Chapter 1

Multinational
Financial
Management:
Opportunities and
Challenges
 Learning Objectives

• Examine the requirements for the creation of

value
• Consider the basic theory, comparative advantage,
and its requirements for the explanation and
justification for international trade and commerce
• Discover what is different about international
financial management

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 The Multinational Enterprise
(MNE)
• Have operations in more than one country
• Branches, foreign subsidiaries, or joint ventures
• Include for profit, non-profit firms, and NGOs
• Reliance on emerging markets for cheaper labor, raw
materials, sales, profits

• New world markets:

– BRICs (Brazil, Russia, India, and China)
– BIITS (Brazil, India, Indonesia, Turkey, and South
Africa)
– MINTs (Mexico, Indonesia, Nigeria, and Turkey)

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 Capital Markets

• Capital Markets are markets where financial

securities like shares and bonds are issued to raise
medium to long term financing and also where the
securities are traded. It helps channelize surplus
funds from small investors to institutions so that it
can be put to productive use.

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 Global Capital Markets

• A global capital market is the interlinking of

various investment exchanges around the world
that enables individuals and entities to buy and
sell financial securities on international level

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 Exhibit 1.1 Global Capital
Markets

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 The Global Financial
Marketplace

• Links among three items

– Financial Assets – Government-issued debt securities
– Foundation for the creation, trading and pricing other
financial assets (loans, corporate bonds and equities)

– Institutions
• Central banks (create & control MS)
• Commercial banks (deposits and loans)
• Other financial institutions (created to trade securities
and derivatives)
• The health and security of the global financial system
relies on the stability of financial institutions

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 The Global Financial
Marketplace

– Linkages – the interbank networks that provide the

actual medium for exchange e.g. LIBOR
– The exchange of currencies, and exchange of all other
currencies globally via currency is international interbank
network/market

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 The Market for Currencies

• Foreign currency exchange rate is the price of any

one country’s currency in terms of another
country’s currency
• E.g. exchange rate between the U.S. dollar ($ or
USD) and the European euro (€) as “1.3654 dollar
per euro”
• or $1.3654/ €
• Or EUR1.00=USD1.3654

• Argentina peso against the US dollar is

Peso 6.6580/$

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 The Market for Currencies
• Rates quoted in exhibit 1.2 are currency “mid-
rates” because they are midway between the
average bid and offer rates among currency
traders
• Most currency quotes follow a convention as a
result of some history or tradition
• The exchange rate between the US dollar and the
euro always quoted as “dollars per euro” ($/€) and
• US Dollar and the British pound is quoted as
“dollars per pound or $/£

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 The Market for Currencies
• US Dollar ($ or USD) / European euro (€ or EUR)
exchange rate stated as “1.3654 dollars per euro”
or as $1.3654/€ ($/€)
• Means “EUR1.00 = USD1.3654”

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 Exhibit 1.2 Global Currency
Exchange Rates

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 Exhibit 1.2 Global Currency
Exchange Rates (cont.)

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 Eurocurrencies and LIBOR

• Eurocurrencies
– Eurocurrencies are domestic currencies of one country on
deposit in a second country – overnight until more than 3
years
– Eurocurrency markets serve two valuable purposes
• Money market device for holding excess corporate liquidity
• Source of short-term bank loans to finance corporate
working capital needs
– Banks in which eurocurrencies are deposited =
eurobank
– Eurobank is a financial intermediary that bids for
time deposits and make loans in a currency other
than home currency

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 Eurocurrencies and LIBOR

• Eurocurrencies
– Eurocurrencies market includes eurosterling, (British
pounds deposited outside the United Kingdom); euroyen
(Japanese yen deposited outside Japan)

– Eurobanks are major world banks that conduct a

Eurocurrency business

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 Eurocurrencies and LIBOR

• Eurocurrency Interest Rates: LIBOR

– Reference rate of interest in the eurocurrency market is
LIBOR- The London Interbank Offered Rate
– Used in standardized quotations, loan agreements, or
financial derivatives valuations
– However most of the major domestic financial centers
construct own interbank offered rate
– PIBOR (Paris Interbank Offered Rate), MIBOR (Madrib
Interbank Offered Rate), SIBOR

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 Eurocurrencies and LIBOR

• Eurocurrency Interest Rates: LIBOR

– Eurocurrency loan market attract both depositors and
borrowers because of narrow interest rate spread
– Deposits rates are higher in the Eurocurrency markets
than in most domestic currency market because FI are
not subject to many regulations and reserve requirement
– Hence, deposit rates are higher and loan rates are lower
– Credit standing, and transaction size is large

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 The Theory of Comparative
Advantage
• The theory of competitive advantage provides a basis
for explaining and justifying international trade in a
model assumed to enjoy
– Free trade
– Perfect competition
– No uncertainty
– Costless information
– No government interference

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 The Theory of Comparative
Advantage
• Explain how the division of labor in productive activities,
international trade, can increased the quality of citizens
• Concept absolute advantage, countries should only
produce goods that they have an absolute advantage
in. This efficiency in production creates “an absolute
advantage,” which allows for beneficial trade.
• Could produce more goods at lower cost, higher quality
• Produce only for goods where you are most efficient,
trade for those where you are not efficient

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 The Theory of Comparative
Advantage

• Comparative advantage explain country boosts its

economic growth the most by focusing on the
industry in which it has the most substantial
comparative advantage.
• ability to produce goods and services at a lower
opportunity cost than that of trade partners.

