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INTERNATIONAL FINANCIAL MANAGEMENT

Fifth Edition EUN / RESNICK

McGraw-Hill/Irwin

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights res

Globalization and the Multinational Firm
Chapter Objectives: Understand why it is important to study international finance.

Chapter One

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Distinguish international finance from domestic finance.
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Chapter One Outline
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What’s Special about “International” Finance? Goals for International Financial Management Globalization of the World Economy Multinational Corporations Summary

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Why do we need to study “international” financial management.

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We are now living in a highly globalized and integrated world economy. Continued liberalization of international trade is certain to further internationalize consumption patterns around the world. Not only consumption but also production of goods and services (thanks to MNCs) are globalized. Recent movement is the integration of financial markets. With a global shift all economic functions are now highly globalized.

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What’s Special about “International” Finance?
Financial management in an international setting. Financial management mainly concers with how to optimally make various financial decisions: Investment, financing, divident policy, working capital management. In order to achieve corporate objectives which are?.......
 Foreign

Exchange Risk  Political Risk  Market Imperfections  Expanded Opportunity Set

Sovereign nations have the right and power to issue currencies, formulate their own economic policies, impose taxes, regulate movement of people, goods and capital.

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if the yen has depreciated to $1 = ¥120.000 per share.  1-6 . your investment has actually lost money in dollar terms.000  But.  Suppose $1 = ¥100 and you buy 10 shares of Toyota at ¥10.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.  One year later the investment is worth ten percent more in yen: ¥110.

when fixed exchange rates were abandoned. 1-7 .What’s Special about “International” Finance?   Foreign Exchange Risk: Why Flactuation? Since the early 1970s.

)  MNC and investors should be aware of political risk when they invest in those countries w/o a tradition of the rule of law. and people across their borders.What’s Special about “International” Finance?  Political Risk Sovereign governments have the right to regulate the movement of goods. (changes in tax rules. These laws sometimes change in unexpected ways.  1-8 . expropriation etc. capital.

1-9 . MNCs are the gifts of these imperfections.What’s Special about “International” Finance?  Market Imperfections  Legal restrictions on the movement of goods. people. and money  Transactions costs  Shipping costs  Tax arbitrage All this imperfections will affect the MNCs to locate production overseas.

 On November 18.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. 1988. allowing them to hold registered shares as well as bearer shares. Swiss citizens could buy registered shares.) The bearer stock was more expensive. Nestlé lifted restrictions imposed on foreigners. 1-10 .(voting diff.

000 0 11 20 31 9 18 24 Source: Financial Times.Nestlé’s Foreign Ownership Restrictions 12. 1988 p.000 Bearer share SF 6.000 10.000 8.1. November 26. Adapted with permission. Registered share 1-11 .000 2.000 4.

 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. 1-12 . the price spread between the two types of shares narrowed dramatically. This implies that there was a major transfer of wealth from foreign shareholders to Swiss shareholders.The Example of Nestlé’s Market Imperfection  Following  this.

International diversification) 1-13 .What’s Special about “International” Finance?    Expanded Opportunity Set 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 .  True for corporations as well as individual investors.  It doesn’t make sense to play in only one corner of the sandbox. They also benefit from greater economies of scale.

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? 1-14 .

but complications arise.  Who are and where are the shareholders?  In what currency should we maximize their wealth? 1-15 .Maximize Shareholder Wealth  Long accepted as a goal in the Anglo-Saxon countries.

1-16 . managers have typically sought to maximize the value of the keiretsu 系列— a family of firms to which the individual firms belongs.Other Goals  In other countries shareholders are viewed as merely one among many “stakeholders” of the firm including:    Employees Suppliers Customers  In Japan.

Nippon Yusen . Bank of Tokyo-Mitsubishi(1996– Kirin Brewery. (2006– ) Mitsubishi Motors.Nippon Oil..An example of keiretsu Namee Mitsubishi Bank Major group companies Mitsubishi Bank (until 1996) Mitsubishi Corporation. Bank of Tokyo-Mitsubishi UFJ Mitsubishi Fuso. Mitsubishi Estate.. Pacific Consultants International Ltd. Tokio Marine and Fire Insurance. Mitsubishi Paper Mills Ltd. Mitsubishi Heavy Industries.. 2005) Mitsubishi Electric. Ltd. Mitsubishi Materials Corp. Mitsubishi Chemical.. . Nikon. Mitsubishi Rayon Co.

