INTERNATIONALFINANCIAL

MANAGEMENT

EUN / RESNICKSecond Edition

Chapter One

Globalization & the

Multinational Firm

Chapter Objectives:

•Understand why it is important to study international finance.

•Distinguish international finance from domestic finance.

1-2

What’s Special about “International” Finance? Goals for International Financial Management Globalization of the World Economy Multinational Corporations.

Chapter One Outline

Introduction

Financial management is mainly concerned with how to optimally make various corporate financial decisions ,those pertaining to investment ,capital structure dividend policy and working capital management with a view to achieving a set of given corporate objectives.

.

1-3

Why do we need to study international financial management????

1-4

Integration of Financial Markets

Diversification of investment portfolio internationally. Example: Japanese investors invests heavily in US and

other foreign financial markets in efforts to recycle their enormous trade surpluses

IBM and Daimler-Benz and Sony have their shares cross listed on foreign stock exchanges thereby rendering their shares internationally tradable and gaining access to foreign capital as well.

1-5

Economic functions CPI are highly globalised

1-6

.

1-7

What’s Special about “International” Finance?

Foreign Exchange Risk Political Risk Market Imperfections Expanded Opportunity Set

1-8

What’s Special about “International” Finance?

Foreign Exchange Risk Suppose Mexico is the major export for your company

and the Mexican peso depreciates drastically against the US dollar. This means that your company’s products can be priced out of the Mexican markets ,as the peso price of American imports will rise following the peso’s fall.

Political Risk

Unexpected changes in the tax rules to outright expropriation of assets held by foreigners.

PR=Sovereign party can change the “rules of the game” and the affected parties may not have effective recourse.

Sovereign governments have the right to regulate the movement of goods, capital, and people across their borders. These laws sometimes change in unexpected ways.

1-9

Case

In 1992 the Enron Development Corporation ,a subsidiary of the Houston based energy company ,signed a contract to build India’s largest power plant .After Enron had spent nearly $300 million ,the project was cancelled in 1995 by nationalist politician in the Maharashtra state who argued India didn’t need the power plant .This episode illustrates the difficulty of enforcing contracts in foreign countries.

1-10

1-11

Market Imperfections-represents various frictions and impediments preventing markets from functioning perfectly ,play an important role in motivating MNC’s to locate production overseas.Example:Honda a Japanese automobile company ,for, instance decided to establish production facilities in Ohio, mainly to circumvent trade barriers. MNC’s are a gift of market imperfections.

Legal restrictions on movement of goods, people, and money

Transactions costs Shipping costs Tax arbitrage

What’s Special about “International” Finance?

1-12

Expanded Opportunity Set-Firms can locate production in any country or region of the world to maximize their performance and raise funds in ant capital market where the cost of capital is the lowest.

Gain from greater economies of scale when their tangible and intangible assets are deployed on a global basis. It doesn’t make sense to play in only one corner of the

sandbox. True for corporations as well as individual investors.

What’s Special about “International” Finance?

1-13

Maximize Shareholder Wealth

Shareholders Wealth Maximization means that the firm makes all business decisions and investments with an eye towards making the owners of the firm –the shareholders better off financially, or more wealthy ,than they were before.

Long accepted as a goal in the Anglo-Saxon countries(Australia,Canada,UK and US) but complications arise.

1-14

Other Goals

In other countries shareholders are viewed as merely one among many “stakeholders” of the firm including: Employees Suppliers Customers

In Japan, managers have typically sought to maximize the value of the keiretsu—a family of firms to which the individual firms belongs.

.

1-15

Other Goals

No matter what the other goals, they cannot be achieved in the long term if the maximization of shareholder wealth is not given due consideration.

1-16

Globalization of the World Economy: Recent Trends

Emergence of Globalized Financial Markets Trade Liberalization and Economic Integration Privatization

Emergence of Globalized Financial Markets

Rapid integration of international capital and financial markets. Deregulation of the financial markets by the government of various

countries.Example:1980 Japan deregulated its foreign exchange market,1985 Tokyo stock exchange,Feb 1986 London stock exchange.

In Europe, financial institutions are allowed to perform both investment banking and commercial-banking functions.

London affiliates of foreign commercial banks were eligible for membership on the LSE.

These changes were desired to give London the most open and competitive capital markets in the world.

The US repealed the Glass-Steagall Act,which restricted commercial banks from investment banking activities.

1-17

Financial Innovations Currency futures and options Multi-currency bonds Cross-border stock listings International mutual funds Corporations also played an active role in integrating the world financial

markets by listing their shares across borders . Well known non-US companies are Seagram,Sony,Toyota Motor,Fiat,Glaxo ,British Petroleum ,and Daimler are directly listed and traded on the New-York stock exchange.

