For the past two days we have just been having class and preparing for what is to come in Eastern Europe! We have had readings for the chapters and assigned hw after class. Here are a few notes I jotted down. This is not as exciting as actually traveling through Europe but this is giving us a Financial frame work to work off of before we go on to Europe.
In class we started to talk about what are the most important things we are interested in Finance. Some of the things that we mentioned were about raising capital, maxing out the stock price, capital budgeting for the cash flows for the year and discounting. When we are discounting in the long term it is hard to figure out the right NPV and IRR. Capital budgeting though has it’s main purpose and effect in raising the value of the stock. The structure of capital budgeting is set out with the CFO in charge of the Treasurer, General Controller and Financial Analyst.
The main concerns of the Treasurer are how to finance the company, raise capital and manage cash. We understand that cash is underperforming so international businesses have cash management systems to put their cash in their right currency in the right payments. Every day all of the access cash is put in the right currency and sent to the U.S. if we are working in the U.S. and investing in other areas such as Europe. You take this excess cash and you use it to pay off debt, buy capital equipment, put it towards accounts payable and accounts receivable.
The job of the general controller is to deal with accounting through the SEC, report results by country and then consolidate from different countries. When doing business in different countries you need to use their GAAP. The EU is not standardized. Supposed to have one stock market, one tax method, one accounting method. Dealing with international tax is also very difficult when you have to comply with the local tax laws, tax planning in ultimately trying to minimize the world tax.
What is special about International finance is that you have to deal with foreign exchange. In 1999 1 Euro was $1.18. At one point after the issuing of the Euro in 1999 the Euro fell to $0.80. Prices for a short period of time became less expensive. It is important to note that there are few companies that can’t be affected by exchange.
One thing that we have to take note of is the foreign exchange risk. There are three different risks that we have to account for such as the translation risk, transaction exposure, and economic exposure risk. The translation risk is where you have less earnings by translating money into a different currency. The transaction exposure risk is where you don’t know what the value of your money is going to be when you have to wait on credit terms. For example when you are conducting business in U.K. pounds and you have a 60 day credit terms. You sell a product as an account receivable for 100 pounds but you will not receive this for another 60 days due to the credit terms. The risk is that you do not know what the value is going to be in terms of your dollar amount in the future. The economic exposure risk becomes bigger in negative impact because you compete with companies in other currencies. This goes hand in hand with the political risk of companies changing the rules of the game in terms of how you condone business.
The Foreign exchange risk is basically determining the balance of having a great return on your investment but the currency you are doing business in could go bad or vice versa.
Market imperfection to be concerned about are where governments can stop the flow of money between business and close borders. One of the biggest mistakes that Americans do when doing business in other countries is to think like an American. The rest of the world does not condone business in the ways that we do.
An Example of an expanded opportunity set is where you could start your own business as an entrepreneur in a garage in California. You get and I.P.O. in the country in which you started but you are limited to only U.S. business so you start to conduct business in other countries for more opportunity. It is always best to learn how to effectively do business in your own country before doing business in another.
The Goal of International finance is to maximize the shareholder wealth over the long term.
The constituency for shareholders in a corporation in the U.S. main goal is to focus on the shareowner by raising the value of the stock. Americans are trying to maximize the value over the long term. In Europe though they have a different focus. In Germany they are more focused on the well being of their employees. They have work councils and can’t fire people. Acquisitions between companies are difficult because you have to pay a premium and make money by firing people. In order to do this you need to pre approve the acquisition. This is not a focus on the share owners but employment stability. You need to make money but the idea in Europe is not always share holder maximizing.
When doing international business you also need to have good relation with the suppliers. Japan has a Kerietsu where companies work together similar to a trust which is illegal here in the U.S. After WW2 Japan had nothing and companies were working together. This works but in the U.S. we say that there is a conflict of interest that needs to be dealt with. There are different business models all around the world. The U.S. is not the same as the world and as Americans we need to adopt the new business practices in order to do business in other countries.
All companies are integrated. There needs to be a privatization check where the republic wanted to privatize v.s. Western European countries moving in. Many countries are still dealing with moving from a communist mind set to a capitalist. People have never known profit. The companies were owned by the government. Not owned by the people. No share holders. Not a single person in the company was thinking about profit now has to condone business after being bought out by the west with a company profit motive in mind. Previously there were not any owners, earning statements or shareholders.
Currently in eastern Europe there has been lots of deregulation and technological financial innovations.
The Euro as a global currency: Europeans wanted a trading black that could compete with the U.S. and Japan. Europe was getting bigger. Greece could not originally be in on the Euro because their debt was to high. Now today they are needing massive bailouts from the countries in the Euro and European Union and Central bank because they are having trouble once again. There were very high standards for convergence criteria that needed to be accounted for. Such criteria was how much inflation that they had in the current year. Once again currently Greece is in trouble. The Euro is amazing because for many centuries there countries have fought each other. It is thought that if you have a financial exchange with each other you will less likely to fight each other. Right now the Euro is seeing its biggest crisis yet.
