INTERNATIONAL FINANCE AND

CAPITAL MARKETS


Muhammad Mujibul Kabir,CFA
Adjunct Faculty
Multinational Corporation (MNC)
Foreign Exchange Markets
Product Markets Subsidiaries International
Financial
Markets
Dividend
Remittance
& Financing
Exporting
& Importing
Investing
& Financing
Part I
The International Financial Environment
Multinational Financial Management:
An Overview
1
Chapter
Chapter Objectives
• To identify the main goal of the
multinational corporation (MNC) and
conflicts with that goal;
• To describe the key theories that justify
international business; and
• To explain the common methods used to
conduct international business.
Goal of the MNC
• The commonly accepted goal of an MNC is
to maximize shareholder wealth.
• We will focus on MNCs that are based in
the United States and that wholly own
their foreign subsidiaries.
Conflicts Against the MNC Goal
• For corporations with shareholders who
differ from their managers, a conflict of
goals can exist - the agency problem.
• Agency costs are normally larger for MNCs
than for purely domestic firms.
¤ The sheer size of the MNC.
¤ The scattering of distant subsidiaries.
¤ The culture of foreign managers.
¤ Subsidiary value versus overall MNC value.
Impact of Management Control
• The magnitude of agency costs can vary
with the management style of the MNC.
• A centralized management style reduces
agency costs. However, a decentralized
style gives more control to those
managers who are closer to the
subsidiary’s operations and environment.
Centralized Multinational Financial Management
for an MNC with two subsidiaries, A and B
Financial
Managers
of Parent
Capital Expenditures
at A
Inventory and
Accounts
Receivable
Management at A
Cash
Management
at A
Financing at A
Capital Expenditures
at B
Inventory and
Accounts
Receivable
Management at B
Cash
Management
at B
Financing at B
Decentralized Multinational Financial Management
for an MNC with two subsidiaries, A and B
Financial
Managers
of A
Capital Expenditures
at A
Inventory and
Accounts
Receivable
Management at A
Cash
Management
at A
Financing at A
Capital Expenditures
at B
Inventory and
Accounts
Receivable
Management at B
Cash
Management
at B
Financing at B
Financial
Managers
of B
Impact of Management Control
• Some MNCs attempt to strike a balance -
they allow subsidiary managers to make
the key decisions for their respective
operations, but the decisions are
monitored by the parent’s management.
Impact of Management Control
• Electronic networks make it easier for the
parent to monitor the actions and
performance of foreign subsidiaries.
• For example, corporate intranet or internet
email facilitates communication. Financial
reports and other documents can be sent
electronically too.
Impact of Corporate Control
• Various forms of corporate control can
reduce agency costs.
¤ Stock compensation for board members
and executives.
¤ The threat of a hostile takeover.
¤ Monitoring and intervention by large
shareholders.
Constraints
Interfering with the MNC’s Goal
• As MNC managers attempt to maximize
their firm’s value, they may be confronted
with various constraints.
¤ Environmental constraints.
¤ Regulatory constraints.
¤ Ethical constraints.
Why are firms motivated to expand
their business internationally?
Theories of International Business
Theory of Comparative Advantage
¤ Specialization by countries can increase
production efficiency.
Imperfect Markets Theory
¤ The markets for the various resources
used in production are “imperfect.”
Why are firms motivated to expand
their business internationally?
Theories of International Business
Product Cycle Theory
¤ As a firm matures, it may recognize
additional opportunities outside its home
country.
 Firm exports
product to
accommodate
foreign demand.
 Firm creates
product to
accommodate
local demand.
The International Product Life Cycle
 Firm
establishes
foreign
subsidiary
to establish
presence in
foreign
country
and
possibly to
reduce
costs.
a. Firm
differentiates
product from
competitors
and/or expands
product line in
foreign country.
b. Firm’s
foreign
business
