Last night I lectured to a class at the MIT Sloan School on topics in international finance. Giving the lecture I realized that my entire career has involved international finance--project finance, Eurodollar loans, currency swaps, IPOs and risk management. I covered four themes.
- In emerging markets one should always eliminate risks. There are so many economic and political risks (not to mention the occasional war) that if there is a vehicle to eliminate a risk, pay the price and reduce or eliminate the risk. For example, I always swap floating rate interest risk for fixed rate because I have seen interest rates increase 10 percent in a single day. Likewise I always try to borrow through term loans to reduce the refinancing risks. Twice I have had banks cancel all short term loan facilities in a country. Obviously I am speaking here about risks related to liabilities on the balance sheet.
- On the asset side of the balance sheet, never chase extraordinary returns in asset investments. Most companies should park operating and excess cash in the safest investment with the lowest counter party risk they can find. Investing in exotic derivatives such as mortgage-backed securities to get additional return usually adds risk to the business, which is already risky enough in an emerging market. Related theme: do not invest in derivatives you do not understand.
- In emerging markets raise cash well in advance of the need for it. I recommended 1-3 years in advance. The carrying cost of the surplus cash is far outweighed by the benefits of knowing that you can continue to execute the business plan despite riots, government overthrows, devaluations, etc.
- All finance is now derivatives or synthetic instruments. The best way now to finance a business is to explain to the banker the objectives of the financing and the risks that you want to mitigate. Let the banker craft the financing instrument using derivatives rather than telling the banker what you want.