At the same time ,US firms such as IBM and GM are listed on the Brussels, Frankfurt and the London and Paris stock exchanges.

Cross-border listings of stocks allows investors to buy and sell foreign share as if they are domestic shares,faccilitating international investments.

1-18

1-19

The euro (€) is the official currency of the European Union (EU), and is currently in use in 16 of the 27 Member States.

The states, known collectively as the Eurozone, are Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovak republic, Slovenia and Spain.

It is consequently used daily by some 327 million Europeans. As of October 2009, with more than €790 billion in circulation, the

euro is the currency with the highest combined value of banknotes and coins in circulation in the world, having surpassed the U.S. dollar

Advent Of Euro

Contd… The euro is managed and administered by the Frankfurt-based European

Central Bank (ECB) and the Eurosystem (composed of the central banks of the Eurozone countries).

As an independent central bank, the ECB has sole authority to set monetary policy. The Eurosystem participates in the printing, minting and distribution of notes and coins in all Member States, and the operation of the Eurozone payment systems.

All intra-EU transfers in euro are considered as domestic payments and bear the corresponding domestic transfer costs.This includes all Member States of the EU, even those outside the Eurozone providing the transactions are carried out in euro.

Credit/debit card charging and ATM withdrawals within the Eurozone are also charged as domestic, however paper-based payment orders, like cheques, have not been standardised so these are still domestic-based.

1-20

Contd…

The euro has precipitated the emergence of continent wise capital markets in Europe that are comparable to US markets in its depth and liquidity.

The European M&A activities,cross border alliances among among financial exchanges and lessening dependence on banking sectors for capital raising are all manifestations of profound effect of EURO.

1-21

1-22

Economic Integration

Over the past 50 years, international trade increased about twice as fast as world GDP.

There has been a sea change in the attitudes of many of the world’s governments who have abandoned mercantilist views and embraced free trade as the surest route to prosperity for their citizenry.

Liberalization of Protectionist Legislation

Principle of international Trade-Theory of Comparative Advantage-In economics, the principle of comparative advantage refers to the ability a country to produce a particular good or service at a lower opportunity cost than another party.

It is the ability to produce a product most efficiently given all the other products that could be produced.

1-23

.

1-24

Liberalization of Protectionist Legislation

The General Agreement on Tariffs and Trade (GATT) a multilateral agreement among member countries has reduced many barriers to trade.

Uruguay Round-(1)reduce import tariffs worldwide by an average of 38 percent(2) increase proportion of duty free products from 20% to 40% for industrialized countries (3) Extend the rules of world trade to cover agriculture, services such as banking and insurance and intellectual property rights.

The World Trade Organization has the power to enforce the rules of international trade.

The North American Free Trade Agreement (NAFTA) calls for phasing out impediments to trade between Canada, Mexico and the United States over a

15-year period.

.

1-25

Privatization

The selling off state-run enterprises to investors is also known as “Denationalization”.

When a national government divests itself of a state run business, it gives up part of its national identity.

Often seen in socialist economies in transition to market economies. By most estimates this increases the efficiency of the enterprise. Often spurs a tremendous increase in cross-border investment.

Case

In Czech Republic the Czech government gave away its business to the Czech people. For a nominal fee vouchers were sold that allowed Czech citizens to bid on businesses as they went on the auction block..From 1991-1995 more than 1700 companies were turned over to private hands. Moreover three quarters of the Czech citizens became stockholders in these newly privatized firms.

1-26

.

1-27

Multinational Corporations

A firm that has incorporated on one country and has production and sales operations in other countries.

Obtaining raw material from one national market, and financial capital from another ,producing goods with labor and capital equipment in the third country and selling the finished goods in yet another national markets.

According to the UN report There are about 60,000 MNCs in the world.

MNCs obtain financing from major financial markets around the world in many different currencies to finance their operations.

Global operations force the treasure’s office to establish international banking relationships ,place short term funds in several currency denominations and effectively manage foreign exchange risk.

1-28

Top 10 MNCs

1 General Electric United States

2 Ford Motor Company United States

3 Royal Dutch/Shell Group

Netherlands/ UK

Netherlands/U.K.

4 General Motors United States

5 Exxon Corporation United States

6 Toyota Japan

7 IBM United States

8 Volkswagen Group Germany

9 Nestlé SA Switzerland

10 Daimler-Benz AG Germany

1-29

End Chapter One