declines as its
competitive
advantages are
eliminated.
or
International
Business Methods
• International trade is a relatively
conservative approach involving
exporting and/or importing.
¤ The internet facilitates international trade
by enabling firms to advertise and manage
orders through their websites.
There are several methods by which firms
can conduct international business.
International
Business Methods
• Licensing allows a firm to provide its
technology in exchange for fees or some
other benefits.
• Franchising obligates a firm to provide a
specialized sales or service strategy,
support assistance, and possibly an initial
investment in the franchise in exchange
for periodic fees.
International
Business Methods
• Firms may also penetrate foreign markets
by engaging in a joint venture (joint
ownership and operation) with firms that
reside in those markets.
• Acquisitions of existing operations in
foreign countries allow firms to quickly
gain control over foreign operations as
well as a share of the foreign market.
International
Business Methods
• Firms can also penetrate foreign markets
by establishing new foreign subsidiaries.
• In general, any method of conducting
business that requires a direct investment
in foreign operations is referred to as a
direct foreign investment (DFI).
• The optimal international business
method may depend on the characteristics
of the MNC.
Degree of International Business by MNCs
26%
62%
58%
33%
47%
50%
66%
12%
46%
40%
0%
10%
20%
30%
40%
50%
60%
70%
Campbell's
Soup
Dow
Chemical
IBM Motorola Nike
Foreign Sales as a % of Total Sales
Foreign Assets as a % of Total Assets
Online Application
• Check out the following international trade
promotion sites.
http://www.tradenet.gov
http://www.business.gov/busadv/
index.cfm
http://www.export.gov
http://www.trade.gov
International Opportunities
• Investment opportunities - The marginal
return on projects for an MNC is above
that of a purely domestic firm because of
the expanded opportunity set of possible
projects from which to select.
• Financing opportunities - An MNC is also
able to obtain capital funding at a lower
cost due to its larger opportunity set of
funding sources around the world.
Marginal
Return on
Projects
Purely
Domestic
Firm
MNC
Asset Level
of Firm
Investment
Opportunities
International Opportunities
Cost-benefit Evaluation for
Purely Domestic Firms versus MNCs
Appropriate
Size for Purely
Domestic Firm
Appropriate
Size for MNC
X Y
Marginal
Cost of
Capital
Purely
Domestic
Firm
MNC
Financing
Opportunities
International Opportunities
• Opportunities in Europe
¤ The Single European Act of 1987.
¤ The removal of the Berlin Wall in 1989.
¤ The inception of the euro in 1999
¤ Expansion of EU.
• Opportunities in Latin America
¤ The North American Free Trade Agreement
(NAFTA) of 1993.
¤ The General Agreement on Tariffs and Trade
(GATT) accord.
International Opportunities
• Opportunities in Asia
¤ The reduction of investment restrictions by
many Asian countries during the 1990s.
¤ Two rising Giants –China and (possibly)
India.
¤ The Asian economic crisis in 1997-1998.
Online Application
• For more information on the Asian crisis,
check out the following sites:
¤ http://www.stern.nyu.edu/~nroubini/asia/Asi
aHomepage.html
Exposure to International Risk
exchange rate movements
¤ Exchange rate fluctuations affect cash
flows and foreign demand.
foreign economies
¤ Economic conditions affect demand.
political risk
¤ Political actions affect cash flows.
International business usually increases an
MNC’s exposure to:
Exposure to International Risk
$130,000
$135,000
$140,000
$145,000
$150,000
$155,000
$160,000
$165,000
Jan Mar May Jul Sep Nov Jan Mar May
2000 2001
U.S. Firm’s Cost of Obtaining £100,000
• Visit FRED
®
, Fed's economic time-series
database, at http://www.stls.frb.org/fred for
numerous economic and financial time series,
e.g., balance of payment statistics, interest rates,
foreign exchange rates.
• Visit http://www.ita.doc.gov/td/industry/otea (Office
of Trade and Economic Analysis) for an outlook
of international trade conditions for each of