(agency problem)+Parmalat 1-18 . the financial and legal framework for regulating the relationship between a firm’s management and its shareholders.  These calamities have painfully reinforced the importance of corporate governance i. managers may pursue their own private interests at the expense of shareholders when they are not closely monitored. WorldCom.Other Goals  As shown by a series of recent corporate scandals at companies like Enron. and Global Crossing.e.

such as Indonesia. Korea. 1-19 . where legal protection of shareholders is weak or virtually non-existing. they cannot be achieved in the long term if the maximization of shareholder wealth is not given due consideration.  No matter what the other goals. and Russia. especially emerging and transitional economies.Other Goals  These types of issues can be much more serious in many other parts of the world.

Globalization of the World Economy: Major Trends: the buzzword.  Emergence of Globalized Financial Markets  Emergence of the Euro as a Global Currency  Trade Liberalization and Economic Integration  Privatization 1-20 .

5 in 1999) which has led to: Financial Innovations. such as  Currency futures and options  Multi-currency bonds  Cross-border stock listings  International mutual funds 1-21 .Emergence of Globalized Financial Markets   Deregulation of Financial Markets 27 Oct. 1986 “big bank” elimination of fixed brokerage commissions in LSE like May Day in 1975 in the US   coupled with Advances in technology have greatly reduced information and transactions costs (cost index of computing power 100 in 1960 0.

facilitating international invesment. Glass Steagall Act. (order processing and settlement internationally) 1-22 . restricted commercial banks from investment banking activities. in the USA. Major changes allowed London to be the financial center.Emergence of Globalized Financial Markets      Tokyo Stock Exchange(1985). Not in Europe Developing countries started to allow foreigners to directly invest in their financial markets. LSE (1986) began admitting foreign firms as full members to their capital markets. Technology allowed cross border listing.

S.  Currently more than 300 million Europeans in 16 countries are using the common currency on a daily basis.  In May 2004.  The “transaction domain” of the euro may become larger than the U.Emergence of the Euro as a Global Currency A momentous event in the history of world financial systems. 10 more countries joined the European Union and adopted the euro. 1-23 . dollar’s in the near future.

 Germany.     Portugal. Spain Slovakia ( 1 Ocak 1999) 1-24 .  Greece. The Netherlands. Slovenia.  France.     Ireland.   Malta. Italy. OCA) Austria.  Cyprus.  Finland.  Belgium. Luxembourg.Euro Area (Mundell.

Value of the Euro in U. Dollars 1-25 .S.

(specialization in the production. David Ricardo.Economic Integration   Over the past 50 years. notably through the use of tariffs and subsidies Protectionist countries are now increasingly pursuing free market and open economy policies because of the gains from international trade. 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. Mercantilism suggests that the ruling government should advance these goals by playing a protectionist role in the economy. international trade increased about twice as fast as world GDP.)   1-26 . theory of comparative advantage. by encouraging exports and discouraging imports.

The World Trade Organization (WTO) has the power to enforce the rules of international trade. On January 1.Liberalization of Protectionist Legislation      The General Agreement on Tariffs and Trade (GATT. now Doha) WTO replaced the GATT. This is an event of historic proportions (dimensions). 2005 the end of the era of quotas on imported textiles ended. 1-27 . (continuing with rounds.1947) a multilateral agreement among member countries has reduced many barriers to trade.

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.NAFTA The North American Free Trade Agreement calls for phasing out impediments (barriers) to trade between Canada.  For Mexico. the ratio of export to GDP has increased dramatically from 2.2% in 1973 to 29% in 2006.  1-28 .

Benefits: brings hard currency to pay debts+increase in the productivity 1-29 . By most estimates this increases the efficiency of the enterprise. Often seen in socialist economies in transition to market economies.Privatization      The selling off state-run enterprises to investors is also known as “De-nationalization”. Often spurs (drives) a tremendous increase in cross-border investment.

000 MNCs in the world. Many MNCs obtain raw materials from one nation. produce goods with labor and capital equipment in a third country and sell their output in various other national markets. 1-30 . financial capital from another.Multinational Corporations    A firm that has incorporated on one country and has production and sales operations in other countries. There are about 60.

Top 10 MNCs 1 2 3 4 5 6 7 8 9 10 1-31 General Electric Vodafone Group PLC General Motors British Petroleum Co. PLC Royal Dutch/Shell Group ExxonMobile Corporation Toyota Motor Corporation Ford Motor Company Total Eléctricité de France United States United Kingdom United States United Kingdom UK/Netherlands United States Japan United States France France .