The U.K. opted out of the Euro along with Switzerland. The biggest thing that you give up with the Euro is your monetary policy. The U.S. has the fed. The Feds funds rate is almost zero. Interest rates are low today. Countries on the Euro are run by the European central bank. Greece on its own can not do any monetary policy because it does not own it. There is no central bank or monetary policy on its own. Countries still have their fiscal policy such as how they spend and tax. Greece needs to spend less and tax more. Greece originally spent a lot and did not tax enough which created ore debt. Today there are people in the European Union that have still not joined the Euro such as the countries I am going to visit such as Hungary, Czech Republic and Poland.
A big question that was answered to day is if the EU is going to save Greece. Germany was against bailing them out along with France because they have the biggest economy. Today German agreed to pay 188 billion dollars for the 950 billion dollar bail out that is going on for Greece. Spain, Portugal, and Italy have high unemployment. The question is who is next?
We discussed briefly about NAFTA and the relations between the U.S. Canada and Mexico.
The Privatization in the Czech Republic.
Multinational firms get raw materials and financial capital from other countries to produce goods with other countries labor. They do this by using capital equipment in a third country and sell in another.
Interesting fact is how Germany’s cost/worker is $35 while Mexico’s is $3/ worker.
The whole idea behind international business is that you go to another country because it poses opportunities that would be more successful than your own country.
Later in class we began to discuss the evolution of the international monetary system. A previous monetary system was bimetallism where there was o risk in exchange rates. This took out the risk of foreign exchange. This is all worked out through the Price Specie Mechanism to account for the change in domestic prices.
The ratio for the Dollar to the Euro started out as
1.50 Euro to 1 Dollar.
Now the ratio has changed as the Euro become more unstable with the down fall of Greece.
1.27 Euro to 1 Dollar.
This is obviously more attractive to the U.S.
The Brentton Woods system came about because of expanding economies shipping gold became too expensive. People did not give up fixed exchange rates that did not change. The goal was to attain exchange rate stability.
International monetary Fund put in 100 billion Euros in for Greece. They are trying to do this to give loans to struggling countries with low interest rates. The goal ws to keep currency within 1% to -1% to keep stable exchange rates.
Flexible exchange rates are external to iron out unwarranted volatilities. Free floating rates don’t interweave and the let the market decide. 48 countries do this. When the Fed is concerned about inflation they raise interest rates. China has a managed float where the try and keep their currency low to create more business from other countries in their own. The EU created the Euro for stable money.
Euro Convergence criteria included low inflation and low debt to GDP which Greece could not originally meet.
Currently in the EU are Hungary, Czech Republic and Poland who are trying to get into the Euro. When they do they will have to give up their monetary policy. Northern Europe such as Germany and France are ticked off at southern Europe because of their irresponsible spending and lack of economic stability. Europeans are starting to believe that Greece may have falsified their original information to get in on the Euro.
The second day of class we went over the Issue of currency. Today 1 Euro is worth $1.273 and continues to fall which is in favor of the dollar. The foreign market currency is composed of 3 trillion dollars exchanged a day. Two weeks ago 1 Euro was $1.40. Greece and the bail out is killing the Euro.
Spot rates: today’s currency rate.
Forward rates: future rate.
Currency rates are in the WSJ everyday.
The currencies = the spot rate + the interest rate.
We are concerned about either the dollar/ foreign currency or the foreign currency/dollar.
Here are the three exchange rates of the three countries that we are going to visit.
Hungary forint is .004551 in U.S. dollars
219.73 forint / U.S. dollar.
Poland Zloty is .3078 in U.S. dollars.
3.2489 Zloty / U.S. dollar.
Czech Republic Koruna is .04963 in U.S. Dollars
20.149 Koruna / U.S. dollar.
Venezuela fuerte dropped 100% to the dollar YTD.
The Americas and Asia Pacific currencies across the board are dominating the dollar while the dollar is dominating Europe in terms of currency exchange.
Problems with the U.S. were over speculation and borrowing in the U.S. with the bail out. U.S. will save California but will the European Central Bank save Greece? The answer seems to be yes as Germany has agreed to help with the bail out.
Spot rates and future rates are based on underlying theory.
The interest rate parity and the purchasing power parity. Future rates are an exact calculation. Spot rates are based on the underlying theory of the purchasing power parity.
The Future exchange rate for currencies are exact while the spot rate is not.
The interest rate parity needs the spot rate and interest rate in two different countries.
Everything around the world in currencies are calculated through the U.S. dollar. If you want a cross rate you get it by looking at it through the U.S. dollar. If you want a cross rate you get it by looking at it through the U.S. dollar.
There is no arbitrage condition. If IRP does not hold then an astute trader could make millions off of this. The Interest parity holds for the future.
Futures market has taken risk out.
Futures rate is given for a year out from the new rate.
If the future rate is different from the IRP then there is opportunity for Arbitrage.
If IRP fails then arbitrage.
Today on the market there is no arbitrage and no risk for the future values of currency. You can borrow in either currency and still have the same fixed rate.
Purchasing power is a theory explaining changes in spot rates. For example if inflation is higher in the U.S. then the U.K. pound depreciates.
We later went on to discuss transaction exposure. We worry about the dollar impact because of the exchange in currencies that amount to cash.
Today 1 U.K. pound is $1.48 today.
We later went on to discuss Forward Market hedges.
If you owe foreign currency then you buy the currency in a long position forward contract.
If you buy foreign currency then you sell the foreign currency in short position forward contracts.
We also discussed exposure netting, invoice currency and decision making on whether or not the firm should hedge.
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