Chapter 1: Exchange Rate

Exchange rate
-​ Definitions: The price of one country’s currency in terms of another
-​ Most currency quoted in terms of dollars (USD)

1.​ Direct Quotation: price of foreign currency expressed in U.S. dollars (dollars per
currency)
2.​ Indirect Quotation: the amount of a foreign currency to buy one U.S. dollars
(currency per dollar)

Cross rate
-​ Definitions: the exchange rate between any two currencies not involving U.S. dollars
-​ Usually calculated from direct or indirect rates
-​ Based on U.S. dollar exchange rate

Currency Appreciation and Depreciation

-​ Appreciation : strengthening
-​ Depreciation : weakening

Spot Rate (S)

-​ The immediate exchange rate on trade

Forward rate (F)

-​ The exchange rate in a forward date
-​ Normally reported as indirect quotations
1.​ Forward Premium:
-​ Future price for a currency is greater than the spot price
-​ Domestic exchange appreciation
2.​ Forward Discount:
-​ Future price for a currency is less than the spot price
-​ Domestic exchange depreciation
​ **90 = forward day

Chapter 2 : The Balance of Payment

Balance of Payments
-​ International economic transactions between the residents of a country and foreign
residents (economic transactions of a country with the rest of the world)
-​ Indication of a pressure on a country’s foreign exchange rate
-​ A signal of the imposition or removal of controls in various sorts of payments (dividends,
interest, license fees, royalties and other cash disbursements)
-​ A forecast of a country’s market potential (especially in the short run)
-​ Statement of cash flows over an interval of time
-​
Debit (inflow) Credit (outflow)

Event, such as export of a good or Foreign exchange spent, such as

service, that records foreign exchange payments for import or purchases of
earned services

Current Account =
Capital Account + Financial Account

Balance of Payment
1.​ Current Account Balance (X-M)
a.​ The net flow of money transactions
b.​ Including goods, services & income (earn-pay)
2.​ Capital Account Balance (inflows - outflows)
a.​ Net change in ownership of assets
b.​ Including debts, assets, grants of capital assets, intangible assets (such as,
brand names, copyrights, trademarks, rights to use land/water
3.​ Financial Account Balance (borrowing - lending)
a.​ Direct investment: long term capital investment
b.​ Portfolio investment: purchase of equity / debt
 c.​ Financial derivative: purchase / sales of derivative
d.​ Reserve assets: assets held by a government that can be converted into cash in
short time
e.​ Trade Credit: currency / deposits; importers did not pay while ordering goods,
only pay when they received the goods

The relationship between Balance of Payment and Exchange rate

(a)​ BOP Surplus (inflow > outflow)
-> currency tends to appreciate due to high demand for home currency
(b)​ BOP Deficit (outflow > inflow)
-> currency tends to depreciate due to higher demand for foreign currency

1.​ Fixed Exchange Rate Countries

-​ Government bears the responsibility to ensure the BOP is near to zero
-​ Benefits: Reflecting a country’s economic stability, competitiveness for importers,
investors and consumers
-​ Risk: inflation may devalued the currency makes export less competitive and
increase import
-​ Eg: Zimbabwe
2.​ Floating Exchange Rate Countries
-​ Government has no responsibility to peg its foreign exchange rate
-​ Benefits: Currency doesn’t stay over or under-valued for long
-​ Limitations: inflation will still devalued the currency, makes export less
competitive and increase import
3.​ Managed Floats
-​ Reduce the risk of deflationary recession 通货紧缩 + 衰退, but less flexible in the
use of interest
-​ Risk: Countries operating often find it necessary to take action to maintain their
desired 理想 exchange rate values

The relationship between Balance of Payment and Inflation

-​ Especially current account (export and import)
-​ Lowering inflation: importers have the potential to lower a country’s inflation rate:
bringing in cheaper foreign goods, the pressure for domestic prices to rise is reduces,
lower inflation rate
-​ Foreign competition replaces domestic competition, helping to maintain a lower rate of
inflation. Without imports, domestic goods might be more expensive, thus imports help
control price levels.
-​ Negative Impact: if lower-priced imports replace domestic production and employment,
country GDP will decrease, BOP current account will tends to negative

The relationship between Trade Balance and Exchange Rate

1. Currency contract period: When a country’s currency suddenly devalues,
existing contracts are usually fixed in terms of the pre-devaluation exchange rate.
This means that initially, the country may experience a deterioration in its trade
balance because import prices rise immediately, but exports may not increase
right away due to the fixed prices in contracts.