1-32 . they can use cheap labor while they gain access to special R&D in advanced countries. pooling global purchasing power over suppliers utilizing their know how globally So.Multinational Corporations    They obtain financing from major money centers around the world in many different currencies to finance their operations. They benefit from economy of scale by spreading R&D. They create job opportunities around the world.

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End Chapter One …the following slides cover the appendix to chapter 1. 1-34 .

labor.The Theory of Comparative Advantage (comparative vs.  Underlying theory’s assumptions of   Free trade between nations Factors of production (land. and capital) are relatively immobile. 1-35 . technology. relative advantage)  Definition: a comparative advantage exists when one party can produce a good or service at a lower opportunity cost than another party.

who can each produce only food and textiles.  There are two countries.The Geometry of Comparative Advantage  Consider the example given in appendix 1A.  Initially they do not trade with one another. A and B. 1-36 .

The production possibilities of country A are such that if they concentrated 100% of their resources into the production of textiles. they could produce 180 million yards of textiles. they could produce as much as 300 million pounds of food. 300 Country A can produce any combination of food and textiles between these two points. Food 1-37 .The Geometry of Comparative Advantage Textiles A production possibilities curve shows the various amounts of food or textiles that each country can make. 180 If country A chose to concentrate 100% of their resources into the production of food.

180 60 Food 200 300 1-38 .The Geometry of Comparative Advantage Textiles As a practical matter. and 60 million yards of textiles. the citizens of country A must choose a point along their production possibilities curve. initially they choose 200 million pounds of food.

200 . they could produce 240 million yards of textiles. they could produce as much as 900 million pounds of food. Food 200 300 1-39 900 1. 240 180 60 If country B chose to concentrate 100% of their resources into the production of food.The Geometry of Comparative Advantage Textiles The production possibilities of country B are such that if they concentrated 100% of their resources into the production of textiles.

The Geometry of Comparative Advantage Textiles As a practical matter.200 . and 80 million yards of textiles. the citizens of country B must choose a point along their production possibilities curve. initially they choose 600 million pounds of food. 240 180 80 60 Food 200 300 1-40 600 900 1.

Geometrically. Food 200 300 600 900 240 180 80 60 1-41 . a comparative advantage exists because the slopes of the production possibilities differ. country B enjoys a comparative advantage in food because they have to give up textiles at a lower rate than A when making more food.The Geometry of Comparative Advantage Textiles Country A enjoys a comparative advantage in textiles because they have to give up food at a lower rate than B when making textiles. Put another way.

then country A should make textiles and trade for food. while country B should grow food and trade for textiles.The Geometry of Comparative Advantage Textiles If the countries specialize according to their comparative advantage. 240 180 80 60 Food 200 300 1-42 600 900 .

200 . the combined production would be 1. if both countries made only food. 420 240 180 80 60 Food 200 300 1-43 600 900 1. the combined production would be 420 million yards of textiles = 240 + 180. if both countries made only textiles.The Geometry of Comparative Advantage Textiles Before trade.200 million pounds of food = 900 + 300. Before trade.

420 240 180 80 60 Food 200 300 1-44 600 900 1.200 .The Geometry of Comparative Advantage Textiles The combined production possibilities curve of country A and B without trade are shown in the green line.

The Geometry of Comparative Advantage Textiles Before trade.200 . 420 240 180 140 80 60 Food 200 300 1-45 600 800 900 1. the combined production is 800 million lbs of food and 140 million yards of textiles.

420 240 180 140 80 60 Food 200 300 1-46 600 800 900 1.The Geometry of Comparative Advantage Textiles County B can produce food at a lower opportunity cost. so let them produce the first 180 million yards of textiles.200 . so let B produce the first 900 million pounds of food. Country A can produce textiles at a lower opportunity cost.

200 .The Geometry of Comparative Advantage Textiles The combined production possibilities curve with trade is composed of the original curves joined as shown. 420 240 180 140 80 60 Food 200 300 1-47 600 800 900 1.

200 . 420 240 180 140 80 60 Food 200 300 1-48 600 800 900 1.The Geometry of Comparative Advantage Textiles The gains from trade are shown by the increase in consumption available—an extra 100 million pounds of food and 40 million yards of textiles are now available in excess of the pre-trade consumption.

1-49 .  In this case consumers freedom to choose imported goods and producers freedom to choose to sell to foreigners.Arguments in Favor of Free Trade  Both partners gain from trade: we have more material goods.  “Freedom” in a good thing in itself.

End Appendix One 1-50 .