INTERNATIONAL FINANCE:
SOME RELATED DISCUSSIONS
INVESTMENT DECISIONS
- The decision to expand into international markets is often determined by the financial
stability of a territory under consideration. A market in the course of development offers
significant advantages to investors who view development prospects as an opportunity to
ensure long term growth. Financial stability of these markets depends to a great extent
upon the availability of investment capital and upon the commitment by investors to the
success of their ventures.
CREDIT AS A MARKETING TOOL
- Superior technical capability and attractive cost packages may not be enough to secure
international contracts nowadays in the area of engineering and construction. Many
international companies active in the global market put together financing packages either
with the help of investment institutions or the government. In countries with a shortage
of capital, outside financing may be necessary to create a market in the region. (Example:
Bechtel Financial Services, a subsidiary of Bechtel Corporation, was involved with such a
project. In the mid 1980's, they signed a protocol with the Turkish government to build a
$1 billion coal-fired power plant. Bechtel and their partners financed, designed, and
built the project and also entered a 15-year joint-venture with the Turkish government to
operate the plant. Revenues came through the sale of power.)
- Credit may sometimes be obtained from the government and extended to the host country.
The Japanese government, for example, offer "soft" loans to developing countries
through private corporations. Because of this advantage, Japanese companies are capable of
making attractive cost packages to secure international contracts.
RISK AND UNCERTAINTY
- Most investors would prefer certainty to uncertainty, given the the same expected
return. An estimated return on investment (ROI) is calculated by averaging the different
possible returns based on different certainties of achievements and varying probabilities
of achieving those targets. Investors may require a higher estimated ROI with an increase
in uncertainties.
|
Percentage ROI |
Probability |
Weighted value |
0 |
0.10 |
0 |
5 |
0.20 |
1 |
10 |
0.40 |
4 |
15 |
0.25 |
3.75 |
20 |
0.05 |
1 |
Estimated ROI |
|
|
9.75% |
Table 1. Calculation of ROI Based
on Different Certainties
- Even the most carefully considered
credit judgments may be destroyed by the adverse political and commercial developments in
the host country. Apart from situations causing delays in payment, the owner may go out of
business before paying the investor. The major types of financial risks include:
- Commercial risk: It refers
primarily to the insolvency of or protracted payment default by an international
client. It usually results from deterioration of economic conditions in the host country,
fluctuations in prices of labor and materials, unanticipated competition either
domestically or internationally, or technological changes. Some of the project-specific
reasons may include:
- Internal changes in the entity of
the client (i.e. retirement or death of a key person)
- Unexpected difficulty experienced
by the owner in meeting operating expenses
- Natural disasters
- Delay in making periodic payments
- Political risk: See Political Environment.
- Foreign exchange risk: It refers
to the effects of fluctuations in exchange rates (price of one currency in respect of
another currency). The currency quotation depends largely on the bargaining positions of
the owner and the constructor as well as on accepted practices in the industry. However,
if the contract price is not in one's home currency, the construction company must be
prepared to protect itself against losses resulting from changes in the value of currency
transaction.
- Formula for calculation of
anticipated exchange rate at the end of a certain period time:
- et = e0 *
[(1 + ih,t)/(1 + if,t)]
- e = the exchange rate quoted in
terms of the number of units of the domestic currency for one unit of foreign currency
- i = the inflation rate
- ih,t = projected
inflation rate in the home country at the end of a certain period of time 't'
- if,t = projected
inflation rate in the foreign country at the end of a certain period of time 't'
- 'h' indicates the home country
- 'f' indicates the foreign country
- '0' indicates the beginning of a
certain period of time
- 't' indicates the end of a certain
period of time
SOURCES OF FINANCING
- With probably the exception of
very large companies that may have their own financial entities, most global companies
need sources to secure appropriate financing. Export financing terms can effect the
project costs significantly. A saving of even 0.25% on interest rate may make a lot of
difference in case international construction projects. In some cases, a client may award
a contract to the provider of cheaper credit overlooking differences in quality and bid
price.
- Financing is available from
private and public sectors. International contractors should assess both domestic and
global programs.
- Commercial banks:
- Commercial banks all over the
world provide trade financing depending on the relationship with the exporter of goods and
services, the nature of the trade, nationality of the borrower, and availability of export
insurance.
- Many banks, however, look at
profits from international trade transactions (particularly with developing nations) as
too small, too risky, or too time-consuming. Investor pressure also sometimes lead banks
to minimize foreign credit risks.
- Official trade finance in U.S.:
- Official trade finance can take
the form of either a loan or a guarantee including credit insurance. For loans, the
government usually provides funds to finance the project and charges interest on those
funds at a stated interest. The risk of possible default is also accepted by the
government. For a guarantee, a private sector bank provides the funds and sets the
interest rate, with the government making assurances of reimbursement if the the loan is
unpaid.
- Eximbank: The Eximbank (Export-Import Bank) of
the United States is an independent federal agency that supports the export of U.S. goods
and services through loan guarantees and insurance programs. Established in 1945, the
purpose of the bank is to aid in financing and facilitating exports. For long term
guarantees, used for transactions in excess of $10 million and repayment periods of eight
or more years, commercial risk cover is 100 per cent. The Eximbank does nor compete with
commercial banks. It complements and supplements commercial bank support for exports by
assuming risks acceptable to the banks.
- Foreign Credit Insurance Association (FCIA): It is an insurance association operating as
Eximbank's agent. It provides export credit insurance to cover losses due to political
reasons (war, expropriation) and commercial losses.
- Overseas Private Sector Investment Corporation (OPIC): It is also a federal agency that
offers investment guarantees, comparable to those offered by the Eximbank and FICA to U.S.
investors who wish to establish plants in developing countries either by themselves or as
joint-venture with local companies. Major risks covered by OPIC are:
- Loss of assets due to political disturbances
- Loss of income to interruption of business caused by political disturbances
- Agency for International Development (AID): The agency administers most of the foreign
economic assistance programs for the U.S. government. The agency is involved in helping
the people of developing nations become participants in the economic and political lives
of their nations, thus creating markets for the United States and reducing global poverty.
Figure 2. A Project in Bangladesh Funded by the Netherlands Government