Multinational Business Finance

11/08/2016
Introduction to MBF
http://www.statisticbrain.com/safest-countries-to-live-in-the-world/
http://www.statisticbrain.com/safest-countries-to-live-in-the-world/
https://www.mastercard.com/us/company/en/insights/pdfs/2008/MCWW_WCoC-Report_2008.pdf
https://www.mastercard.com/us/company/en/insights/pdfs/2008/MCWW_WCoC-Report_2008.pdf
https://www.mastercard.com/us/company/en/insights/pdfs/2008/MCWW_WCoC-Report_2008.pdf
https://www.mastercard.com/us/company/en/insights/pdfs/2008/MCWW_WCoC-Report_2008.pdf
https://www.mastercard.com/us/company/en/insights/pdfs/2008/MCWW_WCoC-Report_2008.pdf
https://www.mastercard.com/us/company/en/insights/pdfs/2008/MCWW_WCoC-Report_2008.pdf
https://www.mastercard.com/us/company/en/insights/pdfs/2008/MCWW_WCoC-Report_2008.pdf
https://www.mastercard.com/us/company/en/insights/pdfs/2008/MCWW_WCoC-Report_2008.pdf
 Thank you
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More on Intro to MBF
16/08/2016
 Meaning
• International/ Multinational Finance is an area
of financial economics that deals with monetary
interactions between two or more countries,
concerning itself with topics such as currency
exchange rates, international monetary
systems, foreign direct investment, and issues
of international financial management including
political risk and foreign exchange risk inherent
in managing multinational corporations.
 Why to Study Multinational
Financial Management ?

In today's world finance can be anything

internationally.
Enormous growth in the volume of international
trade
Cross border capital flows and, in particular, direct
investment have also grown enormously
 Veritable revolution has been taking place in the money
and capital markets around the world
 Liberalization, integration and innovation have created a
giant international financial market which is extremely
dynamic and complex.
 Multilateral negotiations regarding phased removal of
trade barriers have made considerable progress and WTO
had emerged as a meaningful platform
 Post war, World trade has grown faster than World GDP
 Almost all countries getting integrated with the global
economy
 Indian economy needs substantial amounts of foreign
capital to augment domestic savings
 Technology up-gradation in India will require continuing
import of foreign technology, hardware and software

 India’s increasing recourse to commercial borrowings and

direct and portfolio investments by nonresidents

 The efforts of Indian companies to diversify into exports of

engineering equipment and turnkey projects will have to
be supported by the ability to offer long term financing to
buyers

 A number of companies particularly in the Indian IT

sector have begun venturing abroad for strategic reasons
either as partners in joint ventures or by establishing
foreign subsidiaries
Importance of IFM/ Goals of MNC’s
• To increase market share
• To tap untapped market
• Increase Sales
• Increase Profitability
• To increase the customer base
• To offset foreign exchange risk
• To expand – Vertically (Multi products & Multiple counties)
- Horizontally
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Major Trends
Emergence of Globalized Financial Markets

Emergence of Euro as a Global Currency

Trade Liberalization & Economic Integration

Privatization
Recent Changes in Global Financial Market
Banking System

Opening up of Domestic Financial Market for

foreign borrowers
Individual Portfolios Diversification

Securitization & Disintermediation - Loans, Underwriting

commission, fees

Exchange rate floating vs fixed

International Business methods
Mergers
Acquisition
Hostile takeovers
Green field strategy
Joint Venture
Franchising
Licensing
Spin offs
Possible Risks
Foreign Exchange Risk – Asian Currency Crash 1997, cross
border risk

Political Risk – Enron, $300 million, 1995

Market Imperfections – Legal restrictions, excessive transaction

& transportation cost, information asymmetry, discriminatory taxation

Expanded Opportunity Set – location of production,

economies of scale, cost of capital being lowest
International Monetary System
Evolution International Monetary System
Bimetallism – Before 1875

Classical Gold Standard – 1875 – 1914

Interwar Period – 1915 – 1944

Bretton Wood System – 1945 – 1972

Flexible Exchange rate regime – Since 1973

Bimetallism
Double standard, free coinage was maintained for both

gold and silver

Exchange rates between the two countries determined

by either their gold or silver content

Britain, US on gold standard

France had bimetallism

China, India, Germany, Holland on silver standard

Bimetallism Example
Around 1870, exchange rate determination btw British

Pound and French Franc determined by gold content

of the two currencies
Exchange rate btw French Franc and German Mark,

determined by silver content of the two currencies

Exchange rate btw Pound and Mark, determined by

their exchange rate against Franc

Gresham’s Law
Since exchange rate btw two currencies were fixed officially, only the

abundant metal was used as money, driving more scarce metal out of
circulation
Bad (abundant) money drives out good (scarce) money

