Description
This corporate finance PPT about Foreign Currency Borrowing, Cross border Investment decision, Double Taxation, Instruments in International Debt Market
Global Corporations
? ? ? ? ?
What is Different in a Global Corporation The Currency Challenge Foreign Currency Borrowing Cross border Investment decision Double Taxation
Agenda
2
Who will approve
?
5% price discount on revenue?
?
?
10% price escalation on purchases?
Move from fixed interest rates to floating interest rates?
Delegation of Powers?
The Currency Market
3
Profit & Loss Account Revenue Cost of Sales Profit before Interest & tax Interest Profit before tax Tax Profit after tax
Balance Sheet Application of Funds Fixed Assets Investments Current Assets Source of Funds Current Liabilities Loans –Short term Loans –Long term Shareholders funds
What is Different in Global Corporations ?
Decision Makers Outside the Organization
4
The Currency Challenge
Need to Deal with this Spectrum
5
?
41 Exchange arrangement with no separate legal
tender
? ? ? ? ?
07 Currency board arrangements 52 Conventional peg arrangements 06 Pegged exchange rate within horizontal bands: 05 Crawling Pegs 51 Managed floating with no predetermined path for exchange rates
? 25 Independently floating Currency Regimes as of July 31, 2006, ? 187 Total Countries IMF De-facto classification
Based on what countries do not what they say
6
?
41 Exchange arrangement with no separate legal tender 09 Another currency as legal tender, Ecuador, El Salvador, Panama 06 East Caribbean Currency Union, Antigua, Barbuda 14 WAEMU Benin, Senegal, Mali, Togo, CAEMC, Cameroon, Chad, Gabon 12 Euro Area –BAFFLING PIGS
Exchange rate arrangements with no separate legal tender
7
?
07 Currency board arrangements, Hong Kong SAR – Bulgaria -€, Estonia DM later €, Lithuania - €
US$,
?
52 Conventional fixed peg arrangements 47 Against a single currency, Bahamas, Barbados, Malta, Nepal-
INR,
Oman, Bahrain, China-US$, Pakistan 05 Against a Composite, Fiji, Libyan Arab, Morocco
Currency Regimes
8
Currency Regimes
?
06 Pegged exchange rate within horizontal bands: 04 Within a co-operative arrangement, Cyprus 15%, Denmark 2.25%, Slovak Republic 15%, Slovenia 02 Other band arrangements, Hungary 15%, Tonga 5% 05 Crawling Pegs, Costa Rica, Iran, Nicaragua,
?
Botswana
?
51 Managed floating with no predetermined path, India SriLanka, Ghana, Uruguay, Yemen, Thailand, Kenya 25 Independently floating, Australia, Brazil, Canada, Japan, USA, UK, Sweden,
But which are the Critical Currencies?
9
Share of Exchange market Triennial Central Bank Survey, 2007, BIS
Currency US$ Euro Yen Pound Sterling Swiss Franc Australian $ Canadian $ HK $ Norwegian Krone New Zealand India Market share 86.3 37.0 16.5 15.0 6.8 6.7 4.2 2.8 3.8 1.9 0.7 % share 43.15 18.50 8.25 7.50 3.40 3.35 2.1 1.4 1.9 0.95 0.35
The amounts total up to 200; as both legs are counted
10
Location of the FX markets the place where trades are conducted
Rank 1 UK Country % shares 34.1
2
3 4 5 6 17
US
Switzerland Japan Singapore Hong Kong India
16.6
6.1 6.0 5.8 4.4 0.9
Time Zone plays a Critical Role
11
FX market Volumes: Growing
US$ 3.2 trillion daily volume Source: BIS Triennial Central Bank Survey
12
FX market: Size in Perspective
13
24 times trade flows and 17 times capital flows
So, What is the Choice? Functional, Reporting & Foreign Currency
?
?
?
