INTERNATIONAL FINANCE

Dr. Sujatha Selvaraj Department of Banking, Finance and Management

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Chapter One Outline
• • • • • What’s Special about “International” Finance? Goals for International Financial Management Globalization of the World Economy Multinational Corporations Summary

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Chapter 1 Foundations of International finance
• The term financial management is mainly concerned with how to optimally make various corporate financial decisions, pertaining to investment, financing, dividend policy, and working capital management, with a view to achieving a set of given corporate objective. • In anglo american, advanced countries, maximizing share holder wealth is the most important corporate objective.
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We are now living in a highly globalized and integrated world economy. Internationalization of consumption patterns around the world. Production of goods and services has become highly globalized.  Financial markets have also become highly integrated. -Allows investors to diversify their investment portfolios internationally. Undoubtedly, we are now living in a world where all the major economic functions are highly globalized.
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Why we need to study International Financial Management?

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Market imperfections. 2. formulate their own economic policies. goods. and capital across their borders. 6 . impose taxes and regulate movements of people. Expanded opportunity set.What’s special about International Finance? Three major dimensions set international finance apart from domestic finance. They are: 1. These major dimensions of international finance largely stem from the fact that sovereign nations have the right and power to issue currencies. Foreign exchange and political risks. 3.

What’s Special about “International” Finance? • Foreign Exchange Risk – The risk that foreign currency profits may evaporate in dollar terms due to unanticipated unfavorable exchange rate movements. 1-7 .000 – But. – Suppose $1 = ¥100 and you buy 10 shares of Toyota at ¥10.000 per share. if the yen has depreciated to $1 = ¥120. your investment has actually lost money in dollar terms. – One year later the investment is worth ten percent more in yen: ¥110.

Foreign Exchange and Political Risks • When firms and individuals are engaged in cross border transactions.Exchange rate uncertainty will have a pervasive influence on all the major economic fluctuations i. That would not encounter in pure domestic transactions.1.e con. and inv.. pro. . • Another risk that a firm/individual may encounter in an international setting is political risk 8 . they are potentially exposed to Foreign exchange risk.

Monthly Percentage change in Japanese Yen – US Dollar Exchange Rate 9 .

and people across their borders. 1-10 . These laws sometimes change in unexpected ways.What’s Special about “International” Finance? • Political Risk – Sovereign governments have the right to regulate the movement of goods. capital.

11 . Enron. Yuoks • Multinational firms and investors should be particularly aware of political risk. Eg. when they invest in those countries without a tradition of the rule of law.• Political risk arises from the fact that a sovereign country can change the “rules of the game” and the affected parties may not have effective recourse.

Market Imperfections – Legal restrictions on the movement of goods. and money – Transactions costs – Shipping costs – Tax arbitrage 1-12 . people.What’s Special about “International” Finance? 2.

Market Imperfections • The world economy is much more integrated today than was the case of 10/20 years ago. goods. this motivates the MNCs to locate production overseas. • Imperfection in the world financial markets tend to restrict the extent to which investors can diversify their portfolio’s. 13 . • The world markets are thus highly imperfect. services and capital across national boundaries.2. a variety of barriers still hamper free movements of people.

1988. Nestlé lifted restrictions imposed on foreigners.The Example of Nestlé’s Market Imperfection • Nestlé used to issue two different classes of common stock bearer shares and registered shares. – Foreigners were only allowed to buy bearer shares. • On November 18. – Swiss citizens could buy registered shares. 1-14 . – The bearer stock was more expensive. allowing them to hold registered shares as well as bearer shares.

Daily Prices of Nestle’s Bearer and Registered Shares 15 .

1-16 .The Example of Nestlé’s Market Imperfection • Following this. – This implies that there was a major transfer of wealth from foreign shareholders to Swiss shareholders. • The Nestlé episode illustrates both the importance of considering market imperfections and the peril of political risk. • Foreigners holding Nestlé bearer shares were exposed to political risk in a country that is widely viewed as a haven from such risk. the price spread between the two types of shares narrowed dramatically.

17 .3.Expanded Opportunity Set • As mentioned earlier. • In addition. firms can locate production in any country or region of the world to maximize their performance and raise funds in any capital market where the cost of capital is the lowest. • Individual investors can also benefit greatly if they invest internationally rather than domestically. firms can gain from greater economies of scale when their tangible and intangible assets are deployed in a global basis.

Goals for International Financial Management • The focus of the text is to equip the reader with the “intellectual toolbox” of an effective global manager—but what goal should this effective global manager be working toward? • Maximization of shareholder wealth? or • Other Goals? 1-18 .

19 . than they were before. -The fundamental goal of sound financial management is shareholder wealth maximization.Goals of International Finance • International finance is designed to provide todays financial managers with an understanding the fundamental concepts and the tools necessary to e effective global managers. • Share holder wealth maximization means that the firm makes all business decisions and investments with an eye toward making the owner of the firm – the shareholders – better off financially. or more wealthy.

20 . • Especially US is not widely embraced a goal in other parts of the world.• Whereas shareholder wealth maximization is generally accepted as the ultimate goal of the financial management in “Anglo-saxon” countries such as Aus. Can and UK.