2. Pass-through period: Over time, as markets adjust to the new exchange rate,
prices start to change. Foreign buyers may begin to respond to the lower prices
of exports, while domestic consumers start to reduce their demand for now more
expensive imports. This phase reflects the gradual market response to the price
changes caused by the devaluation.

3. Quantity adjustment period: After markets fully respond to the price changes,
trade quantities adjust accordingly. Export volumes increase, and import volumes
decrease. This adjustment typically takes a few months (three to six months) as
the trade balance improves due to the increased competitiveness of domestic
goods and services.

Importance of Balance of Payment

 1.​ Measure overall balance of economic transaction between a country and its trading
partners
a.​ Surplus: indicates that a country earn more investments and exports compared to
its imports and payments
b.​ Deficit: indicates that a country inflow is lower than outflow, discourage import
and promotes export (eg: increase interest rate, impose foreign exchange
controls, devalue the currency)
2.​ Provide government guidance, adjusting import and export tariffs
3.​ Policy development in developing monetary and fiscal policies

Chapter 3: International Parity Condition

Law of one Price

-​ Theory that states that the price of similar goods in different markets (eg: different
countries) should be equal after translation
-​ Four assumptions:
1.​ Free competition and no barrier to trade
2.​ Price flexibility
3.​ Arbitrage opportunities exist if this theory doesn't hold
4.​ Arbitrage is an investment strategy in which an investor simultaneously buys and
sells an asset in different markets to take advantage of a price difference and
generate profit

Purchasing Power Parity (PPP)

a.​ Assumption: the purchase power for all individuals in different country is same
b.​ The rates of currency conversion the equalize the purchasing power of different
currencies by eliminating the different in price levels between countries
International Fisher Effect (IFE)
a.​ The difference in nominal interest rates between two countries will equal the expected
change in exchange rates between their currencies.
b.​ Countries with higher nominal interest rates will see their currency depreciate relative to
countries with lower interest rates.
c.​ Inflation reduces the purchasing power of a currency, leading to its depreciation
d.​ Assumption: IFE assumes that investors will move their capital to countries with higher
interest rates to seek better returns. However, as more investors buy into the
higher-yielding currency, its value will adjust (depreciate), negating the advantage of
higher interest rates due to expected inflation.
e.​ No Arbitrage: The theory suggests that real returns (returns adjusted for inflation) across
countries should be equal once changes in exchange rates are considered. In other
words, no arbitrage opportunities should exist that allow investors to make higher real
returns by simply switching currencies.

Interest Rate Parity (IRP)

a.​ Relationship between the spot exchange rate and the expected spot rate / forward
exchange rate of two currencies, based on interest rate
b.​ The basic premise is that the difference in interest rates between two countries will be
reflected in the differential between the forward exchange rate and the spot exchange
rate. In a world of no arbitrage, IRP ensures that there is no opportunity to make risk-free
profits through currency speculation.
Covered Interest Arbitrage
a.​ A strategy which an investor uses a forward contract to hedge against exchange rate risk
b.​ The practice using favorable interest rate differentials to invest in a higher-yielding
currency and hedging the exchange risk through a forward currency contract
c.​ It occurs when there is a discrepancy between the interest rate differential and the
forward premium or discount on currencies.
d.​ The investor can profit by borrowing in one currency, converting it to another, and
investing in the country with a higher interest rate, while simultaneously locking in the
future exchange rate with a forward contract.