Functional currency is determined considering - Market indicator -market in which the company operates - Sales price indicator –price and price change - Cost indicator - currency in which costs are incurred - Financing indicator –assets located and financed Reporting currency - Functional currency can be the reporting currency, more often than not it is the reporting currency - Reporting currency can be distinct from Functional currency – requiring translation -Translation & Convenience translation Foreign Currency - Any currency other than a functional currency
14
A Critical Decision
3 Types of FX exposure:
1.
Cash
flow
or or
Transaction Translation
exposure, exposure,
triggered by an event
2.
Accounting
triggered by period end accounting
3.
Competitive or Economic risk, exists all the
What Implications does this Choice conscious of it or not Have?
Profits Depend on the Functional Currency
time,
irrespective
of
whether
one
is
15
The Rolls Royce Case: An example
? ? ? ?
Rolls Royce Ltd. – British aircraft engine manufacturer Main customers : Boeing Inc. and Lockheed Martin Inc. in US Main competitors : GE and Pratt & Whitney Inc., US companies Exchange rates : Early 1977 £ 1 = $ 1.71 End of 1979 £ 1 = $ 2.12
? ? ? ? ? ?
Engines manufactured in UK priced in US $ Suffered loss of £ 58 m on sales of £ 848 m (Annual Report 1979 ) Export to US, 40% of sales Cost budgeted at £1 =$1.8; not covered as 1.65 was forecast More engines sold higher the loss Domestic Currency appreciation; loss to exporter
Companies Established Local Mgf. Base
16
Foreign Currency Borrowings for Business Advantage
1.
Cost based decisions – On fully hedged basis
2.
3. 4.
Borrowing as a Hedge – Un-hedged borrowings
Quantum of borrowings – Market size limitations End-use of borrowing – Market maturity e.g. US markets for technology and Intangible assets Long Tenor Loans– Market depth & maturity Security vs. Covenants Borrowing to create competitive advantage or
5. 6. 7.
neutralise competitive advantage
Multiple Reasons: Single Objective
17
Instruments in International Debt Market
?
Less than 1 year tenor -Commercial Paper
?
Debt instruments less than 7 years tenor are called Notes
? 1 -5 year tenor -Medium Term Notes (MTNs) ? 5-7 year tenor –Floating Rate Notes (FRNs)
Names derived from Paper Thickness ? Above 7 year tenor -Bonds
18
A Critical Concept In India
?
Simple maturity (SM)
? Period for which loan is outstanding
?
Average maturity (AM)
? Loan period weighted for the amount outstanding
To Manage India’s Foreign Exchange Reserves
19
?
USSR wanted to keep US$ to pay for its imports
?
In 1960s the cold war between USSR-USA was a deterrent for
USSR to keep money in US
? ?
USSR requested French banks to deposit their $ reserves French Bank acted as an agent for USSR govt. –took $ deposits from USSR and placed $ deposits with US
?
This led to the birth of Offshore markets, which are not influenced by Central Banks
surplus in 1970s Offshore Markets LIBOR & –Arab countries preferred offshore market
?
Market expanded due to Interest equalization tax in 1960s, OPEC
20
LIBOR & LIBID the Reference Rates
Country Risk is: ? Sovereign default risk if it borrows in foreign currency ? Stopping repatriation of foreign exchange on payments due to
? Lenders ? Investors Cross Border Investments & ? Exporters Country of wealth outside the country ? Transfer Risk A Critical Consideration in Investment Decisions
21
Argentina: A Case Study
?
One of the 10 richest countries in the world in 1900s
?
? ? ? ? ? ?
Per capita income in Argentina was 72% of USA in 1913
Per capital income fell to 34% of USA in 1998 Argentina had six different currencies in the 20th century Inflation was in three / four digits between 1975 to 1990 Peak inflation was 5,000% in 1989 Used Currency Board Arrangement to bring Inflation under control Latest default was in March 2002,
?