several industries.
• Visit www.imf.org for International Financial
Statistics for all IMF member countries
Online Application
Overview of an MNC’s Cash Flows
Profile A: MNCs focused on International Trade
U.S. Businesses
Foreign Importers
U.S. Customers
Foreign Exporters
U.S.-
based
MNC
Payments for products
Payments for supplies
Payments for exports
Payments for imports
Overview of an MNC’s Cash Flows
Profile B: MNCs focused on International Trade and
International Arrangements
U.S. Businesses
Foreign Importers
U.S. Customers
Foreign Exporters
Foreign Firms
U.S.-
based
MNC
Fees for services
Costs of services
Payments for products
Payments for supplies
Payments for exports
Payments for imports
Overview of an MNC’s Cash Flows
Profile C: MNCs focused on International Trade, International
Arrangements, and Direct Foreign Investment
U.S. Businesses
Foreign Importers
U.S. Customers
Foreign Exporters
Foreign Firms
Foreign Subsidiaries
U.S.-
based
MNC
Funds remitted
Funds invested
Fees for services
Costs of services
Payments for products
Payments for supplies
Payments for exports
Payments for imports
Managing for Value
• Like domestic projects, foreign projects
involve an investment decision and a
financing decision.
• When managers make multinational
finance decisions that maximize the
overall present value of future cash flows,
they maximize the firm’s value, and hence
shareholder wealth.
( )
( )
¿
+
n
t
t
t
k
1 =
$,
1
CF E
= Value
E (CF
$,t
) = expected cash flows to be received at
the end of period t
n = the number of periods into the future
in which cash flows are received
k = the required rate of return by
investors
Valuation Model for an MNC
• Domestic Model
( ) ( ) | |
( )
¿
¿
¦
¦
)
¦
¦
`
¹
¦
¦
¹
¦
¦
´
¦
+
×
=
n
t
t
m
j
t j t j
k
1 =
1
, ,
1
ER E CF E
= Value
E (CF
j,t
) = expected cash flows denominated in currency j
to be received by the U.S. parent at the end of
period t
E (ER
j,t
) = expected exchange rate at which currency j can
be converted to dollars at the end of period t
k = the weighted average cost of capital of the U.S.
parent company
Valuation Model for an MNC
• Valuing International Cash Flows
Valuation Model for an MNC
• An MNC’s financial decisions include how
much business to conduct in each country
and how much financing to obtain in each
currency.
• Its financial decisions determine its
exposure to the international environment.
Valuation Model for an MNC
Impact of New International Opportunities
on an MNC’s Value
Exchange Rate Risk
( ) ( ) | |
( )
¿
¿
¦
¦
)
¦
¦
`
¹
¦
¦
¹
¦
¦
´
¦
+
×
=
n
t
t
m
j
t j t j
k
1 =
1
, ,
1
ER E CF E
= Value
Political Risk
Exposure to
Foreign Economies
How Chapters Relate to Valuation
Background
on
International
Financial
Markets
(Chapters
2-5)
Exchange Rate
Behavior
(Chapters 6-8)
Long-Term
Investment and
Financing
Decisions
(Chapters 13-18)
Short-Term
Investment and
Financing
Decisions
(Chapters 19-21)
Exchange Rate
Risk Management
(Chapters 9-12)
Risk and
Return of
MNC
Value and
Stock Price
of MNC
Recap…..
• Goal of the MNC
¤ Conflicts Against the MNC Goal
¤ Impact of Management Control
¤ Impact of Corporate Control
¤ Constraints Interfering with the MNC’s
Goal
• Theories of International Business
¤ Theory of Comparative Advantage
¤ Imperfect Markets Theory
¤ Product Cycle Theory
Chapter Review
• International Business Methods
¤ International Trade
¤ Licensing
¤ Franchising
¤ Joint Ventures
¤ Acquisitions of Existing Operations
¤ Establishing New Foreign Subsidiaries
Chapter Review
• International Opportunities
¤ Investment Opportunities
¤ Financing Opportunities
¤ Opportunities in Europe
¤ Opportunities in Latin America
¤ Opportunities in Asia
Chapter Review
• Exposure to International Risk
¤ Exposure to Exchange Rate Movements
¤ Exposure to Foreign Economies
¤ Exposure to Political Risk
• Overview of an MNC’s Cash Flows
• Managing for Value
Chapter Review
• Valuation Model for an MNC
¤ Domestic Model
¤ Valuing International Cash Flows
¤ Impact of Financial Management and
International Conditions on Value
¤ How Chapters Relate to Valuation

