SUBJECT OVERVIEW

Text book:
• CORE: Multinational Business Finance,
13th edition by Eiteman, Stonehill and
Moffett (Pearson)
• Supplement: International Financial
Management, Abridged 10th edition by Jeff
Madura (South Western)

1-1 © 2013 Pearson Education

 What the subject is about

• The environment and key variables affecting

international firms
❖ Interest rates
❖ Foreign exchange rates
❖ Inflation rates
❖ Financial instruments for investment and hedging

• Financing decisions and investment decisions of

international firms
❖ Costs of capital
❖ Risks
❖ Returns

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 Lecture 1

⚫ Business and financial background of MNEs

⚫ Chapter 1: Globalization and the MNEs
⚫ Chapter 3: The international monetary
system

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 Business and Financial
background
• Business:
❖ Strategic decisions
❖ Key financial decisions
 Financing (sources and costs of fund)
 Investing
 Dividends
❖ Investors
 Risk and return concepts
• Perceived risk and required return
 Financial instruments
❖ Time value of money
 Present value vs. Future value
 Valuation

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 Chapter 1

Current
Multinational
Financial
Challenges
 The Multinational Enterprise
(MNE)
• I define globalization as producing where it is most
cost-effective, selling where it is most profitable,
and sourcing capital where it is cheapest, without
worrying about national boundaries.
—Narayana Murthy, President and CEO, Infosys.
• A multinational enterprise (MNE) has operating
subsidiaries, branches or affiliates located in foreign
countries.

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 The Multinational Enterprise (MNE)

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 The Market for Currencies

• Most currencies are quoted against the

dollar as in “so many units per dollar”
• A few are quoted as “dollars per unit” due to
custom e.g., $/£ and $/€.
• Several symbols that can be used to write
the quotations (E.g. £/GBP/STG/UKL)

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 Exhibit 1.2 Selected Global Currency
Exchange Rates

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 Exhibit 1.2 Selected Global Currency
Exchange Rates (cont.)

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 The Global Financial Marketplace

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 What Is Different About International
Financial Management?

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 Market Imperfections: A Rationale for
the Existence of the Multinational Firm

• MNEs take advantage of imperfections in national

markets for products, factors of production, and
financial assets → market opportunities
• Large international firms are better able to exploit
such competitive factors as:
– economies of scale
– managerial and technological expertise
– product differentiation
– financial strength…

than their local competitors.

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 Market Imperfections: A Rationale for
the Existence of the Multinational Firm
• Strategic motives drive the decision to invest
abroad and become a MNE:
– Market seekers
– Raw material seekers
– Production efficiency seekers
– Knowledge seekers
– Political safety seekers

• These categories are not mutually exclusive.

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 The Theory
of Comparative Advantage
• A basis for explaining and justifying international trade
in a model world assumed to enjoy:
– free trade;
– perfect competition;
– no uncertainty;
– costless information; and
– no government interference.
• Origin: Adam Smith, developed by Ricardo (absolute
advantage vs comparative advantage)

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 The Theory
of Comparative Advantage
• Comparative advantage vs. Absolute advantage
• Even if a country possessed absolute advantage in the
production of two products, it might still be relatively more
efficient than the other country in one product than the other
• Each country would possess comparative advantage in the
production of one product, and benefit by specializing
completely in one product and trading for the other.
• Factors of production cannot be moved freely from one
country to the other, the benefits of specialization are realized
through international trade.

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 The Theory
of Comparative Advantage

1. What are absolute advantages of US and Brazil?

2. What are comparative advantages of US and Brazil?

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 The Theory
of Comparative Advantage
• Limitation of the classical theory:
– Existence of government interference (Tariff, quotas…)
– At least two factors of production (capital and technology)
now flow directly and easily between countries
– Modern factors of production are more numerous than in
this simple model (E.g. local and managerial skills, legal
structure, supporting infrastructure…)
→Comparative advantage shifts over time
– Certain issues are not addressed: the effect of uncertainty
and information costs, economies of scale…

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 Exhibit 1.3 Global Outsourcing of
Comparative Advantage

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 The Globalization Process

• Stage I: early domestic phase growing into the

international trade phase (Exhibit 1.5)

• Stage II: A successful firm will continue to grow

from simple international trade to the multinational
phase characterized by production and investment
both at home and abroad (Exhibit 1.6)

• Growth may be limited by the twin agency

problems of corporate insiders and the rulers of
sovereign states (Exhibit 1.7)

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 Exhibit 1.5 Trident Corp: Initiation of the
Globalization Process

