MODULE BUSINESS FINANCE

CHAPTER 10: INTERNATIONAL BUSINESS FINANCE

AND RELATED TOPICS

Learning Objectives:
1. Understand the concept of International Business Finance
2. Appreciate the importance of Foreign Exchange Markets
3. Be familiar with Exchange Rates
4. Enumerate different Commercial Instruments
5. Explain Money Order, Warehouse Receipt, and Plastic Money
6. Recall the meaning of Mergers and Divestitures

International Business Finance

Companies with foreign operations are called global organizations,

international corporations or multinationals. These firms consider financial factors, which
may not directly affect local companies, such as foreign exchange rates, differing
interest rates from one country to another, complex accounting methods for foreign
operations, foreign government intervention, and foreign tax rates.

Principles of business finance also apply to foreign operations. They also

seek to invest in projects that create more value for the shareholders than their cost and
to arrange financing that raises cash at the lowest possible cost. The net present value
principle holds true for both foreign and domestic operations, although it can be more
complicated to apply the time value of money to foreign investments.

When firms enter foreign markets, international financial management

principles apply. These apply when manufacturing firms export their produce to another
country for sale; some firms are given license to use another firm’s name and
technology. They may create direct foreign investment, as owners of operating physical
capital in a foreign country. Direct foreign investment creates risks since the cash flows
from the operation are denominated in foreign currency and must be converted to the
home country’s currency. Firms may take these risks for the following reasons: trade
restrictions may not allow exports into a foreign country; firms find that it is too
dangerous to place their patented product processes in the hands of strangers; labor
costs may be significantly cheaper in a foreign country.

One significant complication of international business finance is foreign

exchange. The foreign exchange markets provide important information and
opportunities for an international corporation undertaking capital budgeting and
financing decisions. These financial variables include international exchange rates,
interest rates, and inflation rates.

Page 1
 MODULE BUSINESS FINANCE

Foreign Exchange Markets

The foreign exchange market is the world’s largest financial market. This is
the market where one country’s currency is traded for another country’s currency. The
foreign exchange market is an over-the-counter market, so there is no single location
where traders get together. Market participants are located in major commercial and
investment banks around the world. They communicate using telecommunications
devices and through the internet.

The different types of participants in the foreign exchange market include the following:

 Importers who pay for goods using foreign currencies.

 Exporters who receive foreign currency and may want to convert to the domestic
currency.
 Portfolio managers who buy or sell foreign stocks and bonds.
 Foreign exchange brokers who match buy and sell orders.
 Traders who ‘make the market’ in foreign currencies.
 Speculators who try to profit from changes in exchange rates.

Exchange Rates

An exchange rate is the price of one country’s currency expressed in terms of

another country’s currency. In practice, almost all trading of currencies takes place in
the U.S. dollar. For example both the Japanese Yen and United Kingdom Pound are
traded with their prices quoted in U.S. dollars. Parity conditions are equilibrium
relationships affecting exchange rates between currencies. These are interest rate,
purchasing power, cross currencies rate, and country or geographic parities.

Page 2
 MODULE BUSINESS FINANCE

Exchange rates are determined by:

 Interest rates
 Inflation rates, and
 Balance of payment flows

Commercial Instruments

Bank Draft and Bill of Exchange

A bank draft is a type of check where the payment is guaranteed to be

available by the issuing bank. Bank drafts are normally involved in transactions covering
huge amounts of money or requiring a trust function. An example may be purchasing of
luxury cars, where dealers will only accept a bank draft which is an assurance to the car
company that there are enough funds for the draft. A cashier’s check is sometimes used
as a bank draft by a bank to another bank or party.

A bill of exchange is an instrument drawn by a bank for the same bank, or on

a correspondent bank in another city, province or country. This is a check drawn by one
bank against funds deposited into its account at a correspondent bank, authorizing the
second bank to release money to the payee identified in the bill of exchange.

