Globalization and multinational firm

International finance

Chapter 1

Assoc. Prof. Dr. Mehmed Ganić Faculty of Business and Administration

– 1
Globalization and the
Multinational Firm 1
Chapter One

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?

International Finance is an important part of financial

economics.
It mainly discusses the issues related with monetary interactions
of at least two or more countries.
International finance is concerned with subjects such as
exchange rates of currencies, monetary systems of the world,
foreign direct investment (FDI), and other important issues
associated with international financial management.

1-3
Importance of International Finance
 International finance plays a critical role in international
trade and inter-economy exchange of goods and services. It
is important for a number of reasons, the most notable
ones are listed here −
1. International finance is an important tool to find the
exchange rates, compare inflation rates, get an idea about
investing in international debt securities, ascertain the
economic status of other countries and judge the foreign
markets.
2. Exchange rates are very important in international finance,
as they let us determine the relative values of currencies.
International finance helps in calculating these rates.
4
Cont.
3. International finance has grown in stature due to
globalization. It helps understand the basics of all
international organizations and keeps the balance
intact among them.
4. An international finance system maintains peace
among the nations. Without a solid finance measure,
all nations would work for their self-interest.
International finance helps in keeping that issue at
bay.

5
What are features of international finance?
 International Finance is a distinct field of study and
certain features set it apart from other fields.
Compared to domestic financial management,
international finance has some important
distinguishing features below.
 Foreign Exchange Risk
 Political Risk
 Market Imperfections
 Expanded Opportunity Set

6
 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.
 FX risk describes the risk that an investment’s value may
change due to changes in the value of two different currencies.
It is also known as currency risk, FX risk and exchange-rate
risk
 FX risk most often affects businesses engaged in exporting
and importing products or supplies. It also applies to
businesses that offer services in multiple countries and
individuals who invest internationally.

1-7
Cont
 Suppose $1 = ¥100 and you buy 10 shares of Toyota at
¥10,000 per share.
 One year later the investment is worth ten percent
more in yen: ¥110,000
 But, if the yen has depreciated to $1 = ¥120, your
investment has actually lost money in dollar terms.

8
 What’s Special about “International” Finance?
 Political Risk
 Political risk is a type of risk faced
by investors, corporations, and governments that political
decisions, events, or conditions will significantly affect the
profitability of a business actor or the expected value of a
given economic action.
 Political risk can be understood and managed with
reasoned foresight and investment.
 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
What’s Special about “International” Finance?

 Market Imperfections
All real-world markets are theoretically imperfect, and the study of
real markets is always complicated by various imperfections. For
example, traders in a financial market do not possess perfect or
even identical knowledge about financial products.
 Legal restrictions on the movement of goods,
people, and money
 Transactions costs
 Shipping costs
 Tax arbitrage
1-10
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.
 Swiss citizens could buy registered shares.
 The bearer stock was more expensive.
 On November 18, 1988, Nestlé lifted restrictions imposed
on foreigners, allowing them to hold registered shares as
well as bearer shares.

1-11
 Nestlé’s Foreign Ownership Restrictions
12,000

10,000
Bearer share
8,000

6,000
SF

4,000
Registered share
2,000

0
11 20 31 9 18 24
Source: Financial Times, November 26, 1988 p.1. Adapted with permission.

1-12
The Example of Nestlé’s Market Imperfection

 Following this, 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.
 Foreigners holding Nestlé bearer shares were
exposed to political risk in a country that is widely
viewed as a haven from such risk.
 The Nestlé episode illustrates both the importance of
considering market imperfections and the peril of
political risk.

1-13
The Multinational Enterprise
 A multinational corporation is a company engaged in
producing and selling goods or services in more than one
country. Usually, it consists of a parent company located in
the home country and several foreign subsidiaries.
 A multinational is characterized more by attitude than the
physical reality of an integrated system of marketing and
production activities worldwide.
 “Where in the world should we build our plants, sell our
products, raise capital, and hire personnel?” i.e. a global
perspective, rather than the perspective of the home
country, where the parent is located.