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 The Theory of Comparative
Advantage

• The features of the theory are as follows;

– Exporters in Country A sell goods or services to unrelated
importers in Country B
– Firms in Country A specialize in making products that can
be produced relatively efficiently, given Country A’s
endowment of factors of production (land, labor, capital,
and technology)
– Country B does the same with different products (based
on different factors of production)

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 The Theory of Comparative
Advantage
– Because the factors of production cannot be transported,
the benefits of specialization are realized through
international trade
– Neither Country A nor Country B is worse off than before
trade, and typically both are better off (albeit perhaps
unequally)

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 The Theory of Comparative
Advantage

• Example: assume Thailand is more efficient than

Brazil at producing both sports shoes and stereo
equipment
• With one unit of production (a mix of land, labor,
capital, and technology), Thailand can produce
either 12 shipping containers of shoes or 6
shipping containers of stereo equipment
• Brazil, being less efficient in both, can produce
only 10 containers of shoes or 2 containers of
stereo equipment with one unit of input

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 The Theory of Comparative
Advantage

• A production unit in Thailand has an absolute

advantage over a production unit in Brazil in both
shoes and stereo equipment
• Thailand has a larger relative advantage over
Brazil in producing stereo equipment (6 to 2) than
shoes (12 to 10)
• As long as these ratios are unequal, comparative
advantage exists
• Thailand produce stereo, Brazil produce shoes

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 The Theory of Comparative
Advantage
• Although international trade might have
approached the comparative advantage model
during the 19th century, it certainly does not
today;
– Countries do not appear to specialize only in those
products that could be most efficiently produced by that
country’s particular factors of production
– Capital and technology flow easily between countries
– Modern factors of production are numerous
– Comparative advantage shifts over time

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 The Theory of Comparative
Advantage

• Comparative advantage still explains why some

countries are better for export

• 21st century comparative advantage is based on

services

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 Exhibit 1.3 What is Different About
International Financial Management?

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 Market Imperfections: A Rationale
for the Existence of the MNE

• Firms become multinational for one or several of

the following reasons:
– Market seekers
• To satisfy local demand or to market other than their home market
– Raw material seekers
• Forest product firm, choose Brazil
– Production efficiency seekers
• If the factors of production (labor, raw material)are underpriced
– Knowledge seekers
• Gain access to technology or managerial expertise
– Political safety seekers

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 The Globalization Process

• The globalization process is the structural and

managerial changes and challenges experienced
by a firm as it moves from domestic to global in
operations
• We will examine the case of Trident
– Trident’s initial strategy is to develop a sustainable
competitive advantage in the U.S. market
– Trident is currently constrained by its small size, other
competitors, and lack of access to cheap capital

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 Exhibit 1.4 Trident Corp: Initiation
of the Globalization Process

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 The Globalization Process

• In Phase One, Trident is not itself international or

global in its operations
• However, some of its competitors, suppliers or
buyers may be
• This is one of the key drivers pushing Trident into
Phase Two, the first transition of the globalization
process
• This is the Global Transition I: from The Domestic
Phase to The International Trade Phase

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 The Globalization Process

• In the International Trade Phase, Trident responds

to globalization factors by importing inputs from
Mexican suppliers and making exports sales to
Canadian buyers
• Exporting and importing products and services
increases the demands of financial management
over and above the traditional requirements of the
domestic-only business

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 The Globalization Process

• First, direct foreign exchange risks are now borne

by the firm
– Pricing and payments may be in different currencies
– The value of these foreign currency receipts and
payments can change, creating a new source of risk

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 The Globalization Process

• Second, the evaluation of the credit quality of

foreign buyers and sellers is now more important
than ever; this is known as credit risk
management
– Potential for non-payment of exports and non-delivery of
imports
– Differences in business and legal systems and practices

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 The Globalization Process

• If Trident is successful in its international trade

activities, it will soon need to establish foreign
sales and service affiliates
• This step is often followed by establishing
manufacturing operations abroad or by licensing
foreign firms to produce and service Trident’s
products
• This is the Global Transition II: from The
International Trade Phase to The Multinational
Phase

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 Exhibit 1.5 Trident’s Foreign
Direct Investment Sequence

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 The Globalization Process

• Trident’s continued globalization will require it to

identify the sources of it competitive advantages
• This variety of strategic alternatives available to
Trident is called the foreign direct investment
sequence which include the creation of foreign
sales offices, licensing agreements,
manufacturing, etc.

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 The Limits to Financial
Globalization

• Once Trident owns assets and enterprises in

foreign countries it has entered the multinational
phase of globalization
• The next exhibit illustrates the agency problems

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 Exhibit 1.6 The Potential Limits
of Financial Globalization

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 Summary of Learning Objectives

• This course analyzes how a firm’s financial

management tasks evolve as it pursues global
strategic opportunities and new constraints unfold
• The evolution of firms from domestic to
multinational is called the globalization process. A
firm may enter into international trade
transactions, then international contractual
arrangements and ultimately the acquisition of
foreign subsidiaries when a firm becomes a
multinational

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 Summary of Learning Objectives

• This globalization process results in a firm

becoming increasingly influenced by exchange
rate movements and other global political and
economic forces in general
• The decision whether or not to invest abroad may
require the MNE to enter into global licensing
agreements, joint ventures, acquisitions or
Greenfield investments

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 Summary of Learning Objectives

• The theory of competitive advantage is based on

one country possessing a relative advantage in the
production of goods compared to another country
• Imperfections in national markets for products,
factors of production and financial assets translate
into market opportunities for MNEs

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 Summary of Learning Objectives

• Strategic motives drive the decision to invest

abroad and become an MNE. Firms could be
seeking new markets, raw materials, production
efficiencies, access to technology or political safety

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