On default the spreads on securities rose and was around 55% to
70% over US bond rates
22
Country Risk Euromoney
Sl no 1 Political Factors Weightage 25%
2
3 4 5 6
Economic Performance
Access to Bank Finance Debt Indicators Debt in Default or reschedule Credit rating
25%
5% 10% 10% 10%
7
8 9
Access to short term finance
Access to capital markets Discount on Forfaiting Total
5%
5% 5% 100%
23
Top 10 in 2008 Country Risk
Rank 1 2 3 4 5 6 7 Norway Switzerland Denmark Sweden Ireland Austria Country Luxembourg Risk Score 99.88 97.47 96.21 93.39 92.96 92.36 92.25
8
9 10
Finland
Netherlands United States of America
91.95
91.95 91.27
24
Principles of Direct taxation
?
Taxes are levied based on ability to enforce the law Taxes are mandatory levy with penalty
?
for non compliance
?
The two principles based on enforceability are Residence of the payer Source of income provide the State with Residence and Source
The apparatus to enforce their claim
25
-
International Practices in Taxation
• Residence principle adopted by countries that have a strong and rich residence base –typically developed countries • Source principle adopted by countries that have a stronger
resource / activity base –typically developing countries
• Tax heaven –countries that thrive primarily on activities generated by business and not on taxes
Tax Heavens are Usually Small Territories for this reason
26
Why to avoid Double Taxation
?
Macro objectives;
? Improve cross border trade and ? Investment for economic growth
?
Model conventions for avoiding double tax started from:
? 1920 League of Nations ? 1945 United Nations
?
Group of experts working convention from mid 1960’s
on
model
27
Micro Objective: Lower Cost
Methods of avoiding double taxation
?
Unilateral treatment
? Tax credits for foreign tax ? Exemption of Foreign Income
?
Bilateral treaties
? On reciprocal basis
?
Multi-lateral treaties
? On Mutual Agreement
28
doc_823862111.ppt
This corporate finance PPT about Foreign Currency Borrowing, Cross border Investment decision, Double Taxation, Instruments in International Debt Market
Global Corporations
? ? ? ? ?
What is Different in a Global Corporation The Currency Challenge Foreign Currency Borrowing Cross border Investment decision Double Taxation
Agenda
2
Who will approve
?
5% price discount on revenue?
?
?
10% price escalation on purchases?
Move from fixed interest rates to floating interest rates?
Delegation of Powers?
The Currency Market
3
Profit & Loss Account Revenue Cost of Sales Profit before Interest & tax Interest Profit before tax Tax Profit after tax
Balance Sheet Application of Funds Fixed Assets Investments Current Assets Source of Funds Current Liabilities Loans –Short term Loans –Long term Shareholders funds
What is Different in Global Corporations ?
Decision Makers Outside the Organization
4
The Currency Challenge
Need to Deal with this Spectrum
5
?
41 Exchange arrangement with no separate legal
tender
? ? ? ? ?
07 Currency board arrangements 52 Conventional peg arrangements 06 Pegged exchange rate within horizontal bands: 05 Crawling Pegs 51 Managed floating with no predetermined path for exchange rates
? 25 Independently floating Currency Regimes as of July 31, 2006, ? 187 Total Countries IMF De-facto classification
Based on what countries do not what they say
6
?
41 Exchange arrangement with no separate legal tender 09 Another currency as legal tender, Ecuador, El Salvador, Panama 06 East Caribbean Currency Union, Antigua, Barbuda 14 WAEMU Benin, Senegal, Mali, Togo, CAEMC, Cameroon, Chad, Gabon 12 Euro Area –BAFFLING PIGS
Exchange rate arrangements with no separate legal tender
7
?
07 Currency board arrangements, Hong Kong SAR – Bulgaria -€, Estonia DM later €, Lithuania - €
US$,
?
