD):

  • increases the international competitiveness of Australian export businesses.
    • decreases price of exports (→ increases demand)
    • increases price of imports (→ decreases demand)

Interest rates

• plans to either relocate offshore or expand domestic production facilities (to increase direct exporting)
  • needs to raise finance to undertake these activities.
• A global business can borrow money from both domestic and international institutions.
  • ==Australian interest rates are traditionally greater== than other countries.
  • the real risk here is exchange rate movements.

Methods of international payment

• International payments can be complicated for both importers and exporters, (e.g. language, time zones, lack of physical meetings)

  • to resolve this, importers and exporters use third parties and intermediaries to minimise complications

• four basic methods of international payment (ordered lowest to highest risk to exporter):
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1. Payment in advance
2. Letter of credit
3. Bill of exchange
4. Clean payment

Payment in advance:

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• a payment method that allows the exporter to receive payment and then arrange for the goods to be sent
• exporter receives payment first
  • then goods are sent

Letter of credit:

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• a document that a buyer can request from their bank that guarantees the payment of goods will be transferred to the seller.
  • The letter of credit is issued by the importer’s bank to the exporter promising to pay.
• document buyer requests from their bank
  • guarantees the payment of goods will be transferred to the seller
• once committed, the buyer cannot withdraw.
• if the buyer fails to pay, the bank has to cover the purchase

Bill of exchange:

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• document drawn up by exporter demanding payment from importer

  • at a specified time period.

• most commonly used

  • as the exporter maintains control over the goods until the payment has been made.

• Two different types:

  • Document against payment
    • importer collects goods only after paying
  • Document against accept
    • importer may collect goods before paying

Clean payment:

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• occurs when the exporter ships the goods directly to the importer before payment is received
• The exporter ships the goods directly to the importer
  • before the payment is received.
• importer doesn’t send payment until they receive goods.

Hedging

• Hedging is :: the process of minimising the risk of currency fluctuations.

• When two parties agree to exchange currency and finalise a deal immediately, the transaction is referred to as a spot exchange.

  • The relevant exchange rate is recorded as the spot exchange rate

• The spot exchange rate is :: the value of one currency in another currency on a particular day.

Natural hedging

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• Businesses adopt strategies to eliminate/minimise the risk of foreign exchange exposures known as natural hedges.
• Natural hedges include:
  • Establishing offshore subsidiaries
  • Arranging for import payments and receipts denominated in the same foreign currency
  • Implementing marketing strategies that aim to reduce price sensitivities of exports
  • Insisting on import and export contracts in AUD so it transfers the risk to the importer

Derivatives

• Derivatives are :: simple financial instruments that may be used to lessen the exporting risks associated with currency fluctuations.

  • Derivatives are developed by financial institutions and sold to businesses/investors.

• The three main derivatives available for exporters include:
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• forward exchange contracts

• option contracts

• swap contracts

Forward exchange contract

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• : A contract to exchange one currency for another currency at an agreed exchange rate on a future date.

  • usually after a period of 30, 90 or 180 days.

• meaning the bank guarantees the exporter, within a set time, a fixed rate of exchange for the money generated from the sale of exports.

Options contract

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• : Gives the buyer (options holder) ==the right but not the obligation== to buy or sell foreign currency at some time in the future.

• holders are protected from unfavourable exchange rate fluctuations,

  • yet maintain opportunity for gain if favourable.

Swap contract

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• : An agreement to exchange currency in the spot market with an agreement to reverse the transaction in the future.

  • It involves a spot sale with a forward repurchase of the currency at a specified date in the future.

• advantages businesses as they can alter their exposure to exchange rate fluctuations without discarding original transactions.

• Example scenario:

  • Swaps are often done between two businesses in different countries who require each other’s currency
    • As they don’t have the reputation to receive foreign loans with favourable interest rates
    • so they each file a domestic loan, and swap the loaned money with each other
      • both businesses agree to repay each other’s loans.