Lecture 5

INTERNATIONAL FINANCE
Overview

 Opportunities in Latin America, Europe and Asia

 Provide a model for the valuation of MNC.

 MNC’s Cash flows with different aspects

Overview
• Balance of Payment (Accounting of transactions)

• Current Account

• Capital Account

• Current Account (Purchase Summary)

• Balance of Trade

• Factor Income

• Transfer Payments
Overview
• Capital Account (Flow of funds; one country to other)

• Direct Foreign Investment

• Portfolio Investment

• Capital Investment

• Trade volume is different

• Over all the World is developing

International Flow of Funds
Lecture 5
 Lecture Objectives

 To explain the key components of the balance of payments

 To explain how the international flow of funds is influenced by

economic factors and other factors.

 Key components of Current Account

Balance of Trade

• It captures simply the difference between exports and imports.

• Merchandise trade involve the exports and imports of tangible products.

• Service trade represents the tourism and other products like insurance, legal and
consultancy.
Key components of Current Account

Balance of Trade

• A deficit in the balance of trade shows that the value of goods &
services exported is less than the value of imported goods &
services.

• Before 1990s the balance of trade focused merchandising

• Afterwards included services

Key components of Current Account

Factor Income

• Represents the inflow and outflow of income (Interest and

Dividend)

• Factor income received by the investors of any country i.e. the

inflow of funds

• Factor income paid by any country is the outflow of funds from

that country
Key components of Current Account

Transfer Payments

• Aids

• Gifts

• Grants

from one country to the other

The U.S. Current Account in 2003
(in billions of $)
(1) U.S. exports of goods + $712
+ (2) U.S. exports of services + 292
+ (3) U.S. income receipts + 275
= (4) Total U.S. exports & income receipts = $1,279
(5) U.S. imports of goods – $1,263
+ (6) U.S. imports of services – 246
+ (7) U.S. income payments – 259
= (8) Total U.S. imports & income payments = $1,768
(9) Net transfers by the U.S. – $68
(10) Current account balance = (4) – (8) – (9) – $557
 Components of Capital Account

Direct Foreign Investment

• Investment in fixed assets in foreign countries
• Can be used for the conduct of business operations
• It includes firm’s acquisitions of the foreign companies
• Construction of new plants for manufacturing
• Expansion of an existing plant in the foreign country
Components of Capital Account
Portfolio Investments

• Represents the long term transactions of financial assets

• Bonds and stocks

• Like purchasing a Netherland stock of company “ABC” by

US investor

• Without changing control of the company

Components of Capital Account

Portfolio Investments

• If US firm purchases all stocks of company ABC in

acquisition so i.e. Direct Foreign Investment

• Since it involve transfer of control

Key components of Capital Account

Capital Investment

• Transactions involving short term financial assets

• Money market financial instruments

• Developed countries rely heavily on trade

 International Trade Flows
• Some countries are more dependent on trade than others.
• The trade volume of a European country is typically between 30 – 40% of its
GDP, while the trade volume of U.S. (and Japan) is typically between 10 – 20%
of its GDP.
• Nevertheless, the volume of trade has grown over time for most
countries.
Distribution of U.S.
Exports across Countries
(in billions of $)
Distribution of U.S.
Exports and Imports
U.S. Balance of Trade
Over Time
 Trade Agreements
• Many agreements have been made to reduce trade restrictions:
• 1988 U.S. and Canada free trade pact
• North American Free Trade Agreement (NAFTA) for Canada, Mexico and US
• General Agreement on Tariffs and Trade (GATT) for 117 nations
• Single European Act and the European Union in 1990s (single currency)
Trade Disagreements
• However, even without tariffs and quotas, governments seem always able to find
strategies that can give their local firms an edge in exporting:

• If the job prospects of people are affected: they have strong opinions about
international trade policy

• On the other hand people are in the favor of free trade since it increases
competition
Trade Disagreements

• Firms in one country are not subject to different

environmental & labor laws
• Firms in one country are allowed to bribe while not in other
country
• Dumping is involved in few countries where the export
products are produced with the help of Government
subsidies.
• Tax breaks for specific industries from Government
The Outsourcing of Services

• Technology support of computer system by US to India

where labor costs are low

• Affects balance of trade since the service is purchased

in another country

• Allows MNCs to do operations at lower costs

• However it shifts jobs to other countries

• Criticized by the people who lose their jobs