52 Conventional fixed peg arrangements 47 Against a single currency, Bahamas, Barbados, Malta, Nepal-
INR,
Oman, Bahrain, China-US$, Pakistan 05 Against a Composite, Fiji, Libyan Arab, Morocco
Currency Regimes
8
Currency Regimes
?
06 Pegged exchange rate within horizontal bands: 04 Within a co-operative arrangement, Cyprus 15%, Denmark 2.25%, Slovak Republic 15%, Slovenia 02 Other band arrangements, Hungary 15%, Tonga 5% 05 Crawling Pegs, Costa Rica, Iran, Nicaragua,
?
Botswana
?
51 Managed floating with no predetermined path, India SriLanka, Ghana, Uruguay, Yemen, Thailand, Kenya 25 Independently floating, Australia, Brazil, Canada, Japan, USA, UK, Sweden,
But which are the Critical Currencies?
9
Share of Exchange market Triennial Central Bank Survey, 2007, BIS
Currency US$ Euro Yen Pound Sterling Swiss Franc Australian $ Canadian $ HK $ Norwegian Krone New Zealand India Market share 86.3 37.0 16.5 15.0 6.8 6.7 4.2 2.8 3.8 1.9 0.7 % share 43.15 18.50 8.25 7.50 3.40 3.35 2.1 1.4 1.9 0.95 0.35
The amounts total up to 200; as both legs are counted
10
Location of the FX markets the place where trades are conducted
Rank 1 UK Country % shares 34.1
2
3 4 5 6 17
US
Switzerland Japan Singapore Hong Kong India
16.6
6.1 6.0 5.8 4.4 0.9
Time Zone plays a Critical Role
11
FX market Volumes: Growing
US$ 3.2 trillion daily volume Source: BIS Triennial Central Bank Survey
12
FX market: Size in Perspective
13
24 times trade flows and 17 times capital flows
So, What is the Choice? Functional, Reporting & Foreign Currency
?
?
?
Functional currency is determined considering - Market indicator -market in which the company operates - Sales price indicator –price and price change - Cost indicator - currency in which costs are incurred - Financing indicator –assets located and financed Reporting currency - Functional currency can be the reporting currency, more often than not it is the reporting currency - Reporting currency can be distinct from Functional currency – requiring translation -Translation & Convenience translation Foreign Currency - Any currency other than a functional currency
14
A Critical Decision
3 Types of FX exposure:
1.
Cash
flow
or or
Transaction Translation
exposure, exposure,
triggered by an event
2.
Accounting
triggered by period end accounting
3.
Competitive or Economic risk, exists all the
What Implications does this Choice conscious of it or not Have?
Profits Depend on the Functional Currency
time,
irrespective
of
whether
one
is
15
The Rolls Royce Case: An example
? ? ? ?
Rolls Royce Ltd. – British aircraft engine manufacturer Main customers : Boeing Inc. and Lockheed Martin Inc. in US Main competitors : GE and Pratt & Whitney Inc., US companies Exchange rates : Early 1977 £ 1 = $ 1.71 End of 1979 £ 1 = $ 2.12
? ? ? ? ? ?
Engines manufactured in UK priced in US $ Suffered loss of £ 58 m on sales of £ 848 m (Annual Report 1979 ) Export to US, 40% of sales Cost budgeted at £1 =$1.8; not covered as 1.65 was forecast More engines sold higher the loss Domestic Currency appreciation; loss to exporter
Companies Established Local Mgf. Base
16
Foreign Currency Borrowings for Business Advantage
1.
Cost based decisions – On fully hedged basis
2.
3. 4.
Borrowing as a Hedge – Un-hedged borrowings
Quantum of borrowings – Market size limitations End-use of borrowing – Market maturity e.g. US markets for technology and Intangible assets Long Tenor Loans– Market depth & maturity Security vs. Covenants Borrowing to create competitive advantage or
5. 6. 7.
neutralise competitive advantage
Multiple Reasons: Single Objective
17
Instruments in International Debt Market
?
