M4: INTERNATIONA FINANCIAL MANAGEMENT (2)

• An international exchange rate, also known as a foreign exchange (FX) rate, is the price of one country's currency in terms of another country's currency. Foreign exchange rates are relative and are expressed as the value of

  one currency compared to another.

  When selling products internationally, the exchange rate for the two trading countries' currencies is an important factor.
• Foreign exchange rates, in fact, are one of the most important determinants of a countries relative level of

  economic health, ranking just after interest rates and inflation.

  Exchange rates play a vital role in a country's level of trade, which is critical to most every free market economy in the world. Consequently, exchange rates are among the most watched, analyzed, and manipulated economic measures (Marshall, 2021).
• THE FOREIGN EXCHANGE MARKET

  As nations and their economies have become increasingly interdependent, the FX market has emerged as a global focal point. With an estimated daily FX turnover exceeding $1 trillion, this is by far the world's largest market.

  In order to remain competitive in the world economy, it is vital to manage the risk of adverse currency fluctuations. In recent times, the worldwide trend has been toward the consolidation of markets and currencies, as in the case of the European Economic Union.
• THE FOREIGN EXCHANGE MARKET

  The largest users of the FX market are commercial banks, which serve as intermediaries between currency buyers and sellers. Corporations and financial institutions also trade currencies, primarily to safeguard their foreign currency-denominated assets and liabilities against adverse FX rate movement. Banks and fund managers trade currencies to profit from FX rate movements. Individuals also are subject to fluctuating FX rates, most commonly when a traveler exchanges his/her native currency for a foreign one before embarking on a business trip or vacation.
• THE FOREIGN EXCHANGE MARKET

  When the Chicago Mercantile Exchange introduced trading in foreign currency futures in 1972, it enabled all currency market participants, including individual investors, to capitalize on FX rate fluctuations without having to make or take delivery of the actual currencies. Foreign currency futures offer risk management and profit opportunities to individual investors, as well as to small firms and large companies.
• THE FOREIGN EXCHANGE MARKET

  There are two types of potential users of foreign currency futures: the hedger and the speculator.

  The hedger seeks to reduce and manage the risk of financial losses that can arise from transacting business in currencies other than one's native currency.

  Speculators provide risk capital and assume the risk the hedger is seeking to transfer in the hope of making a profit by correctly forecasting future price movement.
• Two types of potential users of foreign currency futures:

  Hedger and Speculator
• APPLICATION OF THEORY

  THE EFFECT OF EXCHANGE RATE CHANGES ON

  BUSINESS

  The results of companies that operate in more than one

  nation often must be "translated" from foreign currencies

  into U.S. dollars. Exchange rate fluctuations make financial

  forecasting more difficult for these companies, and also

  have a marked effect on unit sales, prices, and costs.
• APPLICATION OF THEORY

  THE EFFECT OF EXCHANGE RATE CHANGES ON

  BUSINESS

  For example, assume that current market conditions dictate that one U.S. dollar can be exchanged for 125 Japanese yen. In this business environment, an American auto dealer plans to import a Japanese car with a price of 2.5 million yen, which translates to a price in dollars of $20,000. If that dealer also incurred $2,000 in transportation costs aan decided to mark up the price of the car by another $3,000, then the vehicle would sell for $25,000 and provide the dealer with a profit margin of 12 percent.
• APPLICATION OF THEORY

  THE EFFECT OF EXCHANGE RATE CHANGES ON

  BUSINESS

  But if the exchange rate changed before the deal was made so that one dollar was worth 100 yen—in other

  words, if the dollar weakened or depreciated compared to the yen—it would have a dramatic effect on the business transaction.
• APPLICATION OF THEORY

  THE EFFECT OF EXCHANGE RATE CHANGES ON

  BUSINESS

  The dealer would then have to pay the Japanese manufacturer $25,000 for the car. Adding in the same costs and mark up, the dealer would have to sell the car for $30,000, yet would only receive a 10 percent profit margin. The dealer would either have to negotiate a lower price from the Japanese manufacturer or cut his profit margin further to be able to sell the vehicle (Marshall, International exchange rate, 2021). 
• Capital budgeting is the process a business undertakes to evaluate potential major projects or investments.

  Construction of a new plant or a big investment in an outside venture are examples of projects that would require capital budgeting before they are approved or rejected (Kenton, 2020).