Part I
The International Financial Environment
Multinational Corporation (MNC)

Foreign Exchange Markets

Exporting & Importing

Dividend Remittance & Financing

Investing & Financing International Financial Markets

Product Markets

Subsidiaries

Chapter

1

Multinational Financial Management: An Overview

Chapter Objectives
• To identify the main goal of the
multinational corporation (MNC) and conflicts with that goal;

• To describe the key theories that justify
international business; and

• To explain the common methods used to
conduct international business.

Goal of the MNC • The commonly accepted goal of an MNC is to maximize shareholder wealth. . • We will focus on MNCs that are based in the United States and that wholly own their foreign subsidiaries.

¤ The culture of foreign managers.the agency problem. . ¤ The scattering of distant subsidiaries. ¤ The sheer size of the MNC. ¤ Subsidiary value versus overall MNC value. a conflict of goals can exist .Conflicts Against the MNC Goal • For corporations with shareholders who differ from their managers. • Agency costs are normally larger for MNCs than for purely domestic firms.

a decentralized style gives more control to those managers who are closer to the subsidiary’s operations and environment. However. .Impact of Management Control • The magnitude of agency costs can vary with the management style of the MNC. • A centralized management style reduces agency costs.

Centralized Multinational Financial Management for an MNC with two subsidiaries. A and B Cash Management at A Inventory and Accounts Receivable Management at A Financial Managers of Parent Cash Management at B Inventory and Accounts Receivable Management at B Financing at A Capital Expenditures at A Financing at B Capital Expenditures at B .

Decentralized Multinational Financial Management for an MNC with two subsidiaries. A and B Cash Management at A Inventory and Accounts Receivable Management at A Financial Managers of A Financial Managers of B Cash Management at B Inventory and Accounts Receivable Management at B Financing at A Capital Expenditures at A Financing at B Capital Expenditures at B .

but the decisions are monitored by the parent’s management.Impact of Management Control • Some MNCs attempt to strike a balance they allow subsidiary managers to make the key decisions for their respective operations. .

Impact of Management Control • Electronic networks make it easier for the parent to monitor the actions and performance of foreign subsidiaries. . • For example. Financial reports and other documents can be sent electronically too. corporate intranet or internet email facilitates communication.

¤ Stock compensation for board members and executives. . ¤ The threat of a hostile takeover. ¤ Monitoring and intervention by large shareholders.Impact of Corporate Control • Various forms of corporate control can reduce agency costs.

Ethical constraints. they may be confronted with various constraints. Regulatory constraints. .Constraints Interfering with the MNC’s Goal • As MNC managers attempt to maximize their firm’s value. ¤ ¤ ¤ Environmental constraints.

The markets for the various resources used in production are “imperfect.Theories of International Business Why are firms motivated to expand their business internationally?  Theory of Comparative Advantage ¤ Specialization by countries can increase production efficiency.”  Imperfect Markets Theory ¤ .

.Theories of International Business Why are firms motivated to expand their business internationally?  Product Cycle Theory ¤ As a firm matures. it may recognize additional opportunities outside its home country.

or b. a.The International Product Life Cycle  Firm creates product to accommodate local demand.  Firm exports product to accommodate foreign demand. Firm’s foreign business declines as its competitive advantages are eliminated. Firm differentiates product from competitors and/or expands product line in foreign country.  Firm establishes foreign subsidiary to establish presence in foreign country and possibly to reduce costs. .

.International Business Methods There are several methods by which firms can conduct international business. ¤ The internet facilitates international trade by enabling firms to advertise and manage orders through their websites. • International trade is a relatively conservative approach involving exporting and/or importing.

. • Franchising obligates a firm to provide a specialized sales or service strategy.International Business Methods • Licensing allows a firm to provide its technology in exchange for fees or some other benefits. support assistance. and possibly an initial investment in the franchise in exchange for periodic fees.

.International Business Methods • Firms may also penetrate foreign markets by engaging in a joint venture (joint ownership and operation) with firms that reside in those markets. • Acquisitions of existing operations in foreign countries allow firms to quickly gain control over foreign operations as well as a share of the foreign market.

International Business Methods • Firms can also penetrate foreign markets by establishing new foreign subsidiaries. • In general. • The optimal international business method may depend on the characteristics of the MNC. . any method of conducting business that requires a direct investment in foreign operations is referred to as a direct foreign investment (DFI).