P.V. Viswanath 14
Relevance of International Finance
 Many of the problems of multinational firms are due to
the use of different currencies used in different countries
and the consequent need to exchange them.
 There are political divisions as well as currency divisions
between countries.
 A financial manager has to decide how international
events will affect a firm and what steps can be taken to
exploit positive developments and insulate the firm from
harmful ones.

P.V. Viswanath 15
Relevance of International Finance
 Relevant variables are changes in exchange rates,
interest rates, inflation rates and asset values.
 However, these variables are interconnected.
 Hence foreign exchange risk is not simply added to
other business risks. The amount of risk depends
crucially on the way exchange rates and other financial
prices are connected.

P.V. Viswanath 16
Relevance of International Finance
 Even companies that operate only domestically but
compete with firms producing abroad and selling in
their local market are affected by international
developments.
 Thus, US appliance manufacturers with no overseas
sales will find US sales and proift margins affected by
exchange rates which influence the dollar prices of
imported appliances.

P.V. Viswanath 17
 Globalization of the World Economy: Major
Trends
I. Emergence of Globalized Financial Markets
II. Emergence of the Euro as a Global Currency
III. Trade Liberalization and Economic Integration
IV. Privatization

1-18
 I. Emergence of Globalized Financial Markets
Three Major Forces
 Globalization
 All product markets and financial markets
 Technology
Telecommunications, Internet have greatly reduced information and
transactions costs, which has led to:
 Financial Innovations, such as
 Currency futures and options
 Multi-currency bonds
 Cross-border stock listings
 International mutual funds
 Deregulation
 Capital account & financial services liberalization
1-19
Globalization and Technology
 Globalization
 Increased economic integration in all aspects
 Greater specialization and economies of scale
 Resulting in greater trade, also in financial services, through
both capital flows and cross-border entry
 Technology
 Facilitating remote delivery, better telecommunications
 Providing new distribution and access channels
 Revamping industrial structures for financial services, by
allowing entry of non-bank entities (telecoms/utilities

20
 Deregulation
 Product, market and geography
 Integrated banks offering a broad array of services
 Entry of new providers. Increased (foreign) presence in many
markets, more cross border FDI, M&A, etc. activity

21
 II. Emergence of the Euro as a Global Currency
 A momentous event in the history of world financial
systems.
 Currently more than 350 million Europeans in 19
countries are using the common currency on a daily
basis.
 In May 2004, 10 more countries joined the European
Union and adopted the euro.
 The “transaction domain” of the euro may become
larger than the U.S. dollar’s in the near future.

1-22
 Euro Area-19 members
 Austria,  Malta,
 Belgium,  The Netherlands,
 Cyprus,  Portugal,
 Finland,  Slovenia,
 France,  Spain,
 Germany,  Slovakia,
 Greece,  Latvia,
 Ireland,  Lithuania
 Italy,  Estonia
 Luxembourg,
1-23
 Value of the Euro in U.S. Dollars

1-24
 III. Economic Integration
 Over the past 50 years, international trade increased
about twice as fast as world GDP.
 There has been a 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.

1-25
 Liberalization of Protectionist Legislation

 The General Agreement on Tariffs and Trade (GATT)

a multilateral agreement among member countries
has reduced many barriers to trade.
 The World Trade Organization has the power to
enforce the rules of international trade.
 On January 1, 2005 the end of the era of quotas on
imported textiles ended.
 This is an event of historic proportions.

1-26
 NAFTA
 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 beginning in 1994.
 The increased trade has resulted in increased numbers
of jobs and a higher standard of living for all member
nations.

1-27
 IV. Privatization
 The selling off state-run enterprises to investors is
also known as “Denationalization”.
 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.

1-28
 Multinational Corporations
 A firm that has incorporated on one country and has
production and sales operations in other countries.
 There are about 60,000 MNCs in the world.
 Many MNCs obtain raw materials from one nation,
financial capital from another, produce goods with
labor and capital equipment in a third country and
sell their output in various other national markets.

1-29
 Top 10 MNCs in 2019
1. Apple Inc
2. Volkswagen
3. Microsoft
4. FedEX
5. Kimberly Clark
6. Walmart
7. State Grid
8. Sinopec Group
9. China National Petroleum
10.Toyota

1-30