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Introduction to Global

Business
Chapter 14
Global Financial Management
After studying this chapter, you should be able to:

1. Explain how foreign exchange risk affects


firms and investors.
2. Describe different ways to hedge exchange
rate risk.
3. Discuss sources of funds to finance
international trade and investment.
4. Discuss how exchange rate risk affects firms’
cash flows and its impact on stock returns.
Measuring Foreign Exchange
Exposure
• Exchange rate risk
The impact of random change in the value of one
currency with respect to other currencies
• Transactions risk
How short-term changes in exchange rates can
affect operating costs and revenues of firms
engaged in international business activities
• Translation risk
The short-term effects of currency movements on
the consolidated accounting statements of a firm
Measuring Foreign Exchange Risk
(continued)
• Consolidated accounting statements
The income statements and balance sheets of
multinational corporations and of all subsidiaries
abroad
• Economic risk
The ways in which long-term exchange rate
movements affect firms
Hedging Foreign Exchange (Forex) Risk
with Derivatives

• Hedging
Hedgers use currency derivatives to reduce potential
transaction, translation, and economic risks of
currency movements that could lead to losses for
a firm or investor
Futures Contracts
Currency futures contracts
Standardized agreements to buy or sell a specified amount of
currency at a date in the future at a predetermined price
• Long position
Buying a currency contract and profiting on the increased value of the
underlying currency over time
• Short position
Selling a currency contract and profiting on the decreased value of the
currency over time
• Organized exchanges
Trade futures contracts in major currencies and offer price transparency and
efficiency in addition to eliminating counterparty risk due to guaranteed
payments on contacts
Futures Contracts (continued)
• Common rules in trading currency futures
contracts:
Futures contracts are marked-to-market—gains
(losses) are earned (paid) in cash at the end of
each trading day.
Contracts can be purchased for a small commitment
fee called the margin.
If losses occur causing a participant’s balance to fall
below the maintenance margin at the end of the
trading day, a margin call occurs that requires the
customer to replenish the margin account.
Forward Contracts
• Currency forward contracts
Futures contracts in the currencies of emerging-
market countries offered by large banks in the OTC
market
Less standardized than future contracts such that
they can be customized by the seller/counterparty
to meet the hedging needs of the buyer
Are not marked-to-market daily
• Over-the-counter (OTC) market
Derivatives market run by large banks
Options Contracts
• Call option
An investor’s right (but not obligation) to buy an
asset (e.g., a currency) at a predetermined (strike)
price
• Put option
An investor’s right (but not obligation) to sell an
asset (e.g., a currency) at a predetermined price
• Premium
The price paid by the buyer to the seller for an
option contract
Swap Contracts
• Currency swaps
Allow firms to exchange currencies at a previously
agreed exchange rate as a way to hedge exchange
rate movements
• Plain vanilla currency swap
An interest rate swap, often combined with a
currency swap, if the interest being swapped is in
different currencies
Financing International Trade
and Investment
• Firms finance international operations in a
variety of ways.
Short-term financing of goods and services is
handled by large banks.
Long-term financing of capital equipment, land, and
buildings is provided by international bond and
stock markets.
Government financing is also available to meet
international trade policy goals in a particular
country.
International Banking
• Money center banks
Large global banks
• Clearing House Interbank Payments System (CHIPS)
Provides large, wholesale dollar payments services for
businesses, banks, and governments
• Society of Worldwide Interbank Financial
Telecommunications (SWIFT)
Provides secure communications for contracts, invoices, and
other trade documents that accompany cash payments
• Syndicate
A group of banks that collectively make a loan to an
international firm
International Payment Methods
and Documentation