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. 1-21 .

even managers in France. capital markets are becoming more liberalized and internationally integrated in recent years.• European managers tend to consider the promotion of the firm stakeholders. Germany. 22 . • However. Japan and other non Anglo Saxon countries are beginning to pay more attention to shareholders wealth maximization. overall welfare as the most important corporate goal.

. for ex. for the benefit of shareholders. • Shareholder wealth maximization is a long run goal. .A firm cannot stay in business to maximize shareholder wealth if it treats employees poorly. operates inefficiently or fails to satisfy customers.• In Germany. wastes raw materials and natural resources. Companies are now allowed to repurchase stocks. only if it operates efficiently and expect to stay in business in the long run and there by provide employment opportunities. produces shoddy merchandise. 23 .Only a well managed business firm that profitability produces .

the society has painfully learned the importance of Corporate Governance. . 24 .CG can be defined as the economic. legal and institutional framework in which corporate control and cash flow rights are distributed among shareholders. _ CG is the financial and legal framework for regulating the relationship between a co’s management and its shareholders. the ultimate guardians of the interest of shareholders. devastating shareholders and employees alike. managers and other stakeholders of the company. Ex. • If they fail to perform their duties.scandals leads to financial distress and bankruptcy. CEO scandals • In the wake of these calamities.• The Board of Directors.

Eg. • In many countries where shareholder do not have strong legal rights.• CG varies across the countries. 25 . corporate ownership tends to be concentrated. Parmalat – Italian co. • The concentrated ownership of the firm in turn. legal. economic and political environment in different countries. case. may give rise to the conflicts of interest between dominant shareholders and small outside shareholders. reflecting cultural.

it’s their capital that is at risk. • If they vitally important to strengthen corporate governance so that shareholders receive fair returns on their investments. 26 . • It is equitable that they receive a fair return on their investments.• Shareholders are the owners of the business.

Other Goals • These types of issues can be much more serious in many other parts of the world. 1-27 . they cannot be achieved in the long term if the maximization of shareholder wealth is not given due consideration. such as Indonesia. Korea. and Russia. where legal protection of shareholders is weak or virtually non-existing. especially emerging and transitional economies. • No matter what the other goals.

we review a few key trends of the world economy: Emergence of globalized financial markets. Continued trade liberalization and economic integration. 28 .Globalization of the World Economy: Major Trends In this section. and Large scale privatization of state-owned enterprise. Emergence of the euro as a global currency.

which has led to: • Financial Innovations.Emergence of Globalized Financial Markets • Deregulation of Financial Markets coupled with • Advances in Technology have greatly reduced information and transactions costs. such as – – – – Currency futures and options Multi-currency bonds Cross-border stock listings International mutual funds 1-29 .

• Currently more than 300 million Europeans in 15 countries are using the common currency on a daily basis. dollar’s in the near future. 10 more countries joined the European Union and adopted the euro.Emergence of the Euro as a Global Currency • A momentous event in the history of world financial systems. 1-30 . • The “transaction domain” of the euro may become larger than the U. • In May 2004.S.

The Netherlands. Cyprus. Greece. France. Luxembourg. Slovenia. Malta. Italy. Spain 1-31 .Euro Area • • • • • • • Austria. Belgium. Finland. Portugal.         Ireland. Germany.

Value of the Euro in U.S. Dollars 1-32 .

Economic Integration • Over the past 50 years. international trade increased about twice as fast as world GDP. 1-33 . • 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.

Merchandise Exports/GDP in percent 34 .

1-35 . • This is an event of historic proportions. 2005 the end of the era of quotas on imported textiles ended.Liberalization of Protectionist Legislation • The General Agreement on Tariffs and Trade (GATT) a multilateral agreement among member countries has reduced many barriers to trade. • On January 1. • The World Trade Organization has the power to enforce the rules of international trade.

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NAFTA • The North American Free Trade Agreement (NAFTA) calls for phasing out impediments to trade between Canada. the ratio of export to GDP has increased dramatically from 2.2% in 1973 to 29% in 2006. 1-37 . • For Mexico. Mexico and the United States over a 15-year period beginning in 1994. • The increased trade has resulted in increased numbers of jobs and a higher standard of living for all member nations.

• Often spurs a tremendous increase in crossborder investment. • Often seen in socialist economies in transition to market economies. • By most estimates this increases the efficiency of the enterprise.Privatization • The selling off state-run enterprises to investors is also known as “Denationalization”. 1-38 .

produce goods with labor and capital equipment in a third country and sell their output in various other national markets.Multinational Corporations • A firm that has incorporated on one country and has production and sales operations in other countries.000 MNCs in the world. financial capital from another. • Many MNCs obtain raw materials from one nation. 1-39 . • There are about 60.

PLC Royal Dutch/Shell Group ExxonMobile Corporation Toyota Motor Corporation Ford Motor Company Total United States United Kingdom United States United Kingdom UK/Netherlands United States Japan United States France 10 1-40 Eléctricité de France France .Top 10 MNCs 1 2 3 4 5 6 7 8 9 General Electric Vodafone Group PLC General Motors British Petroleum Co.

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Thank You 1-43 .