Key Components How Covered Interest Arbitrage Works:

1.​ Interest Rate Differential: The 1.​ Borrow: The investor borrows money
difference between the interest rates in a country with a lower interest rate.
of two countries. 2.​ Convert: The borrowed money is
2.​ Spot Exchange Rate: The current converted into the currency of a
exchange rate at which two currencies country with a higher interest rate at
can be exchanged. the current spot exchange rate.
3.​ Forward Exchange Rate: The 3.​ Invest: The money is invested in an
exchange rate agreed upon today for interest-bearing asset in the country
a transaction that will occur in the with the higher interest rate.
future, which hedges against 4.​ Forward Contract: At the same time,
exchange rate fluctuations. the investor enters into a forward
4.​ No Risk: By using a forward contract, contract to sell the foreign currency
the investor eliminates exchange rate and buy back the original currency at
risk, ensuring the profit from the the forward rate on a future date
interest rate differential is protected. (typically the maturity of the
investment).
5.​ Profit: On the maturity date, the
investor earns interest on the
higher-yield investment, converts the
funds back to the original currency
 using the forward contract, repays the
original loan, and pockets the
difference as profit.

Chapter 4 & 5 : Transaction exposures and currency derivatives

Types of exchange rate risk

1.​ Transaction exposure
a.​ Exists when 2 contractual transaction cause corporations to receive / need a
certain amount of foreign currency in the future
b.​ The risk that a company faces due to fluctuations in exchange rates when it
engages in international transactions.
c.​ The potential for a firm’s profitability, net cash flow and market value to change
because of a change in exchange rate
d.​ Companies can manage transaction exposure by matching the currency of
revenue and expense, using hedging techniques or diversifying operations
and investment

2.​ Operating exposure

a.​ Economic exposure, competitive exposure. Or strategic exposure
b.​ The change in the present value of the firm resulting from any change in future
operating cash flow of the firm caused by unexpected change in exchange rates
c.​ the long-term risk that a company faces due to unexpected changes in
exchange rates that can affect its future cash flows, revenues, and overall
market value.
d.​ Can affect a company's competitiveness in both domestic and foreign
markets by affecting their costs and revenues
 e.​ Not readily measurable since it depends on the effect of random exchange rate
changes on the firm’s competitive position
f.​ In many cases, operating exposure may account for a larger portion of the firm’s
total exposure than contractual exposure

Transaction exposure Operating exposure

Focuses on specific foreign currency More concerned with the broader impact of
denominated transactions exchange rate changes on a company's
competitive position in the global market over
time.

3.​ Translation exposure (Accounting exposure or balance exposure)

a.​ Arises because financial statements of foreign subsidiaries - which are stated in
foreign currency - must be related in the parent’s reporting currency for the firm to
prepare consolidated financial statement
b.​ Involves converting the foreign subsidiaries financial statements into U.S. dollar
denominated statements
c.​ Potential increase or decrease in the parent’s net worth and reported net income
caused by change in exchange rate since the last transaction

Why Hedging
a.​ Financial technique that involves using derivatives such as futures, options, swap or
future contracts, to lock in a fixed or favorable exchange rate for a future transaction or
cash flow
b.​ Enhancing project planning and control by reducing uncertainty and variability of
currency exchange rates
c.​ Improves cash flow managements by ensuring the project has sufficient funds in the
required currencies to meet its obligations
d.​ The project’s competitiveness and attractiveness by offering more certainty and
transparency to stakeholders, thus reducing the need for currency risk premium or
discounts
e.​ Protect its forecast revenue transaction from fluctuations while remaining hedge its
investment in foreign subsidiaries, intercompany transaction and assets and liabilities in
foreign currencies

Foreign Currency Option

a.​ A contract giving the option purchaser (the buyer) the right, but not the obligations, to
buy or sell a given amount of foreign exchange at a fixed price per unit for a specified
time period (until the maturity date)
b.​ Types of options
i.​ Call Options: buy foreign currency
ii.​ Put option: sell foreign currency
Money Market Hedge
a.​ technique used to protect against foreign exchange risk by using the money markets
(short-term borrowing and lending markets).
b.​ It involves executing transactions in the domestic and foreign money markets to lock in
the exchange rate at which a future foreign currency payment or receipt will be made,
thus mitigating the risk of exchange rate fluctuations.
c.​ Steps:
i.​ Determine the present value of the foreign payable / receivable using foreign
interest rate
ii.​ Borrow and invest the equivalent amount (present value of the foreign currency)
in domestic currency
iii.​ Use maturity proceeds to pay or repay loan with receivable