Degree of International Business by MNCs Foreign Sales as a % of Total Sales Foreign Assets as a % of Total Assets 70% 60% 50% 40% 30% 20% 10% 0% Campbell's Dow Soup Chemical IBM Motorola Nike 62% 46% 26% 12% 66% 58% 50% 40% 33% 47% .

.Online Application • Check out the following international trade promotion sites.

tradenet.gov .http://www.

gov/busadv/ index.cfm .http://www.business.

gov .gov http://www.export.http://www.trade.

The marginal return on projects for an MNC is above that of a purely domestic firm because of the expanded opportunity set of possible projects from which to select. • Financing opportunities .An MNC is also able to obtain capital funding at a lower cost due to its larger opportunity set of funding sources around the world.International Opportunities • Investment opportunities . .

International Opportunities Cost-benefit Evaluation for Purely Domestic Firms versus MNCs Investment Opportunities Marginal Return on Projects Marginal Cost of Capital Purely Domestic Firm MNC MNC Purely Domestic Firm Financing Opportunities Appropriate Size for Purely Domestic Firm Appropriate Size for MNC X Y Asset Level of Firm .

¤ The removal of the Berlin Wall in 1989. ¤ The General Agreement on Tariffs and Trade (GATT) accord. ¤ The inception of the euro in 1999 ¤ Expansion of EU. ¤ .International Opportunities • Opportunities in Europe The Single European Act of 1987. • Opportunities in Latin America ¤ The North American Free Trade Agreement (NAFTA) of 1993.

. Two rising Giants –China and (possibly) India. The Asian economic crisis in 1997-1998.International Opportunities • Opportunities in Asia ¤ ¤ ¤ The reduction of investment restrictions by many Asian countries during the 1990s.

check out the following sites: ¤ http://www.edu/~nroubini/asia/Asi aHomepage.html .nyu.Online Application • For more information on the Asian crisis.stern.

 political risk ¤ Political actions affect cash flows.  foreign economies ¤ Economic conditions affect demand.Exposure to International Risk International business usually increases an MNC’s exposure to:  exchange rate movements ¤ Exchange rate fluctuations affect cash flows and foreign demand. .

000 $155.000 $165.000 $145.S.000 $140.000 $130.000 Jan Mar May Jul Sep Nov Jan Mar May 2000 2001 . Firm’s Cost of Obtaining £100.000 $150.Exposure to International Risk U.000 $160.000 $135.

stls..org/fred for numerous economic and financial time series.imf. balance of payment statistics.g.gov/td/industry/otea (Office of Trade and Economic Analysis) for an outlook of international trade conditions for each of several industries. at http://www.Online Application • Visit FRED®.frb. e. Fed's economic time-series database. interest rates. • Visit http://www.org for International Financial Statistics for all IMF member countries . foreign exchange rates.doc. • Visit www.ita.

S.S.based MNC Payments for supplies Payments for exports Payments for imports .S. Businesses Foreign Importers Foreign Exporters U. Customers U.Overview of an MNC’s Cash Flows Profile A: MNCs focused on International Trade Payments for products U.

Businesses Foreign Importers Foreign Exporters Foreign Firms U.based MNC Payments for exports Payments for imports Fees for services Costs of services .S.S.S.Overview of an MNC’s Cash Flows Profile B: MNCs focused on International Trade and International Arrangements Payments for products Payments for supplies U. Customers U.

S. International Arrangements. and Direct Foreign Investment Payments for products Payments for supplies U.based MNC Payments for exports Payments for imports Fees for services Costs of services Funds remitted Funds invested Foreign Subsidiaries .S.S. Customers U.Overview of an MNC’s Cash Flows Profile C: MNCs focused on International Trade. Businesses Foreign Importers Foreign Exporters Foreign Firms U.

foreign projects involve an investment decision and a financing decision. they maximize the firm’s value.Managing for Value • Like domestic projects. . • When managers make multinational finance decisions that maximize the overall present value of future cash flows. and hence shareholder wealth.

t ) = expected cash flows to be received at the end of period t n = the number of periods into the future in which cash flows are received k = the required rate of return by investors .Valuation Model for an MNC • Domestic Model Value =  t =1 n E CF$. t  1  k  t E (CF$.

