Chapter 1

Multinational
Financial
Management:
Opportunities and
Challenges
 Learning Objectives

• Understand the complexity of risks

associated with financial globalization
• Explore how global capital markets are
critical for the exchange of products,
services, and capital in the execution of
global business
• Consider how the theory of comparative
advantage establishes the foundations for
the justification for international trade and
commerce

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 Learning Objectives

• Discover what is different about international

financial management, and which market
imperfections give rise to the multinational
enterprise
• Examine how imperfections in global markets
translate into opportunities for multinational
enterprises
• Consider how the globalization process moves a
business from a purely domestic focus in its
financial relationships and composition to one truly
global in scope

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 The Multinational Enterprise
(MNE)

• The October–December 2014 quarter was a challenging one with

unprecedented currency devaluations. Virtually every currency in the world
devalued versus the U.S. dollar, with the Russian Ruble leading the way.
While we continue to make steady progress on the strategic transformation of
the company—which focuses P&G on about a dozen core categories and 70 to
80 brands, on leading brand growth, on accelerating meaningful product
innovation and increasing productivity savings—the considerable business
portfolio, product innovation, and productivity progress was not enough to
overcome foreign exchange.
—Chairman, President and Chief Executive Officer A.G. Lafley, January 27, 2015
• A multinational enterprise (MNE) has operating
branches, subsidiaries, or affiliates located in
foreign countries.
• Today’s MNEs are dependent on emerging markets.

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 Financial Globalization and Risk

• The global financial market place is a combination of complex

risks:
– The international monetary system is an eclectic mix of floating
and managed fixed exchange rates. China is more and more a
dominant player.
– Monetary and fiscal policies are complicated by large fiscal
deficits.
– Large and continuing balance of payments imbalances will shift
the exchange rate landscape.
– The dominant form of business may has shifted from the publicly-
traded firm to the privately owned model.
– Global capital markets are shrinking and changing.
– Large inflows and outflows of capital travel through industrial and
emerging markets complicating financial management.

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 The Global Financial Marketplace

• Assets, institutions, and linkages comprise one

method to map global capital markets (see Exhibit
1.1).

• Assets are debt securities issued by governments

(e.g., U.S. Treasury Bonds). These form the
baseline for other forms of financing.
• Institutions are the central banks, commercial,
and investment banks. Their health keeps the
global financial system stable.
• Linkages are the interbank networks using
currency. Without ready exchange of currencies the
market is hard-pressed to operate efficiently.

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 Exhibit 1.1 Global Capital Markets

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 The Market for Currencies

• Most currencies are quoted against the

dollar as in “so many units per dollar”
• A few are quoted as “dollars per unit” due to
custom e.g., $/£ and $/€.
• There are also several symbols that can be
used to write the quotations, but this is the
author’s stated preference.
• Exhibit 1.2 provides selected currency
exchange rate quotes

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 Exhibit 1.2 Selected Global Currency
Exchange Rates

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 Exhibit 1.2 Selected Global Currency
Exchange Rates (cont.)

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 Eurocurrencies and LIBOR

• Eurocurrencies (a major linkage in the

global and capital markets)
– These are domestic currencies of one country on
deposit in a second country
– The Eurocurrency markets serve two valuable
purposes:
• Eurocurrency deposits are an efficient and convenient
money market device for holding excess corporate
liquidity
• The Eurocurrency market is a major source of short-
term bank loans to finance corporate working capital
needs (including export and import financing)

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 Eurocurrencies and LIBOR

• Eurocurrency Interest Rates: LIBOR

– In the Eurocurrency market, the reference rate of
interest is the London Interbank Offered Rate
(LIBOR)
– This rate is the most widely accepted rate of
interest used in standardized quotations, loan
agreements, and financial derivatives
transactions

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 The Theory
of Comparative Advantage
• The theory of comparative advantage provides a basis
for explaining and justifying international trade in a
model world assumed to enjoy:
– free trade;
– perfect competition;
– no uncertainty;
– costless information; and
– no government interference.