Futures versus forward contract

a.​ Futures
i.​ a contract between two parties where both parties agree to buy and sell a
particular asset of specific quantity and at a predetermined price, at a specified
date in future.
ii.​ The payment and delivery of the asset is made on the future date termed as
delivery dare
b.​ Forward contract
 i.​ a contact agreement to buy or sell an asset at a specific price on a specific date
in future
ii.​ Refers to the underlying assets that will be delivered on the specified date, it is
considered a type of derivative

Futures Forward

Exchange-trade Trading Platform Over-the-counter (OTC)

Standardized Contract Specification Customized

Market-based, marked by Price determination Negotiated between parties

market

Active secondary market Secondary Market No secondary market

Required to mitigate Margin Requirement Not typically required

counterparty risk

Regulated by exchanges and Regulatory Oversight Less regulated, often

regulatory authorities governed by contractual
agreements

Types of Futures Contract Traded on Bursa Malaysia Derivatives

a.​ Interest rate futures : FKB3
b.​ Stock Index futures : FKLI, FM70
c.​ Bond Futures : FMG5, FMG3, FMGA
d.​ Commodity Futures : FCPO, FPOL, FUPO, FPKO, FGLD, FTIN

Forward Market Hedge

a.​ A strategy used by companies to protect against currency risk by entering into a forward
contract, which locks in a specific exchange rate for a future transaction.
b.​ Allows the company to secure a fixed rate to convert currency at a future date, shielding
it from potential losses due to exchange rate fluctuations
c.​ The company and a financial institution (usually a bank) agree to a forward contract that
specifies an exchange rate (the “forward rate”) for a future date.
d.​ Type of forward hedge:
i.​ Foreign Payable: expecting to pay a foreign currency in the future
ii.​ Foreign Receivable: expecting to receive foreign currency in the future
e.​ Gain and loss:
​ Unhedged amount - forward hedge amount - proceeds fees
Chapter 6 : Operating and translation exposure

Managing Operating Exposure

-​ Objective: stabilize cash flow in face of fluctuating exchange rates
a.​ Operating Strategies:
i.​ Selecting low-cost production site
1.​ Strategically choose production location where lower cost
ii.​ Flexible sourcing policy
1.​ Sourcing of raw materials and components from different countries
iii.​ Diversification of the market
1.​ Enter and selling products in multiple international markets helps spread
out risk
iv.​ Product differentiation and R and D efforts
1.​ Investing in product differentiation and research and development helps
company build unique products or services
2.​ Enhance brand loyalty and pricing power, allowing company to pass the
costs to customers
v.​ Financial hedging
1.​ Financial instruments such as forward contracts, options and swaps
b.​ Financial Strategies
i.​ Matching currency cash flows
1.​ Matching debt with currency: If a company expects to earn money in a
certain foreign currency, it can take out a loan in the currency first before
the exchange rate drops. While the debt expired, use the income to pay
the loan
2.​ Finding Suppliers in the same currency: A US company could choose to
buy supplies from Canadian suppliers if it has income in Canadian dollars
3.​ Paying Suppliers in the same currency: the company could engage in
currency switching, which the company will pays its suppliers in foreign
(Canadian dollars)
ii.​ Risk sharing agreements
1.​ Suitable for long-term cash flow exposure
2.​ Contractual arrangement in which the buyer and seller agree to share or
split currency movement impact on payments between them
 3.​ Intended to smooth the impact on both parties of volatile and
unpredictable exchange rate movements
iii.​ Back to back or parallel loans or credit swap
1.​ Occurs when two business firms in separate countries arrange to borrow
each other’s currency for a specific period of time
2.​ At an agreed terminal date they return the borrowed currencies
3.​ Creates a covered hedge against exchange loss
iv.​ Cross-currency swaps
1.​ Similar to a back-to-back loan expect it does not appear on a firm’s
balance sheet
2.​ Firm and swap dealer/bank agree to exchange an equivalent amount of
two different currencies for a specified amount of time
v.​ Leading and lagging
1.​ Techniques using adjustment to the timing of a payment request or
disbursement to reflect expectations about future currency movements
2.​ Leading: A company expecting a foreign currency to strengthen in the
near future might pay its debts or make purchases earlier to take
advantage of the current lower exchange rate
3.​ Lagging: A company expecting a foreign currency to weaken might delay
receiving payments or postpone payments to take advantage of the future
lower exchange rate
vi.​ Currency diversification
1.​ Diversify business across numerous countries
2.​ Ensuring those currencies are not highly correlated
3.​ If one of the currencies substantially depreciate, the others would
increase due to low correlation amongst currencies

