International Corporate Finance PDF

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Summary

Understanding the foreign exchange, the exchange rate risk, international taxation, segmenting capital markets and capital budgeting....

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International Corporate Finance What is Foreign Exchange?

-The foreign exchange market is where currencies are traded. -It has very high volume, is dominated by large international banks, and operates 24 hours a day during the week. -An exchange rate is a price for one currency denominated in another currency.

Exchange Rate Risk

-Firms can manage exchange rate risk in financial markets using currency forward contracts to lock in an exchange rate in advance and using currency options contracts to protect against an exchange rate moving beyond a certain level. -The cash-and-carry strategy is an alternative strategy that provides the same cash flows as the currency forward contract. By the Law of One Price, we determine the forward exchange rate by the cost-of-carry formula, called the covered interest parity equation. Using “FC” to represent any foreign currency, for an exchange that will take place in 1 year, the corresponding forward exchange rate in FC per $ is:

-Currency options allow firms to insure themselves against the exchange rate moving beyond a certain level. A firm may choose to use options rather than forward contracts if: -It would like to benefit from favorable exchange rate movements but not be obligated to make an exchange at unfavorable rates. -There is some chance that the transaction it is hedging will not take place.

Internationally Integrated Capital Markets

-The condition necessary to ensure internationally integrated capital markets is that the value of a foreign investment does not depend on the currency (home or foreign) used in the analysis. -Two methods are used to value foreign currency cash flows when markets are internationally integrated and uncertainty in spot exchange rates are uncorrelated with the foreign currency cash flows:

International Corporate Finance -Compute the expected value of the foreign currency cash flows in the home currency by multiplying the expected value in the foreign currency by the forward exchange rates, and then compute the NPV of this home currency cash flows using the domestic cost of capital. -Calculate the foreign currency value of a foreign project as the NPV of the expected foreign currency future cash flows discounted at the foreign cost of capital, and then convert the foreign currency NPV into the home currency using the current spot exchange rate.

Valuation and International Taxation

-A U.S. corporation pays the higher of the foreign or domestic tax rate on its foreign project, so project valuation should use the higher of these two rates as well. The U.S. corporation may be able to reduce its tax liability by undertaking foreign projects in other countries whose earnings can be pooled with those of the new project or by deferring the repatriation of earnings.

Internationally Segmented Capital Markets

-Capital markets might be internationally segmented. The implication is that one country or currency has a higher cost of capital than another country or currency, when the two are compared in the same currency.

Capital Budgeting with Exchange Rate Risk

-When a project has inputs and outputs in different currencies, the foreign-denominated cash flows are likely to be correlated with changes in spot rates. To correctly value such projects, the foreign and domestic cash flows should be valued separately....