Valuation Model for an MNC • Valuing International Cash Flows m  E CFj .t ) = expected cash flows denominated in currency j to be received by the U.S.S. t  E ER j . parent company .t ) = expected exchange rate at which currency j can be converted to dollars at the end of period t k = the weighted average cost of capital of the U. parent at the end of period t E (ERj. t  n   j 1  Value =    t 1  k  t =1       E (CFj.

.Valuation Model for an MNC • An MNC’s financial decisions include how much business to conduct in each country and how much financing to obtain in each currency. • Its financial decisions determine its exposure to the international environment.

t  E ER j .Valuation Model for an MNC Impact of New International Opportunities on an MNC’s Value Exposure to Foreign Economies Exchange Rate Risk m  E CFj . t  n   j 1  Value =    t 1  k  t =1       Political Risk .

How Chapters Relate to Valuation Exchange Rate Behavior (Chapters 6-8) Background on International Financial Markets (Chapters 2-5) Exchange Rate Risk Management (Chapters 9-12) Long-Term Investment and Financing Decisions (Chapters 13-18) Risk and Return of MNC Value and Stock Price of MNC Short-Term Investment and Financing Decisions (Chapters 19-21) .

• Goal of the MNC ¤ ¤ ¤ ¤ Conflicts Against the MNC Goal Impact of Management Control Impact of Corporate Control Constraints Interfering with the MNC’s Goal Theory of Comparative Advantage Imperfect Markets Theory Product Cycle Theory • Theories of International Business ¤ ¤ ¤ ..Recap….

Chapter Review • International Business Methods ¤ ¤ ¤ ¤ ¤ ¤ International Trade Licensing Franchising Joint Ventures Acquisitions of Existing Operations Establishing New Foreign Subsidiaries .

Chapter Review • International Opportunities ¤ ¤ ¤ ¤ ¤ Investment Opportunities Financing Opportunities Opportunities in Europe Opportunities in Latin America Opportunities in Asia .

Chapter Review • Exposure to International Risk ¤ ¤ ¤ Exposure to Exchange Rate Movements Exposure to Foreign Economies Exposure to Political Risk • Overview of an MNC’s Cash Flows • Managing for Value .

Chapter Review • Valuation Model for an MNC ¤ ¤ ¤ ¤ Domestic Model Valuing International Cash Flows Impact of Financial Management and International Conditions on Value How Chapters Relate to Valuation .

t A± n ± ± ±!1 j Value = § ¯ ¿ t . j .

1  k t =1 ± ± ± ± À ° Political Risk .

How Chapters Relate to Valuation Exchange Rate Behavior (Chapters 6-8) Background on International Financial Markets (Chapters 2-5) Exchange Rate Risk Management (Chapters 9-12) Long-Term Investment and Financing Decisions (Chapters 13-18) Short-Term Investment and Financing Decisions (Chapters 19-21) Risk and Return of MNC Value and Stock Price of MNC .

. ‡ Goal of the MNC ¤ ¤ ¤ ¤ Conflicts Against the MNC Goal Impact of Management Control Impact of Corporate Control Constraints Interfering with the MNC¶s Goal Theory of Comparative Advantage Imperfect Markets Theory Product Cycle Theory ‡ Theories of International Business ¤ ¤ ¤ .Recap«.

Chapter Review ‡ International Business Methods ¤ ¤ ¤ ¤ ¤ ¤ International Trade Licensing Franchising Joint Ventures Acquisitions of Existing Operations Establishing New Foreign Subsidiaries .

Chapter Review ‡ International Opportunities ¤ ¤ ¤ ¤ ¤ Investment Opportunities Financing Opportunities Opportunities in Europe Opportunities in Latin America Opportunities in Asia .

Chapter Review ‡ Exposure to International Risk ¤ ¤ ¤ Exposure to Exchange Rate Movements Exposure to Foreign Economies Exposure to Political Risk ‡ Overview of an MNC¶s Cash Flows ‡ Managing for Value .

Chapter Review ‡ Valuation Model for an MNC ¤ ¤ ¤ ¤ Domestic Model Valuing International Cash Flows Impact of Financial Management and International Conditions on Value How Chapters Relate to Valuation .

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