Corporations that operate in more than one country are often referred to as international corporations or multinational corporations. These corporations must consider many financial factors that do not affect purely domestic firms. These include foreign exchange rate (currency) risk, different interest rates that vary between country to country, complex accounting methods for foreign operations and compliancy risk, foreign tax rates, and political risk that could result in changes to regulation, expropriation and corruption.
The basic principles of corporate finance apply to international corporations: firms look to invest in projects that create value for shareholders, look to finance these projects by raising capital at the lowest possible cost, and look to reduce risk, or balance risk with returns. However, multinational corporations often find it more complicated to apply capital budgeting and net present value analysis principles to foreign operations.
Three Areas of International Corporate Finance:
1. Foreign exchange rates and hedging exchange rate risk
2. International capital budgeting
3. International financing decisions
International financing decisons typically involve a choice between three basic choices of financing: (1) export cash from the business's domestic operations to the foreign operation, (2) borrow in the country where the investment is located, or (2) borrow in a third country. There are also more complicated options such as interest rate swaps that allow international companies to manage risk. International corporations typically use hedging strategies to protect against foreign exchange rate risk as well.
There is some important terminology in international finance that corporate finance students should know.
Euro: The Euro is the single monetary unit used by 17 countries in the European Union. It has been in use since January 2002.
Cross Rate: The cross rate is the exchange rate between two currencies, neither of which is the currency of the country in which the exchange rate was quoted. For example, a U.S. newspaper reports the cross rate between the Japanese Yen and the Euro. Typically exchange rates are quoted in relation to the US dollar; as a result, cross rates typically refer to an exchange rate between two currencies rather then the USD.
Eurobonds: Eurobonds are bonds that are denominated in a currency not native to the corporation which issued them, and which are issued in the bond markets of several countries simultaneously. Eurobonds are typically named after the currency they are denominated in: ie. the Euroyen bonds or Eurodollar bonds.
Eurocurrency: Eurocurrency is money deposited in a financial centre outside of the country whose currency is involved. Eurodollars are American dollars deposited in foreign insitutions, and are the most commonly used Eurocurrency.
Foreign bonds: Foreign bonds are corporate bonds issued in one country only, typically in the currency of that country. Foreign corporation bonds are typically distinguished from bonds issued in that country by its domestic corporations because of different tax rates, etc. Foreign bonds are typically nicknamed for the country where they are issued. For example, American foreign bonds are often called Yankee bonds.
American Depository Receipts (ADR): Shares of many non-US companies that trade on a US stock exchange are often traded through ADRs. ADRs are negotiable securities that represent securities of non-US companies. American depository receipts are only one form of depository receipt, as these reciepts are used to sell foreign shares in new markets in countries other than just the US. The benefit of ADRs is that it allows investors to buy shares of a foreign corporation without the same currency exchange and border considerations. When a broker purchases foreign shares in the foreign market and deposits them in a foreign bank, a domestic custodian bank will issue the depository receipts to be traded in the domestic market.
The London Interbank Offered Rate (LIBOR): LIBOR is the estimated average interest rate that the major London banks would be charged if borrowing from other banks. The LIBOR rate (along with the Euribor) is the benchmark used for short-term interst rates around the world.
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