Managing Translation Exposure

a.​ Balance Sheet Hedge
i.​ The main technique to minimize translation exposure
ii.​ Requires an equal amount of exposed foreign currency assets and liabilities on a
firm’s consolidated balance sheet
iii.​ Eliminating the mismatch of exposed net assets (and exposed net liabilities in the
same currency
iv.​ 2 methods:
1.​ Temporal Method
a.​ Current and non-current monetary accounts carried on the books at current
value are converted at the current exchange rate
b.​ Accounts carried on the book at historical costs are translated at the
historical exchange rate
c.​ Fixed assets and inventory are usually carried at historical costs
d.​ Result -> the temporal method will typically provide the same translation
2.​ Current rate Method
 a.​ All balance sheet accounts are translated at the current exchange rate
except stockholder’s equity, which translated at the exchange rate on the
date of issuance
b.​ Simplest of all translation method to apply
c.​ Cumulative translation adjustments (CTA) is used to make the balance
sheet balance, since translation gains or losses do not go through the
income statements according to this method

Current rate method vs temporal method

Topic 7 : Multinational Capital budgeting

Net Present Value (NPV)

a.​ The value of all future cash flow (including positive and negative) over the entire life of
an investment discounted to the present
b.​ For determining the value of a business, investment security, capital project, new
venture, cost reduction program, and anything that involves cash flow
NPV with foreign currency translation
a.​ NPV of an international project is normally calculated by converting the overseas cash
flows into the domestic currency using a forecast exchange rate.
b.​ The are two alternative approaches for calculating the NPV from an overseas project
i.​ NPV first approach
1.​ Forecast foreign currency cash flows including inflation
2.​ Forecast exchange rates and therefore the home currency cash flows
3.​ Discount home currency cash flows at the domestic cost of capital
ii.​ NPV second approach
1.​ Forecast foreign currency cash flows including inflation
2.​ Discount foreign currency cost of capital and calculate the foreign
currency NPV
3.​ Convert into a home currency NPV at the spot exchange rate
iii.​ Second approach is useful because it does not require an exchange rate to be
forecast. However, exam question to date have all been based on using the first
approach. First approach is more useful where project’s cash flows are in variety
of currencies
iv.​ Example question

The effect of exchange rates on NPV

a.​ Domestic currency depreciation -> domestic currency value of the net cash flow increase
-> NPV increase.
b.​ Domestic currency appreciation -> domestic currency value of the net cash flow decline
-> NPV sterling decrease .
c.​ Example question
WACC of multinational corporations (MNCs)
Domestic firm MNCs

-​ Have a relatively high cost of capital -​ Have access to international source of

and capital
-​ Will face limited availability of such -​ May reach a lower weighted average
cost of capital
capital
-​ Which will, in turn, reduce the overall
competitiveness of the firm
a.​ The crowding out effect theory suggests that rising public sector spending drives down
private sector spending. Crowding suggests that government borrowing and spending
can increase (economic) demand. When demand is higher,cost of WACC may increase
(higher interest rate)
b.​ For a domestic firm (which residents in active or segmented capital markets), as long as
the firm stays small and has a small amount of optimal capital budget, the crowd out
effects is not significant. The firm could still have a lower WACC for its projects
c.​ Once the opportunity set of projects increases, the crowd out effect is significant and the
firm will have a higher WACC for larger budget
d.​ Therefore, the domestic firm will eventually need to increase its capital budget to the
point where its WACC is increasing

Multinational Tax Management

a.​ Objective : multinational tax planning is the minimization of the firms worldwide tax
burden
b.​ MNC should understand different structures and tax liabilities across countries
c.​ Controlled Foreign Corporations (CFC)
d.​ Any foreign corporation in which US shareholders, including corporate parents, own
more than 50% of the combined voting power or total or total
 e.​

