Fin 6303 International Finance: Learning Outcomes

Fin 6303 International Finance 1course Learning Outcomes For Unit Vii

Examine methods for financing international trade, evaluate short-term financing options available to multinational companies, and prescribe international short-term cash management investments that maximize firm value.

Paper For Above instruction

International trade has become a cornerstone of the global economy, reflecting increasing interconnectedness among nations, and necessitating sophisticated financial management techniques to mitigate the inherent risks involved. This essay explores the key methods and instruments used in international trade financing, the short-term financing options available to multinational corporations (MNCs), and the strategic considerations for managing cash flows across borders to maximize firm value.

Methods of Payment in International Trade

One of the fundamental aspects in international trade is the payment method, which directly influences the level of risk exuded by both exporters and importers. Several payment mechanisms have been developed to address the unique challenges posed by cross-border transactions.

The simplest method is prepayment, where the importer makes payment upfront before the exporter ships the goods. While secure for the exporter, this method risks deterring potential buyers due to the high initial cost and trust concerns. It is often used in first-time transactions or when the importer’s creditworthiness is uncertain. Electronic funds transfer (EFT) systems, such as SWIFT, facilitate rapid and secure prepayments, minimizing transaction costs and delays (Madura, 2021).

Letters of credit are another widely used mechanism, providing a high level of security for both parties. Issued by the importer’s bank, a letter of credit guarantees payment to the exporter once the appropriate shipping documents are presented and verified, thus insuring the exporter against the risk of nonpayment. For the importer, the bank’s involvement ensures that payment is only released once evidence of shipment is provided, which minimizes the risk of fraud (Couto, Saldanha, & Batista, 2017). Importantly, letters of credit can also serve as a source of finance, especially through bank guarantees and standby letters of credit.

The draft, or bill of exchange, is an unconditional order written by the exporter directing the importer to pay a specified amount on a predetermined date. A draft can be with or without the backing of a letter of credit. When backed by a letter of credit, it offers higher security; without such backing, it poses a higher risk to the exporter. The draft may be processed through 'documents against payment' (D/P) or 'documents against acceptance' (D/A), where the former requires payment before release of shipping documents (Madura, 2021).

Other payment methods include:

• Consignment: The exporter ships goods and retains title until the goods are sold by the importer, which involves high risk for the exporter but can be advantageous when establishing trust.
• Open account: The exporter ships goods with payment due at a later date, relying heavily on the importer’s creditworthiness and often used for established trade relations.
• Countertrade: Involves barter, compensation, or counterpurchase agreements, often used when currency convertibility is restricted or to facilitate exchange of goods without cash flow considerations (Madura, 2021).

Trade Finance Instruments and Strategies

Trade finance encompasses various instruments that facilitate liquidity and mitigate risks. Accounts receivable financing allows exporters to borrow funds against their receivables, providing immediate liquidity. However, these involve credit and political risks, especially in volatile markets, and often attract higher interest rates compared to domestic financing (Claeys & Sugiarto, 2014).

Factoring involves the sale of receivables to a third-party (factor) at a discount, allowing exporters to bypass the collection process and transfer credit risk, which is especially valuable when dealing with uncertain or high-risk markets (Eljuri & Anand, 2016). Forfaiting extends this concept for medium-term financing, where exporters sell their promissory notes or bills of exchange to forfaiting banks, often without recourse, thus transferring the payment risk completely (Madura, 2021).

Letters of credit also serve as a financing tool, functioning as a guarantee of payment by the importer's bank. A time draft or banker’s acceptance can provide financing, with the bank guaranteeing the payment at maturity. These instruments facilitate international transactions by bridging liquidity gaps and providing assurance to both exporters and importers (Couto et al., 2017).

Countertrade, including barter, counterpurchase, and compensation agreements, is often used in markets with currency constraints or for political reasons, enabling countries or firms to trade goods directly without cash dependency (Madura, 2021). These arrangements can be complex but are crucial in promoting exports and imports under particular economic conditions.

Sources of Short-Term Financing for Multinational Corporations

Multinational firms (MNCs) have access to multiple financing sources for managing short-term assets and liabilities. Internal funds are usually preferred due to lower costs but may be insufficient, especially for substantial transaction volumes. Excess cash generated by subsidiaries can be employed to fund international operations, incentivizing liquidity management across borders (Cavusgil et al., 2014).

When external funding is needed, short-term notes and commercial paper are popular instruments. These debt securities, typically with maturities of 1, 3, or 6 months, are issued at interest rates tied to benchmarks like LIBOR. They are generally unsecured and depend heavily on the creditworthiness of the issuing entity (Madura, 2021).

Banks also provide short-term loans, often with relatively favorable interest rates given the low risk and high liquidity of such facilities. These loans typically have flexible terms to accommodate the fluctuating needs of multinational firms (Cavusgil et al., 2014).

Foreign Exchange and Currency Financing

Foreign currency financing allows MNCs to capitalize on low-interest rates in certain currencies, provided they carefully assess the associated currency exchange risks. Borrowing in foreign currencies such as the euro, yen, or Swiss franc can offer cost savings if the interest rates are competitive and the exchange rate remains stable (Rogoff, 2017).

The portfolio approach to currency financing involves borrowing in a mix of currencies with low and uncorrelated interest rates, effectively reducing overall exposure to currency risk while optimizing cost efficiency. However, this strategy requires sophisticated risk management to hedge against currency fluctuations and interest rate volatility (Froot & Ramadorai, 2013).

In conclusion, effective international financing and trade payment strategies require an understanding of various instruments, methods, and risk mitigation techniques. Multinational firms that leverage these tools strategically can optimize cash flows, minimize risks, and enhance their competitive position in the global marketplace.

References

• Cavusgil, S. T., Knight, G., Riesenberger, J. R., Rammal, H. G., & Rose, E. L. (2014). International Business. Pearson.
• Claeys, S., & Sugiarto, S. (2014). Trade Finance and Policy Risks. Journal of International Commerce, 10(2), 45-62.
• Couto, R., Saldanha, S., & Batista, P. (2017). Bank Guarantees and Letters of Credit in International Trade. International Finance Review, 22(3), 112-128.
• Eljuri, R., & Anand, P. (2016). Factoring and Export Financing in Emerging Markets. Journal of Financial Markets, 30, 26-46.
• Froot, K., & Ramadorai, T. (2013). The Portfolio Approach to Currency Hedging. Journal of International Money and Finance, 33, 536-550.
• Madura, J. (2021). International Financial Management (14th ed.). Cengage Learning.
• Rogoff, K. (2017). The Architecture of the Global Currency System. BIS Working Papers, No. 657.
• Rogoff, K. (2017). Currencies and Global Liquidity. Review of International Economics, 25(2), 236-255.
• Saldanha, P., & Batista, S. (2018). Trade Risk Management in Global Supply Chains. Journal of Economic Studies, 45(8), 1234-1250.
• Secretariat, UNCTAD. (2020). Trade Finance in the Global Economy. UNCTAD Reports.