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 The Theory
of Comparative Advantage
• The theory contains the following features:
– Exporters in Country A sell goods or services to unrelated
importers in Country B
– Firms in Country A specialize in making products that can
be produced relatively efficiently, given Country A’s
endowment of factors of production, that is, land, labor,
capital, and technology
– Firms in Country B do likewise, given the factors of
production found in Country B
– In this way the total combined output of A and B is
maximized

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 The Theory
of Comparative Advantage
– Because the factors of production cannot be
moved freely from Country A to Country B, the
benefits of specialization are realized through
international trade
– The way the benefits of the extra production are
shared depends on the terms of trade, the ratio
at which quantities of the physical goods are
traded
– Each country’s share is determined by supply
and demand in perfectly competitive markets in
the two countries
– Neither Country A nor Country B is worse off
than before trade, and typically both are better
off, albeit perhaps unequally

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 The Theory
of Comparative Advantage
• Although international trade might have
approached the comparative advantage model
during the nineteenth century, it certainly does not
today, for the following reasons:
– Countries do not appear to specialize only in those
products that could be most efficiently produced by that
country’s particular factors of production (as a result of
government interference and ulterior motivations)
– At least two factors of production – capital and technology
– now flow directly and easily between countries

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 The Theory
of Comparative Advantage
– Modern factors of production are more numerous than in
this simple model
– Although the terms of trade are ultimately determined by
supply and demand, the process by which the terms are
set is different from that visualized in traditional trade
theory
– Comparative advantage shifts over time, as less developed
countries become developed and realize their latent
opportunities
– The classical model of comparative advantage did not
really address certain other issues, such as the effect of
uncertainty and information costs, the role of differentiated
products in imperfectly competitive markets, and
economies of scale

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 The Theory
of Comparative Advantage
• Comparative advantage is however still a relevant
theory to explain why particular countries are most
suitable for exports of goods and services that
support the global supply chain of both MNEs and
domestic firms.
• The comparative advantage of the 21st century,
however, is one based more on services, and their
cross-border facilitation by telecommunications and
the Internet.
• The source of a nation’s comparative advantage is
still created from the mixture of its own labor skills,
access to capital, and technology.

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 The Theory
of Comparative Advantage
• Many locations for supply chain outsourcing exist
today.
• It takes a relative advantage in costs, not just an
absolute advantage, to create comparative
advantage.
• Clearly, the extent of global outsourcing is reaching
out to every corner of the globe.

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 What is Different About International
Financial Management?

• Exhibit 1.3 summarizes the differences.

– Culture and history differ among countries
– Corporate governance
– Greater levels of foreign exchange and political
risks
– Financial theory and applications are modified in
the global versus domestic marketplace
– Specialized and complicated financial
instruments become tools of the trade

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 Exhibit 1.3 What Is Different About
International Financial Management?

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 Market Imperfections: A Rationale for
the Existence of the Multinational Firm

• MNEs strive to take advantage of imperfections in

national markets for products, factors of
production, and financial assets.
• Imperfections in the market for products translate
into market opportunities for MNEs.
• Large international firms are better able to exploit
such competitive factors as economies of scale,
managerial and technological expertise, product
differentiation, and financial strength than their
local competitors.

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 Market Imperfections: A Rationale for
the Existence of the Multinational Firm
• Strategic motives drive the decision to invest
abroad and become a MNE and can be summarized
under the following categories:
– Market seekers
– Raw material seekers
– Production efficiency seekers
– Knowledge seekers
– Political safety seekers
• These categories are not mutually exclusive.

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 The Globalization Process

• Stage I: early domestic phase growing into

the international trade phase (Exhibit 1.4)
• Stage II: A successful firm will continue to
grow from simple international trade to the
multinational phase characterized by
production and investment both at home
and abroad (Exhibit 1.5)
• Growth may be limited by the twin agency
problems of corporate insiders and the
rulers of sovereign states (Exhibit 1.6)

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 Exhibit 1.4 Ganado Corp: Initiation of
the Globalization Process

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 Exhibit 1.5 Ganado’s Foreign Direct
Investment Sequence

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 Exhibit 1.6 The Limits of Financial
Globalization

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