Tax Types
a.​ Taxes are classified on the basis of whether they are applied directly to income or some
other measurable performance characteristic of the firm
b.​ Corporate income tax rates differ widely across the globe and may take a variety of
different forms
c.​ Source of direct taxes include
i.​ Income tax -> usually a primary revenue source for governments
ii.​ Withholding tax 预扣税 -> a portion of passive income earned in a foreign country
is typically withheld to assure payment of taxes
d.​ Source of Indirect tax include
i.​ Value-added tax (VAT) -> type of a national sales tax collected at each level of
production
ii.​ Goods and service tax -> applied to the sales of most goods and services
iii.​ Consumption tax -> charged to individuals when they spend money on goods
and services
iv.​ Excise duties -> levied on targeted item
v.​ Others
e.​ Indirect tax obligations appear to be on the rise and are making up greater proportions of
government revenues globally

Foreign Tax Credits and Deferral

a.​ To prevent double taxation of the same income, most countries grant a foreign tax credit
for income taxed paid to the host country
b.​ The value-added tax and other sales taxes are not eligible for a foreign tax credit but are
typically deductible from pre-tax income as an expense
c.​ Credit limit the tax no more than the highest single rate among jurisdiction
Transfer Pricing
a.​ The pricing of goods, service and technology transferred to a foreign subsidiary from an
affiliated company.
b.​ Transfer pricing is the first and foremost method of transferring funds out a foreign
subsidiary
c.​ A parent firm wishing to transfer funds out a particular country can charge higher prices
on goods sold to its subsidiary in that country
d.​ A foreign subsidiary can be financed by the reverse technique, a lowering of transfer
price
e.​ A parent wishing to reduce the taxable profits of a subsidiary in a high-tax environment
may set transfer prices at a higher point to increase the costs of the subsidiary, thereby
reducing taxable income
f.​ US IRS regulations provide three methods to establish arm’s length prices:
i.​ Comparable
ii.​ Resale prices
iii.​ Cost-plus calculations
g.​ Challenges
i.​ Managerial Difficulties: Managers in one country may struggle to determine what
is optimal for the MNE as a whole, especially when negotiating transfer prices
with related companies in different jurisdictions. Differences in local regulations,
tax systems, and market conditions can complicate decisions.
ii.​ Joint Ventures: Transfer pricing in joint ventures poses unique challenges: Local
shareholders may prioritize maximizing profits within the country of operation.
However, this may not align with the overall profit optimization goals of the
multinational enterprise (MNE).
iii.​ Compliance and Auditing: Ensuring compliance with international tax laws
requires extensive documentation and precise record-keeping. Discrepancies in
 transfer pricing can result in penalties, double taxation, or disputes with tax
authorities.

Tax Havens and International Offshore Financial Centres

a.​ Many MNEs have foreign subsidiaries that act as tax havens for corporate funds
awaiting reinvestment or repatriation汇回本国
b.​ Tax-haven subsidiaries, categorically referred to as international offshore financial
centers, are partially a result of tax-deferral features on earned foreign income allowed
by some of the parent countries 避税地子公司被统称为国际离岸金融中心，部分原因是
一些母国允许对赚取的国外收入实行税收递延政策。

Basis Erosion and Profit Shifting (BEPS)

a.​ refers to tax strategies used by multinational corporations (MNEs) to shift profits to
low-tax jurisdictions and reduce their tax base in higher-tax countries. These practices
often exploit gaps and mismatches in international tax rules, enabling companies to
avoid or delay paying taxes.
b.​ Global Concerns: The G20 finance ministers, in collaboration with the OECD, developed
an action plan to address BEPS, aiming to ensure that taxes are paid where economic
activities and value creation occur.
c.​ Digital Economy: Companies like Amazon, Apple, and Microsoft, which operate largely in
the digital realm, can easily move intangible assets (e.g., intellectual property) across
borders. This creates an uneven playing field, as they can leverage these strategies
more effectively than traditional firms.