Example: When new gold was discovered in mines of California and

Australia, which was then poured into the market, the value of gold became
depressed in the market, causing overvaluation of gold under French
Official Ratio, which equated a gold franc to a silver franc 15.5 times as
heavy, as a result of this, the Franc effectively became a gold currency
Classical Gold Standard: 1875 to 1914
Most countries adopted to gold standard as a treasure

of wealth
London became center for International Financial

System, reflecting Britain’s advanced economy and its

preeminent position in international trade
International Gold Standard is said to exist when:
 Gold alone is assured of unrestricted Coinage

 There is a two – way convertibility between gold and national currencies at a

stable ratio
 Gold may be freely exported or imported

Soon, Banknotes had to be backed by gold reserves, at a particular

minimum ratio
Also as gold flows in and out of country, domestic money stock must

raise and fall

Example: One ounce of gold = 6 pounds and One ounce of Gold = 12

Franc
 1 Pound = 2 Franc
Interwar Period: 1915 to 1944
Gold standard lost its charm

Pound was made to float

Paper standard came into being as gold standard was

abandoned
This period was characterized by economic nationalism, half

hearted attempts and failure to restore the gold standard,

economic and political instabilities, bank failures and panicky
flights of capital across borders.
Bretton Woods System: 1945 - 1972
Signing of Articles of Agreement of the IMF

Creation of International Bank for Reconstruction &

Development (IBRD) / World Bank – for financing

individual development projects
US Dollar was the only currency that could be fully

converted into gold directly, hence countries held gold

and USD
Bretton Wood System = Dollar Based Gold Exchange

Standard
Deficits of BoP, crises for currency

Dollar being overvalued compared to Mark & Yen

SDRs (Special Drawings Rights)
IMF created artificial reserve called SDR in 1970

Its Basket of currency comprising major individual currency,

allotted to members of IMF

Who could use it for transaction among themselves or with IMF

Also used to make International payments

Percentage share of each currency is in SDR was proportionate

to the country’s share in World export

Flexible Exchange Rate Regime: 1973 -
Present
Jamaica Agreement
Flexible Exchange Rate, central bank allowed to
intervene
Gold was abandoned as official reserve, IMF returned
half gold to member countries & rest half used to help
poor nations
Non – Oil exporting countries & less – developed
countries were given greater access to IMF funds
 Assistance to countries having BoP & exchange rate
difficulties
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 Scope and Nature of MFM
– The treasurer is responsible for
• financial planning analysis
• fund acquisition
• investment financing
• cash management
• investment decision and
• risk management
– Controller deals with the functions related to
• external reporting
• tax planning and management
• management information system
• financial and management accounting
• budget planning and control, and
• accounts receivables etc.
 Domestic financial management
vs.
International financial management

• International finance is different from domestic

finance in many aspects like,
• Foreign currency exposure
• Political,
• Cultural,
• Legal,
• Economical,
• and Taxation
 Cont….
• International financial management involves into a lot of currency
derivatives where as such derivatives are very less used in
domestic financial management.
• In domestic financial management, we aim at minimizing the cost
of capital while raising funds and try optimizing the returns from
investments to create wealth for shareholders.
• We do not do any different in international finance. So, the
objective of financial management remains same for both
domestic and international finance i.e. wealth maximization
of shareholders.
• Still, the analytics of international finance is different from
domestic finance. Following are the major differences
 The Major Differences
• Exposure to Foreign Exchange: Currency exposure impacts almost
all the areas of an international business starting from your
purchase from suppliers, selling to customers, investing in plant
and machinery, fund raising etc. Wherever there is need of money,
currency exposure will come into play and as we know it well that
there is no business transaction without money.
• Macro Business Environment : An international business is
exposed to altogether a different economic and political
environment. All trade policies are different in different countries.
Financial manager has to critically analyze the policies to make out
the feasibility and profitability of their business propositions. One
country may have business friendly policies and other may not.
• Legal and Tax Environment: The other important aspect to look at is
the legal and tax front of a country. Tax impact directly to your
product costs or net profits i.e. „the bottom line‟ for which the whole
story is written. International finance manager will look at the
taxation structure to find out whether the business which is feasible
in his home country is workable in the foreign country or not.

• Different group of Stakeholders: It is not only the money which along

matters, there are other things which carry greater importance the
group of suppliers, customers, lenders, shareholders etc. Why these
group of people matter? It is because they carry altogether a different
culture, a different set of values and most importantly the language
also may be different. When you are dealing with those stakeholders,
you have no clue about their likes and dislikes. A business is driven by
these stakeholders and keeping them happy is all you need.
• Foreign Exchange Derivatives: It is inevitable to expose to the
risk of foreign exchange in a multinational business. Knowledge
of forwards, futures, options and swaps is invariably required. A
financial manager has to be strong enough to calculate the cost
impact of hedging the risk with the help of different derivative
instruments while taking any financial decisions.