Money Order

This is similar to a certified check, where the amount should be prepaid for
the amount on its face. A money order is purchased for the amount desired. This is a
more trusted method of payment, but usually limited in maximum face value as
specified by the local postal service company.

Warehouse Receipt

Warehouse receipts are guarantees that the quantity and quality of items are
in store within an approved facility. A warehouse receipt is a document that provides
proof of ownership of commodities that are stored in a warehouse, vault or depository
for safekeeping. (Investopedia) A negotiable warehouse receipt can be eligible as
collateral for loans.

Plastic Money

At present, the country prints money using a fiber composite of 20 percent

abaca and 80 percent cotton. The use of abaca fiber was deliberate to support the local
abaca industry. Plastic money is not susceptible to ‘wear and tear’ because of its
coating protecting it from dirt and moisture. This is made from polymer substrate which
prevents counterfeiting and allows the manufacturer to incorporate security features
such as optically variable devices that are difficult to reproduce. This process is also

Page 3
 MODULE BUSINESS FINANCE

used for making credit, debit and post paid cards.

Plastic money helps develop the electronic payment industry in the country,
providing everyone a convenient method of payment and local businesses to enjoy
more efficient operations.

Debit cards are prepaid credit cards, combining credit and cash. E-money
services are now most used for sending and receiving remittances from other parts of
the country or from overseas.

House Bill 3689 mandates the Bangko Sentral ng Pilipinas to use non-porous
polymer instead of paper in the printing of Philippine bank notes. This bill requires the
Monetary Board to issue the necessary resolution to implement the provisions of the
proposed Act, as required by the “New Central Bank Act”.

Mergers and Divestitures

Firms may change their financial structure either by external or internal

growth.

Merger is a combination of partners and an acquisition is the purchase of one

company by another. Mergers of firms belonging to the same industry are called
horizontal mergers. When companies in the same industry, (supposing a supplier and a
retailer) combine, vertical mergers happen. Conglomerate mergers are a combination of
companies not belonging to the same industry.

A divestiture is the partial or full disposal of a business unit through sale, exchange,
closure, or bankruptcy. A divestiture most commonly results from a management
decision to cease operating a business unit because it is not part of a core competency.
A divestiture may also occur if a business unit is deemed to be redundant after a
merger or acquisition, if the disposal of a unit increases the resale value of the firm, or if
a court requires the sale of a business unit to improve market competition.
In its simplest form, a divestiture is the disposition or sale of an asset by a company.
Divestitures are essentially a way for a company to manage its portfolio of assets. As
companies grow, they may find they are trying to focus on too many lines of business
and they must close some operational units to focus on more profitable lines.
Many conglomerates face this problem.

Companies may also sell off business lines if they are under financial duress. For
example, an automobile manufacturer that sees a significant and prolonged drop in
competitiveness may sell off its financing division to pay for the development of a new
line of vehicles.

Divested business units may be spun off into their own companies rather than closed
in bankruptcy or a similar outcome. Companies may be required to divest some of their

Page 4
 MODULE BUSINESS FINANCE

assets as part of the terms of a merger before the deal goes through. Governments may
divest some of their interests in order to give the private sector a chance to profit.

By divesting some of its assets, a company may be able to cut down on its costs,
repay its outstanding debt, reinvest, and focus on its core business(es) and streamline
its operations. This, in turn, can enhance shareholder value. This is especially important
when there is volatility in the markets or if the company experiences unstable
conditions.

For further discussion, please refer to the link provided: Foreign Exchange Markets
https://www.youtube.com/watch?v=-qvrRRTBYAk
For further discussion, please refer to the link provided: Divestitures
https://www.youtube.com/watch?v=fTwMkS5WSh4

REFERENCES:
Basic Business Finance: Management Approach, 2nd Ed., Ruby F. Alminar-Mutya
Business Finance, 2nd Ed., Roberto G. Medina
https://www.mathsisfun.com/money/currency.html

Page 5