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 Exhibit 1.6 Trident’s Foreign Direct
Investment Sequence

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 The limits to financial globalization

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 Chapter 3

The
International
Monetary System
 Exhibit 3.1 The Evolution of Capital
Mobility

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 History of the International
Monetary System
• The Gold Standard (1876 – 1913)
– Gold has been a medium of exchange since 3000 BC
– Each country set the rate at which its currency unit could be
converted to a weight of gold
→ “fixed” exchange rates
- In effect until the outbreak of WWI when the free movement
of gold was interrupted
• Example: If an ounce of gold is worth 30$ in the USA, and £6
in the UK:
$30 = 1 ounce of gold = £6
$30 = £6
→$5 = £1
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 History of the International
Monetary System
• The Inter-War Years & WWII (1914-1944)
– Currencies were allowed to fluctuate over a fairly wide
range in terms of gold and each other
– The U.S. adopted a modified gold standard in 1934
– During WWII and its chaotic aftermath the U.S. dollar was
the only major trading currency that continued to be
convertible

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 History of the International
Monetary System
• Bretton Woods and the
International Monetary Fund
(IMF) (1944)
– The Bretton Woods Agreement
established a U.S. dollar based
international monetary system and
created two new institutions the
International Monetary Fund (IMF)
and the World Bank
– All countries fixed the value of their
currencies in terms of gold but were
not required to exchange their
currencies for gold. Only the dollar
remained convertible into gold (at
$35 per ounce)
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 History of the International
Monetary System
• Fixed Exchange Rates (1945-1973)
– The currency arrangement negotiated at Bretton Woods
and monitored by the IMF worked fairly well during the
post-World War II period of reconstruction and rapid
growth in world trade.
– Widely diverging monetary and fiscal policies, differential
rates of inflation and various currency shocks resulted in
the Bretton Woods system’s demise
– Most currencies were allowed to float to levels determined
by market forces as of March 1973.

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 The IMF’s Exchange Rate
Regime Classifications
In effect since January 2009
• Category 1: Hard Pegs
– Countries that have given up their own sovereignty over
monetary policy
– E.g., dollarization or currency boards
• Category 2: Soft Pegs
– AKA fixed exchange rates, with five subcategories of
classification:
• Conventional pegged arrangement
• Stabilized arrangement
• Crawling peg
• Crawl-like arrangement
• Pegged exchange rate within horizontal bands

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 The IMF’s Exchange Rate
Regime Classifications
• Category 3: Floating Arrangements
– Mostly market driven, these may be free floating or
floating with occasional government intervention
• Category 4: Residual
– The remains of currency arrangements

• Vietnam: since 2016, the rate is pegged to three

benchmarks: demand and supply of the Vietnam dong
(VND), the exchange rates for a basket of eight strong
foreign currencies, and for any change to balance
macro-economic needs.
→ setting the official mid-point rate of the Vietnamese
dong against the U.S. dollar on a daily basis.
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 Fixed Versus Flexible
Exchange Rates

• A nation’s choice as to which currency regime to

follow reflects national priorities about all facets
of the economy, including:
– inflation,
– unemployment,
– interest rate levels,
– trade balances, and
– economic growth.
• The choice between fixed and flexible rates may
change over time as priorities change.

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 Fixed Versus Flexible
Exchange Rates
• Countries would prefer a fixed rate regime for the
following reasons:
– Stability in international prices --> growth of
international trade and lessen business risks
– Inherent anti-inflationary nature of fixed prices
→ Restrictive monetary and fiscal policy
• However, a fixed rate regime has the following
problems:
– Need for central banks to maintain large quantities of
hard currencies and gold to defend the fixed rate
– Fixed rates can be maintained at rates that are
inconsistent with economic fundamentals

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 Attributes of the “Ideal” Currency

• Possesses three attributes, often referred to

as the Impossible Trinity:
– Exchange rate stability
– Full financial integration
– Monetary independence

• The forces of economics do not allow the

simultaneous achievement of all three

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 Exhibit 3.5 The Impossible Trinity

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 The impossible trinity

Choice #1 Choice #2 Therefore,

United Independent Free movement of Currency value

States monetary policy capital floats

Restricted
Independent Fixed value of
China movement of
monetary policy currency
capital

Fixed rate of
Europe Free movement Integrated
currency exchange
(EU) of capital monetary policy
between countries

Global finance in practice 3.3

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 Summary

• Global financial markets and MNEs

• Theory of comparative advantage
• History of international monetary system
• The current exchange rate regimes
• The impossible trinity

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