• Different Standards of Reporting: If the business has presence

in say US and India, the books of accounts need to be
maintained in US GAAP and IGAAP. It is not surprising to know
that the booking of assets has a different treatment in one
country compared to other. Managing the reporting task is
another big difference. The financial manager or his team needs
to be familiar with accounting standards of different countries.
 Conti….
• Capital Management: In an MNC, the financial
managers have ample options of raising the capital.
More number of options creates more challenge with
respect to selection of right source of capital to
ensure the lowest possible cost of capital.
 Thank you
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 Module II

Environment of International
Financial management
 Transactional Corporation
• A multinational corporation or worldwide
enterprise is an organization that owns or
controls production of goods or services in
one or more countries other than their home
country. It can also be referred as an
international corporation, a "transnational
corporation", or a stateless corporation
What is Foreign Exchange market??
 Foreign Exchange market
• The foreign exchange market is global decentralized
market for trading of currencies. This includes all the
aspects of buying, selling and exchanging currencies
at current or pre determined price.

• In terms of volume of trading, it is by for the largest

market in the world.

• Its trading around $1.5 trillion each day.

• The market is open for 24 hours.

 Conti….
• The foreign exchange market is mostly an over
the counter (OTC) market.
• Foreign exchange market is also called as Forex
Market or Currencies Market.
• Trading in forex is not done at one central location
but conducted between participants through
Electronic Communication Networks (ECN’s).
• Forex market is split into three main regions:
* Australasia * Europe * North America
 Conti…
• With which of three main areas there are several
major financial centers.
• Example: *Europe- London, Paris, Frankfurt and
Zurich, North America- New York and Chicago and
Asia- Tokyo and Hong Kong.
• Each day Fx trading start with the opening of Austrasia
area followed by europe and then America.
• Banks Institutions and dealers all conduct forex trade
for themselves and their clients in each of these
market.
 How does Forex market work????
• Forex trading is the simultaneous buying of
one currency and selling of another.
• These two currencies make up what is known
as a “currency pair”
• Currencies are always traded in pairs- each
currency is represented by three letters.
• The first two letters represents the country
and the third letter identifies the currency.
 Conti…
• Forex pairs are read in the opposite direction
of mathematical proportions or ratio.
• Example: EUR/USD: 1.23700
Dealers/ Participants in Forex market
 Dealers/ Participants in Forex market

Banks
Business firms or companies
The central Banks
Investment Management Firms
Retail Forex Brokers/Delears
 Types of Transaction
• Business Transaction
• Hedging
• Arbitrage
• Speculation
 Financial Instruments
• Spot Contracts
• Forward Contracts
• Futures
• Options
• Swaps
 Exchange Rate Mechanism
• The exchange of foreign currencies into home
currency is carried out by exchanging some
units of home currency for some units of
foreign currency. The ratio of exchange
between two currencies is known as Foreign
Exchanges Rates
 Spot Rate
• The exchange rate between two currencies is
the number of units of other currency. The
exchange rate determined in the spot market
is know as Spot Rate.
 - In the spot market, deals are arranged for
immediate delivery . Here, transaction takes
place second working day after the date of
transaction.
 The Bid-Ask Spread
• The Buying rate is termed as Bid Rate and bid
price is the price a dealer is willing to pay you
for something.
• The selling rate is termed as Ask Rate and ask
price is the amount the dealer wants you to
pay for the thing.
• The bid-ask spread is the difference between
the bid and ask prices.
 Forward Contract & Forward Market
• Forward contracts are customized agreements between two
parties (OTC) to buy or sell an asset for a specific price at a specific
point of time in future.
• The forward market, the purchase or sale of foreign currency is
arranged today at the exchange rate, but with the delivery
scheduled to take place some time in future.
• Parties cannot shy away from performance or pay full
compensation for non-performance.
• Usually, there is no cash outflow/inflow to get into the future
obligation under the forwards at the time of entering the contract.
• Eg: If you have ever had to order an out-of-stock textbook, then
you have entered into a forward contract
• The simplest form of a forward contract is you are ordering
for pizza over phone with ‘Dominos’ Dominos agrees to
deliver you items 1….5 that you had ordered in 30 minutes
time at your doorstep and you agree to pay the amount
when the delivery boy pops up with the pizza and the bill.
• What are the risks associated with this transaction?
– For Domino
• When the delivery boy comes, you may not be around in your
home
• When he delivers, you may not have necessary cash to pay
– For you
• The delivery may not happen at all because the delivery boy saw
his girlfriend on his way, and decided to eat the pizza (you
ordered) with her
• If you substitute currency, wheat, tin, stocks, bonds, etc. for pizza and
the Banker for the delivery boy, you get the idea what forward contracts
in actual practice are all about
 Futures
• Futures contracts are very similar to forward
contracts .
• A currency futures contract
– specifies that a ‘specified’ currency will be exchanged for another ‘specified’
currency at a specified time in the future at prices fixed today

• The similarities can be listed as

– Both lock the parties into definite rates
– Both can be settled through delivery or cash settlement (where NDF is okay)
– Both create rights and obligations for both parties to the deal

• Then what are the differences between the two?