Corporate Inversion
a.​ Changing the company’s country of incorporation is used to reduce global tax liabilities
by re-incorporating in a lower-tax jurisdiction改变公司的注册国，通过在低税率地区重新
注册来减少全球税负。
b.​ Although the company’s operations and headquarters may be completely unchanged of
incorporation will now be only one of many countries in which the firm operates foreign
subsidiaries
c.​ The American Jobs Creation Act (AJCA) of 2004 reduced the use of corporate inversion.
Today there are three basic types of corporates inversions in use
i.​ The substantial business presence: establishes a significant presence in the new
jurisdiction
ii.​ Merger with a larger foreign firms and re-establishes itself in the foreign firm’s
home country

Chapter 8 Foreign Direct Investment, country and political risk

Foreign Direct Investment (FDI)

a.​ An investment from a party in one country into a business or corporation in another
country with the intention of establishing a lasting interest (wish to have a long-term
relationship)
 b.​ How is FDI Different from Portfolio Investment?
i.​ FDI: The investor is actively involved in the foreign business (e.g., owning a part
of the company and helping make decisions).
ii.​ Portfolio Investment: The investor only buys stocks or bonds in a foreign
company without being involved in its management.
c.​ Method of foreign direct investment
i.​ Acquiring voting stock in a foreign company
ii.​ Mergers and acquisitions
iii.​ Joint ventures with foreign corporations
iv.​ Starting a subsidiary of a domestic firm in foreign country

Case study
Country risk (Macro risk)
a.​ Affect all firms, domestic and foreign that are resident in a host country.
b.​ This risk affect the MNC at the project or corporate level but originate at the country level
c.​ Main country-specific political risk are
i.​ Transfer risk : the limitations on the MNC’s ability to transfer funds into and out of
a host country without restrictions
ii.​ Cultural and institutional risk
1.​ Differing Business Practices
2.​ Language Barriers
3.​ Religion Differences
 4.​ Labor Demographics

Political Risk
a.​ Potential discontinuity or seizure of an MNC’s operations in a host country via the host’s
implementation of specific rules and regulations
b.​ Usually manifested in the form of nationalization, expropriation or confiscation
c.​ In general, the host government takes over the assets and operations of a foreign firm,
usually without proper or any compensation
d.​ Macro political risk is the subjection of all foreign firms to political risk (takeover) by a
host country because of political change, revolution, or the adoption of new policies
e.​ Micro political risk is the subjection of an individual firm, a specific industry or companies
from a particular foreign country to a political risk (takeover) by a host country

Chapter 9: International trade

Issues in international trade

a.​ The safest and most secure arrangement for the exporter is cash-in-advance
b.​ But, the importer does not want to have inability to stop or withhold payment if the
merchandise is not as promised
c.​ Risk for importer/ exporter
i.​ The risk of noncompletion (timely and complete payment)
ii.​ Foreign exchange risk
iii.​ To provide a means of financing
d.​ RIsk of noncompletion skyrocketed during global pandemic

Trade Financing: Letter of credit (L/C)

a.​ Letter of credit are used to provide credit in international payment transaction
b.​ L/C is an agreement in which the buyer’s bank guarantees to pay the seller’s bank at the
time goods/ services are delivered
 c.​ Once the buyer and seller agree to do business, the buyer requests for a L/C from the
issuing bank to ensure that the international transaction is secure and guaranteed.
d.​ Once the seller ship the goods (in accordance to the contract), the issuing bank sends
the L/C to the advising bank
e.​ Once goods are delivered and a request for payment (with or without documentation -
depending on types of L/C) is made, the issuing bank pays this amount to the seller
banks
f.​ Finally, the issuing bank obtains the payment from the buyer and releases documents so
that the buyer can now claim the goods from the carrier
g.​ An L/C reduces the risk of noncompletion because the bank agrees to pay against
documents rather than actual merchandise
h.​ L/C is the promise of the issuing bank to pay against specific documents, which must
accompany any draft drawn against the credit
i.​ L/C not a guarantee of the underlying commercial transaction, but rather a separate
transaction from any sales or other contracts on which it might be based
j.​ Benefits to exporters
i.​ Exporters sell their goods abroad against the promise of a bank rather than a
commercial firm. Because banks are usually larger and have better credit risk
than most business firms, exporters are almost completely assured of payment if
they meet specific conditions
ii.​ Exporters can obtain funds as soon as they have such necessary documents.
When shipment is made, the exporter prepares all necessary documents and
presents them to his local bank. If the bank finds that papers are in order, it
advances the funds

Bill of Lading (B/L)

a.​ The key documents for international trade
b.​ B/L is issued to the exported by a common carrier transporting the merchandise
c.​ Three purposes
i.​ Receipt
ii.​ Contract
iii.​ Document of title
d.​ Bills of lading are either straight (Ownership of the goods cannot be transferred to
another party) or to or order (Ownership can be transferred to another party)