  As part of capital budgeting, a company might assess a prospective project's lifetime cash inflows and outflows

  to determine whether the potential returns that would be generated meet a sufficient target benchmark.
• The capital budgeting process is also known as investment appraisal.
• International capital budgeting is more complicated than domestic capital budgeting because Multinational

  Corporations (MNC’s) are typically large and capital intensive, and because the process involves a larger number of parameters and decision variables.
• In general, international capital budgeting involves a consideration of more risk than domestic capital budgeting. But international capital budgeting involves the estimation of some measures or criteria that indicate the feasibility or otherwise of a project such as the Net Present Value (NPV). However, certain factors that are not considered in domestic capital budgeting should be taken into account in international capital budgeting because of the special nature of FDI projects.
• International capital budgeting involves substantial spending capital investment in projects that are located in foreign countries, rather than in the home country of the MNC.
• Foreign projects differ from purely domestic projects concerning several factors- the foreign currency dimension, different economic indicators in different countries, and different risk characteristics with which the MNC is not as familiar as those about domestic projects.

  All these differences lead to a higher level of risk in international capital budgeting than in domestic capital budgeting.
• Capital budgeting is a process of investigation and analysis that leads to a key financial decision for both purely domestic firms and MNCs.

  More broadly, capital budgeting is defined as the process of analyzing capital investment opportunities and deciding which, if any, to undertake.
• While calculating the cash flows for international capital budgeting the following accounts must be taken into

  account:

  * Cannibalization

  * Fees and Royalties

  * Opportunity Cost

  * Transfer Pricing
• While calculating the cash flows for international capital budgeting the following accounts must be taken into

  account:

  Cannibalization

  Sometimes the new projects cause the existing cash flows to diminish because of the new projects ; these diminish cash flows are considered as the cash outflows for the new projects and these cash out flows are deducted in the final analysis.
• While calculating the cash flows for international capital budgeting the following accounts must be taken into

  account:

  Fees and Royalties

  Sometimes you have to pay an extra fee of license and other royalties to the domestic government; these are

  considered as cash outflows.
• While calculating the cash flows for international capital budgeting the following accounts must be taken into

  account:

  Opportunity Cost

  Sometimes the opportunity cost is also considered as the cash outflows.
• While calculating the cash flows for international capital budgeting the following accounts must be taken into

  account:

  Transfer Pricing

  In the international transfer major portion of some product is manufactured in some other subsidiary and the host

  country has little value to the finished product.

  The parent country and the host country are involved in transfer pricing.
• So, all this discussion implies that:

  Incremental Cash flow of International =

  Global corporate Cash flow with project- Global corporate Cash flow without project.
• Benefits of International Capital Budgeting

  • Valuable learning experience.

  • Knowledge

  • Globalization
• Importance of International Capital Budgeting:

  * Develop and Formulate Long-term Strategic Goals

  * Seek out New Investment Projects

  * Estimate and Forecast Future Cash Flows

  * Facilitate the Transfer of Information

  * Monitoring and Control of Expenditures

  * Creation of Decision
• Importance of International Capital Budgeting

  Develop and Formulate Long-term Strategic Goals:

  The ability to set long-term goals is essential to the growth and prosperity of any business. The ability to appraisal investment projects via capital budgeting creates a framework for businesses to plan out future long term direction
• Importance of International Capital Budgeting

  Seek out New Investment Projects:

  Knowing how to evaluate investment projects gives a business the model to seek and evaluate new projects, an important function for all businesses as they seek to compete and profit in their industry.
• Importance of International Capital Budgeting

  Estimate and Forecast Future Cash Flows:

  Future cash flows are what create value for business over time. Capital budgeting enables executives to take a potential project and estimate its future cash flows, which then helps determine if such a project should be accepted.
• Importance of International Capital Budgeting

  Facilitate the Transfer of Information:

  From the time that a project starts as an idea to the time it is accepted or rejected, numerous decisions have to be made at various levels of authority. The capital budgeting process facilitates the transfer of information to the appropriate decision-makers within a company.
• Importance of International Capital Budgeting

  Monitoring and Control of Expenditures:

  Since a good project can turn bad if expenditures aren’t carefully controlled or monitored, this step is a crucial benefit of the capital budgeting process.
• Factors Affecting International Capital Budgeting

  1. Blocked Funds.
  2. Amenities and Concessions Granted by Host Countries.
  3. Differing Rates of National Inflation.
  4. Political Risk involved in Foreign Investment.
  5. Exchange Rate Fluctuations.
  6. Subsidized Financing.
  7. Lost Exports.
  8. International Diversification Benefits.
  9. Host Government Incentives.
• The exchange rate is fundamental for several reasons:

  For instance, it serves as the basic link between the local

  and the overseas market for various goods, services and financial assets.

  Using the exchange rate, we are able to compare prices of goods, services, and assets quoted in different currencies.

  In general, a firm and country’s currency is welcome news as it reflects positive developments in the country’s economic fundamentals both in micro and macro level of economic analysis.