Differences between Forwards and Futures
– Markets and liquidity
• Futures contracts are traded on organized exchanges (liquid)
• Forwards are private contracts (OTC) and do not trade. (illiquid)
– Standardisation
• Futures contracts are highly standardized – to the T
• Forwards are bespoke to satisfy the requirements of contracting parties
– Counter-party
• No counter-party risk due to clearing house mechanism
• Originating parties are counter parties and hence credit risk exists
– Regulation
• There is governmental influence in futures markets.
• OTC markets are seldom regulated – Indian Contract Act, 1872, generally
governs all contracts. Of course, forward contracts with banks are subject
to central banks’ dictates)
– Mark to Market and daily margins
 What are options?
• An option gives the holder the right, but not
the obligation, to buy or sell a given quantity
of an asset in the future, at prices agreed
upon today
• An option buyer / option holder is the buyer
of the option
• An option seller / option writer is the seller of
the option
 Illustration of how options work
On 19 April 2016, I have heart attack
I want to buy a Depending on our
health conditions, we will
insurance for 5 provide you health Hospital
year period now insurance, but you expenses are
need to pay the taken care
premium now

If nothing happens to me for next 5

years

Thanks for all

the premiums
paid.
 Basic Types of Option

• Call Option:
• Gives a right to the option buyer without the obligation to
purchase a currency Y against a currency X at a stated price Y/X, on
or before the stated date.
• Ex: If you have to buy a 3 – month call option on US dollar against
rupees for Rs. 63.0000, you have the right to do so within the next
3 months, however you may choose to not to do it (obligation)
• Put Option:
• Gives a right to the option buyer and not the obligation
to sell a currency Y against a currency X at a stated price
Y/X, on or before the stated date.
• Ex: If you have to sell a 5 – month put option on
Australian dollar against Indian rupee for Rs. 57.0000,
you have the right to do so within the next 5 months,
however you may choose not to do it (obligation)
• European Option vs American Option
An option that can be exercised anytime during its life. American
options allow option holders to exercise the option at any time
prior to and including its maturity date, thus increasing the value
of the option to the holder relative to European options, which
can only be exercised at maturity. The majority of exchange-
traded options are American.
• A swap is an agreement to provide a counterparty with
something he wants in exchange for something that you
want
• Hull – A swap is an agreement between two companies to
exchange cash flows in the future
• Robert A. Strong – Swaps are arrangements in which one
party trades something with another party.
• Alan Shapiro – A Swap is a financial transaction in which
two counterparties agree to exchange streams of
payments over time, such as in a currency swap or interest
rate swap
 Types of Swaps
• Commodity Swaps
– One party pays a fixed price for the goods purchased/sold and the
counterparty pays a market rate over the swap period – very common in the
energy industry
• Interest Rate Swaps
– Counterparties (can be more than two) agree to exchange interest payments
over a specific time period – Fixed-Floating, Floating-Fixed, Floating-Floating
– Also called Coupon swaps
• Currency Swaps
– Parties agree to exchange of interest payments (either fixed or floating) on
loan in one currency to an equivalent loan in another currency. This may or
may not involve initial exchange of principal (NOTIONAL transaction)
• Equity Swaps
– Exchange of dividends earned and capital gains on a portfolio, which is based
on a stock index against periodic interest payments. Similar to interest rate
swap
• Other swaps
– Power swaps, weather swaps, etc. – very idiosyncratic and in their infancy.
 Traders in the derivative Market
• Hedgers
• Speculators
• Arbitrageurs
 Risk in Derivative Trading
• Market Risk
• Imperfect match of the underlying assets.
• Counterparty Risk
 CURRENCY DERIVATIVE EXCHANGES
• Singapore International Monetary Exchange (SIMEX)
• London International Financial and Futures
Exchange(LIFFE)
• Chicago Mercantile Exchange (CME)
• New York Mercantile Exchange (NYMEX)
• Chicago Board Option Exchange (CBOE)
• Hong Kong Future Exchange
• Philadelphia Board of Trade
• Tokyo International Financial Futures Exchange
• Sydney Futures Exchange (SFE)
 Thank you….
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day….!!
Financing Foreign Operations
Sources of Funds
Internal Sources
Equity
Preference Share
Private placement
Financial Intermediaries
Capital market
Interest Rate
Debt
Thank you