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CENTRAL PHILIPPINE UNIVERSITY

COLLEGE OF BUSINESS AND ACCOUNTANCY
Iloilo City, Philippines 5000
Tel. No. (63-33) 3307262 / 3307264
Website: http://www.cpu.edu.ph | Email: [email protected]
Academic Year 2024-2025
Second Semester

BUS 4106 – INTERNATIONAL BUSINESS & TRADE

LECTURE NOTES
Module 9 – International Financial Management
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Learning Objectives:

L01. Explain the functioning of foreign exchange markets and their role in global business
operations.
L02. Develop strategies to manage currency risk and foreign exchange exposure.
L03. Analyze global trade financing options, including letters of credit, open accounts, and bank
guarantees.
L04. Evaluate the role of international capital flows in supporting business expansion and
operations.
L05. Assess the financial risks and opportunities associated with operating in global markets.

A. Foreign Exchange Markets and Currency Risk

1. What is the Foreign Exchange (Forex) Market?

Definition: A global marketplace for exchanging national currencies against one another.

Scale: The largest financial market globally, with over $6 trillion traded daily (BIS, 2022).

Purpose of Foreign Exchange (Forex) Market

1. Facilitates international trade and investment

2. Determines currency values through supply and demand

3. Enables hedging against foreign exchange risks

4. Offers a platform for speculation

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2. Key Players in the Forex Market

Participants Role
Commercial Banks Primary market-makers; facilitate large trades.
Central Banks Intervene to stabilize or guide national currencies.
Multinational Corporations (MNCs) Hedge and transact for global operations.
Hedge Funds and Investors Speculate on short-term movements.

Example: A Philippine exporter earning U.S. dollars must convert them to pesos. Exchange rate
fluctuations affect revenue.

3. Types of Foreign Exchange Markets

• Spot Market - Immediate currency transactions

• Forward Market - Contracts to exchange currencies at a future date at a set price

• Futures Market - Standardized contracts similar to forwards but traded on exchanges

• Options Market - Contracts giving the right, but not obligation, to exchange currency

4. Exchange Rate Systems

• Floating Rates - Determined by market forces (e.g., U.S. dollar, Euro)

• Fixed Rates - Pegged to another currency (e.g., Saudi Riyal to USD)

• Managed Float - Market-driven but influenced by government interventions (e.g., Peso)

5. Understanding Currency Risk

• Transaction Exposure - Risk from foreign currency-denominated transactions.

Example: Payment for imported goods fluctuates before settlement.

• Translation Exposure - Risk in consolidating foreign assets and liabilities into the home
currency.

Example: An MNC’s foreign subsidiary reports earnings in local currency.

• Economic Exposure - Risk to future cash flows from exchange rate changes affecting
competitiveness.

Example: Stronger domestic currency makes exports more expensive.

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B. Managing International Capital and Financial Operations

1. Hedging Strategies Against Currency Risk

Strategy Description Example

Forward Lock in exchange rates for future Filipino importer locks USD rate for a
Contracts transactions. purchase.
Similar to forwards but standardized and Buy USD futures to pay future U.S.
Currency Futures
traded. suppliers.
Purchase right (not obligation) to exchange Buy an option to buy euros if euro
Currency Options
at a specific rate. strengthens.
Match cash flows (revenues and expenses) Philippine exporter pays European
Natural Hedging
in same currency. supplier in euros.

Choosing a strategy depends on: transaction size, duration, cost, and risk appetite.

2. International Capital Flows and Business Expansion

• Foreign Direct Investment (FDI) - Building production facilities abroad (e.g., Toyota
plants in the Philippines)

• Portfolio Investment - Buying foreign stocks and bonds for returns (no direct control)

• Cross-border Loans - Borrowing from foreign banks with better interest rates

Impact: Capital flows help businesses expand globally, access technology, and improve
competitiveness.

3. Managing International Financial Operations

Cash Management
• Accelerate receivables

• Delay payables (if currency depreciates)

• Centralized treasury management for multinational firms

Tax Optimization

• Use tax treaties to avoid double taxation.

• Structure operations in tax-friendly jurisdictions (e.g., Singapore, Ireland).

Transfer Pricing and Cost Allocation

• Pricing intercompany transactions to optimize taxes and manage profits.

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C. Global Trade Financing and Payment Methods

1. Importance of Trade Financing

• Bridges the payment gap between shipment and receipt of goods

• Reduces non-payment risk for exporters

• Enhances trust in international transactions

2. Key Payment Methods in International Trade

Method Description Risk to Seller Risk to Buyer

Advance Payment Buyer pays upfront Low High
Letter of Credit (L/C) Bank guarantees seller’s payment Low Low
Documentary Banks handle documents, but no payment
Moderate Moderate
Collection guarantee
Open Account Goods delivered before payment High Low

3. Letters of Credit (L/C)

Written undertaking by buyer’s bank to pay seller upon presentation of documents complying
with L/C terms.

Types:

• Revocable - Can be changed without consent (rare)

• Irrevocable - Cannot be changed unless all parties agree

• Confirmed - Another bank guarantees payment

Process:

a. Buyer arranges L/C

b. Seller ships goods and presents documents

c. Bank pays seller after verifying documents

Example: A Philippine furniture exporter uses an L/C when shipping to Europe.

4. Open Account

Buyer receives goods before payment.

Used When:

a. Strong relationship exists

b. Buyer is in a low-risk country

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Advantages: Simpler and cheaper

Disadvantages: High risk to the seller without insurance

5. Bank Guarantees

Bank promises to compensate if the buyer fails to fulfill obligations.

Types:

• Payment Guarantee

• Performance Guarantee

Example: A construction company receives a bank guarantee to assure payment milestones

abroad.

D. Assessing Financial Risks and Opportunities in Global Markets

1. Financial Risks
• Exchange Rate Volatility - Sudden changes hurt profits

• Political Risk - Instability may lead to asset seizures or capital controls

• Credit Risk - Counterparty defaults

• Interest Rate Risk - Rising rates increase borrowing costs

• Liquidity Risk - Difficulty in quickly converting assets to cash

2. Financial Opportunities
• Lower Financing Costs - Emerging markets offer cheaper loans

• Market Expansion - New customer bases

• Investment Diversification - Reduce domestic market dependency

• Favorable Currency Movements - Weakened home currency boosts export

competitiveness

Prepared by: HERMELY A. JALANDO-ON, DM