The Financial Environment

1
The Financial Environment

• Chapter 5

Dr. Tanuja Singh Spring 2002 Northern Illinois
University
2
Financial Concerns in Global Marketing

• Financial Issues
• Getting paid
• Avoiding/minimizing risk
• Currency Exchange Risks
• Political, Legal, other Risks
• Investment Decisions--which markets to invest in?
• Financing Decisions--how to finance a companys
  operations?
• Money Management Decisions--how to manage
  financial resources most efficiently?

3
Types of Financial Risks

• Commercial Risk
• If buyers does not pay or goes bankrupt
• may be caused by conditions outside the buyers
  control such as deteriorating conditions in the
  buyers market, buyer losing a large account
• Marketers can insure against some risk but risk
  insurance is also expensive

4
Types of Financial Risks

• Non-Commercial (e.g., Political Risk)
• beyond control of either the buyer or seller
• When governments delay payments, even when the
  buyer has paid
• War, revolution, expropriation
• political risk can be insured to some extent by
  agencies such as the EXIM bank but the higher the
  risk the more expensive the insurance

5
Types of Financial Risks

• Foreign Exchange Risk
• Effects of fluctuating exchange rates, when the
  quote is not in the sellers currency
• Can be hedged but hedging is also not entirely
  free from risk
• Hedging strategies such as forward buying cost
  money and may not be useful or feasible for small
  transactions
• Seller can try to get payment in her/his currency
  but may not always be possible

6
Previous International Monetary Mechanisms

• Paper money was backed by gold
• Originally One US Dollar Was 23.22 Grains of Pure
  Gold 480 Grains in an Ounce
• One Ounce of Gold 480/23.22 20.67
• One 113 Grains of Pure Gold, One Ounce of Gold
  Was Also 480/113 4.25
• Thus 20.67 4.25
• Exchange Rate Was 1 4.87

7
Previous International Monetary Mechanisms

• Fixed Exchange Rate System
• IMF Created to Stabilize Currencies (1944)
• Countries Fixed Their Currencies in Terms of Gold
  but Not Required to Exchange Them for Gold
• Only US Dollar Remained Convertible to Gold and
  Fixed at 35 for One Ounce
• Eventually abandoned in 1972
• Jamaica agreement in 1976 formally accepted
  floating system

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The Need to Manage Foreign Exchange Risk

• Currency values are not fixed
• Payments and transactions occur at different
  times
• Change in the value of a currency can change a
  transaction from profitable to unprofitable

9
Foreign Exchange Rates

• What affects rates
• Inflation
• Balance of payment
• Economic growth
• Government spending
• Interest rate policy
• Money Supply
• Political factors
• Others

10
Managing Financial Risks

• Hedging -- mechanism to minimize risk
• e.g., forward sale for currency)
• Foreign-Exchange Options -- agreement between two
  parties in which one party grants the other the
  right, but not the obligation, to buy or sell
  foreign exchange under specific conditions

11
Relevance of Exchange Rates

• Example
• US Company Imports Computers From Japan Each
  Costing 200,000 Yens, to Be Paid in Yens
• Payment in 30 Days
• Current Exchange Rate Is 1 120 Y (Each
  Computer Costs 1667, i. e., 200,000/120)
• In 30 Days Yen Appreciates to 1 95 Y
• Since Payment Still Needs to Be Made in Yens, the
  US Importer Now Pays 2105 (200,000/95), Losing
  Money
• Bank May Offer a Fixed Rate Between the Two
  Values Such That the US Importer Has to Pay More
  Than 1667 but Less Than 2105 Depending Upon the
  Expected Currency Movement

12
Currency Speculation

• Speculation
• Short-term Movement of Funds When Shift in
  Exchange Rates May Be Profitable
• Say US Is Overvalued Against the FFr. (i.e.,
  Will Likely Depreciate Against the FFr.)
• Today F.Fr. Exchange Rate Is 1 6 FFrs.
• Company Converts 10 Million to 60 Million FFrs.
• Over the Next Month Depreciates to 1 5 FFrs.
• Now It Can Convert 60 Million FFrs. Into 12
  Million Dollars

13
The Foreign Exchange Market

• Exchange rate the rate at which one currency is
  converted to another
• Spot Market rate of exchange on the spot
• Forward Market buying/selling for future date

14
Forward Exchange Rates

• If a Currency Is Expected to Decline in Value in
  the Future Against Another Currency, It Is
  Selling at a Discount
• If a Currency Is Expected to Appreciate Against
  Another Currency in the Future, It Is Selling at
  a Premium
• Forward Buys Are Normally Available for 30, 60,
  90, and 180 Days Although in Some Cases, They Can
  Be Bought for Transactions Several Years Into the
  Future

15
Options and Futures Market

• Options Market
• gives the holder the right to buy or sell foreign
  currency at a pre-specified price on or up to a
  pre-specified date

16
Managing Debt and Foreign Exchange Risk

• Countertrade trading in which payment might be
  made in a form other than just hard currency
• Debt/equity swap when a company buys equity in a
  foreign company in exchange for the countrys
  debt
• Debt/product swap when a company buys the
  products of a foreign country in exchange for
  their debt

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Sources of Financing

• Forfaiting
• A trade financing mechanism
• Allows exporter to sell receivables or other
  instruments (e.g., promissory notes) before they
  are due for a discounted value
• Provides exporter with cash
• Reduction of risk, simplicity of documentation,
  100 coverage
• May not be available where exporter needs it most
  (high risk countries, developing countries)

18
Sources of Financing

• Factoring Houses
• companies that purchase an exporters receivable
  for discounted price
• Similar in concept to forfaiters but different
  focus

19
Forfaiting and Factoring

• Difference between forfaiting and factoring
• forfaiters deal with exporter on a one-shot
  business, factors want regular business
• forfaiters finance is medium term (6 months to 5
  years), factors are short-term
• factors do not have experience with developing
  nations,
• forfaiters work with capital goods factors with
  consumer goods
• Factoring is mostly with recourse

20
Sources of Financing

• Official (Government or Government Agency) Trade
  Finance
• loan or a guarantee
• government agencies often provide funds or risk
  protection
• e.g., EXIM bank may lend directly or provide loan
  guarantees to banks who lend

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Sources of Financing

• Export Credit Agencies
• Exist in many countries
• Benefit from explicit or implicit support from
  the government
• Many countries provide soft funds (having
  international aid tied to their own country
  exporters)

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Official Trade Finance

• In the US, EXIM bank is the major supporter of
  exporters
• Functions
• aids in financing and facilitating exports
• Provides pre-export support in the form of
  working capital guarantee and export-credit
  insurance (post-export)
• Provides Working capital guarantee program (WCG)
• Provides Guarantee to the lender against default
  by the exporter

23
Official Trade Finance

• Overseas Private Investment Corporation (OPIC)
• federal agency that offers investment guarantees
  to U.S. manufacturers
• Agency for International Development (AID)
• administers most of the foreign economic
  assistance programs for the U.S. government

24
Private-Sector Export-Credit Insurance

• Private Export Funding Corporation (PEFCO)
• private corporation founded in 1970
• makes fixed-rate U.S. dollar loans to foreign
  importers to finance purchases of goods and
  services of U.S. manufacture or origin