Payment in Commercial Banker’s Open Account


Advance Letter of Credit Acceptance • A simple
• The safest (LC) • When a bank sells agreement
method for a LC into the wherein the
• Provides payment
exporters, but it financial exporter sends an
protection to invoice with the
exposes importers both exporters marketplace as a
to risk related to money market goods before due
and importers, as payment from
delivery of goods the importer’s instrument
importer, risky
bank writes a option for
guarantee of exporter
payment
International Bond Markets
• Bond ratings
Moody’s and Standard and Poor’s rating services that are important in
assuring foreign investors of the credit quality of bond issues
• Domestic bonds
Debt contracts sold by firms domiciled in a country in the home currency
• Foreign bonds
Bonds that are issued by foreign firms in another country in the home
currency of that country
• Eurobonds
Bonds that are sold in any country outside the home country, but in the
home country’s currency
International Stock Markets
Stock markets allow firms to issue new equity and raise long
term capital
• Diversification
Buying securities in a portfolio with price patterns over time that are
different from one another, which reduces the volatility of the
portfolio
• Home bias
Investing most of retirement and other savings in one’s home country,
which reduces diversification
• Contagion
When stock markets in many countries move down in concert with one
another and thereby reduce international diversification benefits
Government Financing
• International Monetary Fund (IMF)
Provides “lender-of-last-resort” short-term loans to countries
in financial crisis
Evaluates exchange rate policies
Gives technical assistance to countries
• World Bank
Provides long-term loans for economic reform and
infrastructure development in emerging and developing
markets
• IMF and World Bank are major suppliers of emergency and
development assistance to poorer countries.
Government Financing (continued)

• Major government-supported international


financing institutions include:
Export-Import (Ex-Im) Bank—a U.S. government
export finance agency that supports U.S. firms
competing against government-supported exports
of other countries
Bank of International Cooperation (JBIC)—Japanese
bank that supports exporters around the world
that have at least 30 percent Japanese content
Government Financing (continued)

• Trade finance
Bank and government loans used by exporters to
finance working capital (i.e., labor, materials,
inventory, and accounts receivables)
• Term financing
Bank and government loans to importers to cover
the cost of major purchases
Key Terms
exchange rate risk organized exchanges
transactions risk marked-to-market
translation risk margin
consolidated accounting margin call
statements currency forward contracts
economic risk over-the-counter (OTC) market
Special Drawing Right (SDR) call option
hedging put option
speculators premium
currency swaps
currency futures contracts
plain vanilla currency swap
long position
money center banks
short position
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitt
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Key Terms (continued)
CHIPS (Clearing House Interbank bonds
Payments System) Stock markets
SWIFT (Society of Worldwide
Interbank Financial
Telecommunications)
payment in advance
commercial letter of credit (LC)
banker’s acceptance
open account
syndicate

© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Introduction to Global
Business
Chapter 15
Accounting and Taxation
in Global Business
After studying this chapter, you should be able to:

1. Explain briefly the function of accounting and describe


the two parts of the accounting information system.
2. Describe briefly the function of generally accepted
accounting principles (GAAP).
3. Recount the goal of the International Accounting
Standards Board and describe why International
Financial Reporting Standards are important to global
business operations.
4. Explain how auditing contributes to the usefulness of
financial reporting.

© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitt
ed in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
After studying this chapter, you should be able to:

5. Explain how financial statement analysis can


be used to evaluate a company’s financial
situation and compare it to other companies.
6. Describe briefly tax issues that MNCs face.

© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitt
ed in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Introduction
• Accounting is the “language of business.”
• Accounting is the recording, summarizing, and
reporting of the economic activities and events
of an organization.
Used to make business decisions
Essential to managing and controlling operations
• Financial statements are the most important
reports produced by the accounting information
system.
Introduction (continued)
• For a corporation, financial statements are:
Income statement—summarizes the revenues earned and
the expenses incurred by a business over a period of time
Balance sheet—lists the balances of the asset, liability, and
owners’ equity accounts of a business on a specific date
Statement of retained earnings—shows beginning balance,
additions and reductions, and ending balance of retained
earnings
Statement of cash flows—indicates the firm’s inflows and
outflows of cash
EXHIBIT 15.1 FUNDAMENTAL FINANCIAL QUESTIONS AND ANSWERS
Accounting and Financial Reporting in
Global Business
• The accounting information system (AIS)
has two principal objectives:

Management accounting
Provides all financial information needed internally by
business managers for efficient (timely) and effective
(correct) decision making
Financial accounting
Provides financial information needed by external users, such
as investors and lenders
Management Accounting
Management accounting
• Management accounting in most firms includes similar
kinds of financial analysis
Cost-volume-profit analysis
Capital budgeting
Inventory planning
• Sophisticated technology has had an impact on how
management accounting tasks are performed.
Financial Accounting
• Financial accounting
Two major categories of external users:
• Organizations that require accounting information to be
reported. These include federal, state, and local
governments.
• Organizations that expect accounting information. These
include lenders, credit-rating agencies, suppliers,
employers, and customers.
EXHIBIT 15.2 EXTERNAL USERS OF ACCOUNTING INFORMATION
Generally Accepted Accounting
Principles (GAAP)
• Financial statements of publicly traded
companies must be prepared according to
generally accepted accounting principles
(GAAP).
• Accounting practices have developed in each
country in the world that relate to the culture
and business environment of that country, which
create to differences in GAAP among different
countries.
International GAAP
• GAAP used by companies based in other countries is
determined by the governments in those countries.
• Different GAAPs in other countries made it difficult for
investors and financial statement users to compare
financial reports of firms from different countries .
• International GAAP is now used by many
countries.
International GAAP is developed by the International
Accounting Standards Board.
The Board’s international GAAP is called
International Financial Reporting Standards (IFRS)
International Accounting
Standards Board (IASB)
An independent, privately funded accounting standard-setter
based in London, UK, which issues International Financial
Reporting Standards (IFRS)
• Objectives of the IASB
Increasing harmonization of accounting standards and
disclosures to meet the needs of the global market
Providing an accounting basis for underdeveloped or newly
industrialized countries to follow
Increasing compatibility of domestic and international
accounting requirements for audited financial statements
The Role of Auditing & The Sarbanes-
Oxley (SOX) Act

• Many business firms have an internal audit


function charged with the responsibility of
ensuring that the internal control structure is
operating effectively.
• Publicly traded companies use independent
external auditors to assure that financial
statements:
1. do not contain material misstatements, either intentional
or unintentional
2. are fairly presented according to generally accepted
accounting principles
Steps in the Auditing Process

Obtain and Communicate


Plan the Arrive at an
evaluate the audit
audit audit opinion
evidence results
Financial Statement Audit
Objectives
• Confirm the existence of assets and liabilities and
occurrence of income and expenses
• Assess the completeness of the financial statements (all
assets, liabilities, income, and expenses are accounted for)
• Ensure proper valuation of assets, liabilities, income, and
expenses
• Show that the auditee owns the assets and is obligated to
the extent of liabilities shown
• Assure that financial statement items are properly
presented and disclosure regulations have been followed
Financial Statement Analysis
• Financial statement analysis
An evaluation of financial statements to identify
significant trends or relationships among the items
Begins with the information provided on financial
statements and builds to provide a comprehensive
understanding of a company’s financial situation
Can provide answers to questions asked by
management, investors, lenders, and others
Financial Ratios
• Financial ratios
Use the relationship of a number on the financial
statement to another number to assess the firm’s
financial condition
• Debt ratio:

• Current ratio:
Evaluating Trends
• Positive trends in financial performance indicate
that a company has positive future prospects.
Good news for investors, typically leading to higher
stock prices
Good news for lenders, indicating a high likelihood
that loans will be repaid
• Negative trends suggest a difficult time for a
firm.
Global Tax Matters
Income
tax

Corporate
income tax Sales tax

Types
of
Value-
added tax Taxes Property
tax
(VAT)

Goods
and Payroll
services tax
tax (GST)
Tax Rates Among Selected
Countries
• Almost every country has a corporate income tax.
Countries that have little or no corporate tax are tax havens.
Countries that are tax havens may still impose other taxes.
• Taxes are just one factor to consider when locating
business operations in a country.
Other factors such as strong economy, quality labor force,
good access to transportation, well-established legal
system, and political stability can outweigh tax rates.
EXHIBIT 15.4 CORPORATE INCOME TAX RATES IN OECD COUNTRIES
Transfer Pricing
• Transfer pricing is the pricing of goods and services
transferred (bought and sold) internally between units of
an international firm involving:
Raw materials and semi-finished and finished goods
Allocation of fixed costs
Loans, fees, and royalties for use of trademarks and copyrights
• Transfer pricing can affect local taxes owed and the firm’s
profits.
• Transfer pricing may be subject to the laws and
regulations of the countries in which the firm conducts
business.
Key Terms
accounting Statements of Financial
income statement Accounting Standards (SFAS)
balance sheet International Accounting
Standards Board (IASB)
statement of retained earnings
International Financial
statement of cash flows
Reporting Standards (IFRS)
accounting information system
financial statement analysis
(AIS)
financial ratio
management accounting
financial accounting
generally accepted accounting
principles (GAAP)

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