A trade transaction could conceivably be handled in many ways

The transaction that would best illustrate the interaction of the various document would be an
export financing under a documentary commercial letter of credit, requiring an order bill of
lading, with the exporter collecting via a time draft accepted by the importer’s bank

Letter of credit (L/C) Bill of Lading (B/L)

 A certification by a bank that its client account A itemized list of goods included in a
holder will make payment the client shipment
undertakes

Bill of Exchange (B/E)

a.​ The instrument normally used in international commerce to effect payment
b.​ A draft, simply an order writer by an exporter (seller) instructing an importer or its agent
to pay in a specific time
c.​ The person or business initiating the draft is called as the maker, drawer or originator
d.​ Normally the exporter is the one who sells and ship the merchandise
e.​ The payee of bill exchange is the drawee
i.​ The bill of exchange will facilitate a line of credit for international traders
f.​ A bill of exchange facilitates secure transactions by ensuring that the bank will accept
the bill of exchange written up by the drawee, which means that the seller will receive the
funds regardless of whether the buyer pays or not

Letter of credit (L/C) Bill of Exchange (B/E)

Facilitate international transaction between buyers and sellers, facilitate lines of credit to the
buyer and provide assurance to the seller that the payment will be made regardless of
whether the buyer is able to meet his payment obligations

An agreement in which the buyer’s bank One party will pay a fixed amount of funds to
guarantees to pay the seller’s bank at the another party at a predetermined date in the
time good / services are delivered [payment future [payment instrument]
mechanism]

Trade Financing: The flow of goods, funds and documents - Forfaiting

a.​ A longer term financing instruments used to eliminate the risk of nonpayment by
importers in instances where the importing firm of nonpayment by importers and/or its
government is perceived by the exporter to be too risky for open account credit
b.​ A typical Forfaiting transaction involves five parties - importer, exporter. Forfaiter and the
imposters bank
c.​ The essence of Forfaiting is the non-recourse sale by an exporter by an exporter of
bank-guarantee promissory notes, bills of exchange or similar documents received from
an importer in another country
d.​ Type of Forfaiting
i.​ Transform a credit-based sale into an immediate cash payment: Exporter selling
account receivables to a Forfaiter at a discount
ii.​ Exporter sells the account receivables at a discount to a Forfaiter
iii.​ Forfaiting allow the exporter to transfer the credit risk while accommodating the
importer’s need for extended credit terms
1.​ Forfaiting transactions maturity: 180 days - 7 years in US export
 iv.​ Forfaiters are responsible for collecting payments from foreign buyers, reducing
exporter from payment-related risk
1.​ Fees associated are often higher
e.​ Flows
i.​ Communicate with prospective importer - exporter discusses a potential sale with
an importer in need of extended credit terms
ii.​ Contact a forfaiter - An exporter should approach a forfaiter early in the process
before pricing negotiations with the importer (can build the forfaiting cost into the
sale price)
iii.​ Present transaction details to a forfaiter - The exporter presents details of the
proposed sale and financing to the forfaiter. Typical details include name of
buyer, type of goods being sold, date, duration and currency of the contract,
credit period, payment schedule and evidence of debt
iv.​ Sign commitment letter with forfaiter - Within days the forfaiter evaluates the
transaction and feasibility of the deal and determines a discounted price at which
to purchase the account receivable. If the discounted price is accepted, the
exporter signs a commitment letter issued by forfaiter
v.​ Since this payment without recourse, the exporter has no further interest in the
financial, and it is the forfaiter who must collect the future payments due from the
importer

f.​ Advantages for an exporter

i.​ Forfaiting eliminates virtually all risk of non-payment to the exporter, with 100
percent financing of contract value
ii.​ Process fast, documentation simple, concise and straightforward
iii.​ Forfaiters can generally work with the most commonly used negotiable
instruments in international trade, such as bills of exchange, promissory notes or
letter of credits
iv.​ Forfaiting can be used in conjunction with officially supported credit backed by
export credit agencies such as US Export-Import bank (provide guarantees or
insurance to exporters or their financiers, protecting against risks)