FINANCING OUTSIDE THE DOMESTIC MARKET Because of the globalization of capital markets throughout the world, a

FINANCING OUTSIDE THE DOMESTIC MARKET Because of the globalization of capital markets throughout the world, a

corporation is not limited to raising funds in the capital market where it is domiciled. Globalization means the integration of capital markets throughout the world into a global capital market.

From the perspective of a given country, capital markets can be clas- sified into two markets: an internal market and an external market. The internal market is also called the national market. It can be decomposed into two parts: the domestic market and the foreign market. The domes- tic market is where issuers domiciled in the country issue securities and where those securities are subsequently traded.

The foreign market of a country is where issuers not domiciled in the country issue securities and where the securities are then traded. The rules governing the issuance of foreign securities are those imposed by regulatory authorities where the security is issued. For example, securi- ties issued by non-U.S. corporations in the United States must comply with the regulations set forth in U.S. securities law and other requirements imposed by the Securities and Exchange Commission. A non-Japanese

3 R.L. Benke, Jr. and J.D. Edwards, Transfer Pricing: Techniques and Uses (New York: National Association of Accountants, 1980).

SELECTED TOPICS IN FINANCIAL MANAGEMENT

corporation that seeks to offer securities in Japan, for example, must comply with Japanese securities law and regulations imposed by the Japanese Ministry of Finance.

EXHIBIT 25.4 Illustration of Effect of Transfer Price on Worldwide Net Income Assumptions:

Units sold by parent = 100,000 U.S. parent tax rate = 35% Subsidiary tax rate = 42%

Price and Costs in U.S. dollars

Parent

Subsidiary

Selling price

$80 Unit variable manufacturing cost

Transfer price

Transfer price + $10 Fixed manufacturing costs

a. Transfer price = $40

U.S. Parent Company Alone

Subsidiary

Revenue

$8,000,000 Variable manufacturing costs

5,000,000 Fixed manufacturing costs

500,000 Taxable income

$2,500,000 Income taxes

1,050,000 Net income after taxes

$1,450,000 Worldwide income taxes = $1,400,000

Worldwide net income after taxes = $2,100,000

b.Transfer price = $60

U.S. Parent Company Alone

Subsidiary

$8,000,000 Variable manufacturing costs

Revenue

7,000,000 Fixed manufacturing costs

500,000 Taxable income

$500,000 Income taxes

210,000 Net income after taxes

$290,000 Worldwide income taxes = $1,260,000

Worldwide net income after taxes = $2,240,000

International Financial Management

The external market, also called the international market, includes securities with the following distinguishing features: (1) they are under- written by an international syndicate, (2) they are offered at issuance simultaneously to investors in a number of countries, and (3) they are issued outside the jurisdiction of any single country. The external mar- ket is commonly referred to as the offshore market or, more popularly, the Euromarket. 4

We refer to the collection of all these markets—the domestic market, the foreign market, and the Euromarket—as the global capital market. The global capital market can be further divided based on the type of financial claim: equity or debt.

Several factors have lead to the better integration of capital markets throughout the world. We can classify these factors as follows: (1) deregulation or liberalization of capital markets and activities of market participants in key financial centers of the world; (2) technological advances for monitoring world markets, executing orders, and analyz- ing financial opportunities; and, (3) increased institutionalization of capital markets. These factors are not mutually exclusive. We discuss each factor below.