Question

In: Finance

1. What are the major instruments used to facilitate the conduct of commonly occurring international transactions?...

1. What are the major instruments used to facilitate the conduct of commonly occurring international transactions? In your discussion, provide rationales for why one instrument would be favored over others for use in a particular category of transactions. Find some real-world examples of such instruments provided by major banks, as well as the applicable fees charged.

2. Address the importance of working capital in relation to the firm’s conduct of its day-to-day operations. Discuss the decision choices that MNCs have in light of IRP. Find some real-world examples of working capital management from annual or quarterly reports of MNCs.

Solutions

Expert Solution

Instruments used in international transactions:

  • Foreign bills of exchange:

This is considered to be customary form of international payments. This is a written request from the drawer to the drawee to pay a certain amount either to himself or to payee as directed by the drawer on demand. Hence this facility has an additional formality of letter of credit.

The working process is also simple. The exporters of one country draw bills on their importers in other country & have duly accepted by them. These bills are then sent to the debtors in their own country who desire to send money abroad.

  • Bank drafts & telegraphic transfers:

This is order b a bank to its branch or some other bank to pay the bearer on demand a certain amount from its deposit account. The debtor can get such a facility from his bank & send it to his creditor who can collect the amount from his bank in his own country.

  • Telegraphic transfer:

This is an order by a bank to its correspondent bank in abroad to pay money to a certain person out of his deposit account, this enables quick transaction.

  • Letter of credit:

This is an instrument authorizing a person to draw a bill or a check for a specified amount on the issuing bank at a stipulated time. The letter of credit makes the exporter willing to ship the goods to the importer for a liability for which payment is assumed by the bank issuing such letter of credit.

These types of credit are also issued to the travelers travelling abroad.

Out of the various instruments used above, I would consider telegraphic transfer to be beneficial. This is because it is considered to be very simple as it enables easy transactions between the importer & exporter who take part in international transactions. It also saves lot of time for both the parties.

Example of one such service offered by bank of America is a facility called as viewpost. This helps the businesses to streamline their payment process with various countries. It also helps in simple billing & improves their cash management. It helps the businesses to send electronic invoices to its customers, track & receive electronic deposits etc. these services are charged at the rate of $14.99 per month. For check payment - $1 per check, check full fees - $9.50 per pulled check etc.

Importance of working capital:

Working capital is nothing but difference between a company’s current assets & current liabilities. It indicates whether a company has adequate cash to cover short term debt & expenses. They are also used to make routine payments, cover unexpected costs, used to purchase materials for used in day to day production

Decisions on IRP:

For example, if the company wants to invest 1000 pounds per year, it has two options for making decisions:

  • Home investment:

For example, if the spot exchange rate in US is $1.2245/1pound

We get an exchange of 1000 pounds at the rate of $1.2245 = $1,224.50

For example, if we invest this $1224.50 at the rate of 3% for 1 year which yields $1261.70 at the end of the year.

  • International investment:

We can also invest €1000 in an international market, where the rate of interest is 5.0% for 1 year.

So, €1000 @ of 5% for 1 year = €1051.27

Let the forward exchange rate be $1.20025 / €1.

So, we buy forward 1 year in the future exchange rate at $1.20025/€1 since we need to convert our €1000 back to the domestic currency, i.e., the U.S. Dollar.

Then, we can convert € 1051.27 @ $1.20025 = $1261.79

Thus, when there is no arbitrage, the Return on Investment (ROI) is equal in both cases, regardless the choice of investment method.

Arbitrage is the activity of purchasing shares or currency in one financial market and selling it at a premium (profit) in another.

Working capital management of EY:

From the 2017 report, the key findings is that the total sales decreased by 4%, net working capital increased by 2%.C2C cycle by 8 days to 116 days. The overall days payable outstanding has improved by 5 days compared to the previous year. The days inventory outstanding (DIO) detoriated by 5 days in the current year as compared to the previous year.


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