Less than 1 year tenor -Commercial Paper
?
Debt instruments less than 7 years tenor are called Notes
? 1 -5 year tenor -Medium Term Notes (MTNs) ? 5-7 year tenor –Floating Rate Notes (FRNs)
Names derived from Paper Thickness ? Above 7 year tenor -Bonds
18
A Critical Concept In India
?
Simple maturity (SM)
? Period for which loan is outstanding
?
Average maturity (AM)
? Loan period weighted for the amount outstanding
To Manage India’s Foreign Exchange Reserves
19
?
USSR wanted to keep US$ to pay for its imports
?
In 1960s the cold war between USSR-USA was a deterrent for
USSR to keep money in US
? ?
USSR requested French banks to deposit their $ reserves French Bank acted as an agent for USSR govt. –took $ deposits from USSR and placed $ deposits with US
?
This led to the birth of Offshore markets, which are not influenced by Central Banks
surplus in 1970s Offshore Markets LIBOR & –Arab countries preferred offshore market
?
Market expanded due to Interest equalization tax in 1960s, OPEC
20
LIBOR & LIBID the Reference Rates
Country Risk is: ? Sovereign default risk if it borrows in foreign currency ? Stopping repatriation of foreign exchange on payments due to
? Lenders ? Investors Cross Border Investments & ? Exporters Country of wealth outside the country ? Transfer Risk A Critical Consideration in Investment Decisions
21
Argentina: A Case Study
?
One of the 10 richest countries in the world in 1900s
?
? ? ? ? ? ?
Per capita income in Argentina was 72% of USA in 1913
Per capital income fell to 34% of USA in 1998 Argentina had six different currencies in the 20th century Inflation was in three / four digits between 1975 to 1990 Peak inflation was 5,000% in 1989 Used Currency Board Arrangement to bring Inflation under control Latest default was in March 2002,
?
On default the spreads on securities rose and was around 55% to
70% over US bond rates
22
Country Risk Euromoney
Sl no 1 Political Factors Weightage 25%
2
3 4 5 6
Economic Performance
Access to Bank Finance Debt Indicators Debt in Default or reschedule Credit rating
25%
5% 10% 10% 10%
7
8 9
Access to short term finance
Access to capital markets Discount on Forfaiting Total
5%
5% 5% 100%
23
Top 10 in 2008 Country Risk
Rank 1 2 3 4 5 6 7 Norway Switzerland Denmark Sweden Ireland Austria Country Luxembourg Risk Score 99.88 97.47 96.21 93.39 92.96 92.36 92.25
8
9 10
Finland
Netherlands United States of America
91.95
91.95 91.27
24
Principles of Direct taxation
?
Taxes are levied based on ability to enforce the law Taxes are mandatory levy with penalty
?
for non compliance
?
The two principles based on enforceability are Residence of the payer Source of income provide the State with Residence and Source
The apparatus to enforce their claim
25
-
International Practices in Taxation
• Residence principle adopted by countries that have a strong and rich residence base –typically developed countries • Source principle adopted by countries that have a stronger
resource / activity base –typically developing countries
• Tax heaven –countries that thrive primarily on activities generated by business and not on taxes
Tax Heavens are Usually Small Territories for this reason
26
Why to avoid Double Taxation
?
Macro objectives;
? Improve cross border trade and ? Investment for economic growth
?
Model conventions for avoiding double tax started from:
? 1920 League of Nations ? 1945 United Nations
?
Group of experts working convention from mid 1960’s
on
model
27
Micro Objective: Lower Cost
Methods of avoiding double taxation
?
Unilateral treatment
? Tax credits for foreign tax ? Exemption of Foreign Income
?
Bilateral treaties
? On reciprocal basis
?
Multi-lateral treaties
? On Mutual Agreement
28
doc_823862111.ppt