Financial Mgt Test 3

Front 1

considerations in international financial management

Back 1

exchange rates

political risks

more financing opportunities in global mkt., which reduces the cost of capital

Front 2

global capital mkts.

Back 2

as number of foreign exchanges between countries increases, so does liquidity

exchanges that allow for flow of capital are very important for developing nations

US has one of most developed capital mkts., but other countries are coming up with innovative ways to do business

Front 3

exchange rates

Back 3

price of one country's currency in terms of another

most are quoted in terms of dollars

Front 4

forwards vs. spots

Back 4

if forward is selling higher than spot, currency is being sold a premium

if forward is selling lower than the spot, currency is being sold at a discount

Front 5

absolute purchasing power parity

Back 5

price of an item is the same regardless of the currency used to purchase it

requirements of PPP:
- transaction costs are 0
- no barriers to trade
- no difference in commodity b/t locations

for most goods absolute PPP rarely holds

Front 6

relative purchasing power parity

Back 6

provides info. on what causes changes in exchange rates

basic result: exchange rates depend on inflation between countries

Front 7

covered interest arbitrage

Back 7

examines the relationship b/t spot rates, forward rates, and nominal rates b/t countries

formulas assume exchange rates are quoted in terms of US dollars

US risk free rate is assumed to be T_bill rate

Front 8

interest rate parity

Back 8

forward rate that would derail arbitrage opportunity

Front 9

unbiased forward rates

Back 9

current forward rate is an unbiased guess as to the future spot rate

means that on average the forward rate will be equal to the spot rate

Front 10

international fischer effect

Back 10

when we combine PPP an UIP

tells us that real rate of return must be consistent across countries

if not investors move money to a place with a higher real rate of return

Front 11

home currency approach

Back 11

estimate cash flows in foreign currency

estimate future exchange rates using UIP

convert future cashflows into dollars

discount using domestic required rate of return

Front 12

foreign currency approach

Back 12

estimate cash flows in foreign currency

use IFE to convert domestic required return to foreign required return

dicount using foreign required return

convert NPV to dollars using current spot rate

Front 13

repatriated cash flows

Back 13

some of the cash flows earned from a foreign country must remain there due to restrictions on repatriation

can occur by: dividends to parent company, mgt. fees for central services, royalties on use of trade names or patents

Front 14

short-run exposure

Back 14

risk from day to day fluctionations in exchange rates and the fact that companies have contracts to buy and sell goods at short-run fixed prices

mgt. risk: entering into a forward agreement to gaurantee the exchange rate; find ways to lock in rate if rates move against you, but benefit from rates if they move in your favor

Front 15

long-run exposure

Back 15

long-run fluctuations come from changes in economic conditions

can be due to changes in labor mkts. or govts.

harder to hedge against

try to match long-run inflows and outflows of currency

borrowing in foreign currency may help to mitigate some of the problems

Front 16

translation exposure

Back 16

income from foreign operations must be translated back to US dollars for accounting reasons, even if company does not actually physically change it back

current accounting practices state that all cash flows by converted to prevailing exchange rates with currency gains and losses kept in special account within s/h equity

Front 17

managing exchange risk

Back 17

firm needs to figure out its net exposure to currency risk instead of just looking at each currency separately

hedging individual currencies can be very costly and may actually increase exposure

Front 18

political risk

Back 18

changes in value due to political actions of the foreign country

investment in countries with unstable govts. should require higher returns

extent of political risk depends on the nature of the business: more dependent business is on other operations within the firm, the less valuable it is to others; natural resource development may be very valuable to others esp. if ground work has already been done

local financing can often reduce political risk

Front 19

lease

Back 19

contractual agreement for use of an asset in return for payment

Front 20

lesee

Back 20

user of the asset; makes payments

Front 21

lessor

Back 21

owner of the asset; receives payments

Front 22

direct lease

Back 22

lessor if the manufacturer

Front 23

captive finance company

Back 23

subsidiaries that lease products for the manufacturer

Front 24

operating lease

Back 24

shorter-term
lessor is responsible for insurance, taxes, and matienence\
often cancellable

ex: copy machine

Front 25

financial or capital lease

Back 25

long-term
lessee if responsible for insurance, taxes, maitenence
usually not cancellable
specific types: tax-oriented, leveragable, sales and leaseback

Front 26

lease accounting

Back 26

primarily governed by FASB 13

financial leases usually treated as debt financing: pres. value must be included on balace sheet as a liability; same amt. shown on asset as as capitalized value of leased assets

operating leases are still off balance sheet -- no impact on balance sheet

Front 27

criteria for a capital lease

Back 27

lease transfers ownership at the end of lease term

lessee can purchase the asset below mkt. price

lease term is for 75% or more of the asset

present value of lease payments is at least 90% of fair mkt. value at the start of the lease

Front 28

taxes and leases

Back 28

lessee can deduct lease payments for income tax purposes

must be used for business reasons ad not to avoid personal taxes

term of lease is less than 80% of the economic life of the asset

should not include option to acquire the asset at or below mkt. price

payments should not start high and drop dramatically

must survive profit test: lessor should earn a fair return

renewal options must be reasonable and consider fair mkt. value at the end of the renewal

Front 29

incremental cashflow

Back 29

cash flows that are avoided: initial cost of machine, lost depreciation tax shield, incremental matienence, taxes, insurance

depending on nature of contract there may or may not be other incremental differences b/t leasing and purchasing

ex: car - you incur these costs when you buy or lease
ex: copy machine - leasing company incurs these costs

Front 30

lease or buy?

Back 30

company must determine whether they are better off buying the asset and borrowing, or leasing

compute NPV of incremental cash flows

appropriate discount rate is the after-tax cost of debt since the lease is pretty much the same as risk as the company's debt

Front 31

net advantage of leasing

Back 31

net of advantage of leasing (NAL) is the same thing as NPV of incremental cash flows

if NAL > 0 firm should lease
if NAL < 0 firms should buy

Front 32

good reasons for leasing

Back 32

taxes may be less

can reduce uncertainty

may have lower transaction costs

fewer restictive covanents

fewer assets than secured borrowing

Front 33

dubious reasons for leasing

Back 33

balance sheet, esp. leveraged ratios, may look better if lease does not have to be accounted for on the balance sheet

100% financing: except that leases usually require downpayment or security deposit

low cost: some people may try to compare the implied rate of interest to other mkts. but this is not directly comparable