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INTERNATIONAL
FINANCIAL
MANAGEMENT
Fifth Edition
EUN / RESNICK
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
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.
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Chapter One Outline
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What’s Special about “International” Finance?
Goals for International Financial Management
Globalization of the World Economy
Multinational Corporations
Summary
Why do we need to study “international”
financial management.
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1-3
We are now living in a highly globalized and integrated
world economy.
Continued liberalization of international trade is certain to
further internationalize consumption patterns around the
world.
Not only consumption but also production of goods and
services (thanks to MNCs) are globalized.
Recent movement is the integration of financial markets.
With a global shift all economic functions are now highly
globalized.
What’s Special about
“International” Finance?
Financial management in an international setting.
Financial management mainly concers with how to optimally make
various financial decisions: Investment, financing, divident policy,
working capital management.
In order to achieve corporate objectives which are?.......
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Foreign Exchange Risk
Political Risk
Market Imperfections
Expanded Opportunity Set
Sovereign nations have
the right and power to
issue currencies,
formulate their own
economic policies,
impose taxes, regulate
movement of people,
goods and capital.
What’s Special about
“International” Finance?
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Foreign Exchange Risk
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The risk that foreign currency profits may evaporate
in dollar terms due to unanticipated unfavorable
exchange rate movements.
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.
What’s Special about
“International” Finance?
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Foreign Exchange Risk: Why Flactuation?
Since the early 1970s, when fixed exchange rates
were abandoned.
What’s Special about
“International” Finance?
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Political Risk
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1-7
Sovereign governments have the right to regulate the
movement of goods, capital, and people across their
borders. These laws sometimes change in unexpected
ways. (changes in tax rules, expropriation etc.)
MNC and investors should be aware of political risk
when they invest in those countries w/o a tradition of
the rule of law.
What’s Special about
“International” Finance?
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1-8
Market Imperfections
 Legal restrictions on the movement of goods, people,
and money
 Transactions costs
 Shipping costs
 Tax arbitrage
All this imperfections will affect the MNCs to locate
production overseas. MNCs are the gifts of these
imperfections.
The Example of Nestlé’s Market Imperfection
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Nestlé used to issue two different classes of
common stock bearer shares and registered
shares.
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Foreigners were only allowed to buy bearer shares.
Swiss citizens could buy registered shares.(voting diff.)
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.
Nestlé’s Foreign Ownership Restrictions
12,000
10,000
Bearer share
SF
8,000
6,000
4,000
Registered share
2,000
0
11
20
31
9
Source: Financial Times, November 26, 1988 p.1. Adapted with permission.
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The Example of Nestlé’s Market Imperfection
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Following this, the price spread between the two
types of shares narrowed dramatically.
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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.
What’s Special about
“International” Finance?
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Expanded Opportunity Set
Firms can locate production in any country or region of
the world to maximize their performance and raise funds
in any capital market where the cost of capital is the
lowest .
They also benefit from greater economies of scale.
 It doesn’t make sense to play in only one corner of the
sandbox.
 True for corporations as well as individual investors.
International diversification)
Goals for International Financial
Management
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The focus of the text is to equip the reader with the
“intellectual toolbox” of an effective global
manager—but what goal should this effective
global manager be working toward?
Maximization of shareholder wealth?
or
Other Goals?
Maximize Shareholder Wealth
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Long accepted as a goal in the Anglo-Saxon
countries, but complications arise.
 Who are and where are the shareholders?
 In what currency should we maximize their
wealth?
Other Goals
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In other countries shareholders are viewed as merely one
among many “stakeholders” of the firm including:
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Employees
Suppliers
Customers
In Japan, managers have typically sought to maximize the
value of the keiretsu 系列—a family of firms to which the
individual firms belongs.
An example of keiretsu
Namee
Mitsubishi
Bank
Mitsubishi Bank (until 1996)
Bank of TokyoMitsubishi(1996–2005)
Bank of Tokyo-Mitsubishi
UFJ (2006– )
Major group companies
Mitsubishi Corporation, Kirin
Brewery, Mitsubishi
Electric, Mitsubishi
Fuso, Mitsubishi
Motors, Nippon Yusen,Nippon
Oil, Tokio Marine and Fire
Insurance, Nikon, Mitsubishi
Chemical, Mitsubishi
Estate, Mitsubishi Heavy
Industries, Mitsubishi Rayon
Co., Ltd., Mitsubishi Materials
Corp., Mitsubishi Paper Mills
Ltd., Pacific Consultants
International Ltd.
Other Goals
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As shown by a series of recent corporate
scandals at companies like Enron, WorldCom,
and Global Crossing, managers may pursue their
own private interests at the expense of
shareholders when they are not closely monitored.
These calamities have painfully reinforced the
importance of corporate governance i.e. the
financial and legal framework for regulating
the relationship between a firm’s management
and its shareholders. (agency problem)+Parmalat
Other Goals
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These types of issues can be much more serious in
many other parts of the world, especially emerging
and transitional economies, such as Indonesia,
Korea, and Russia, where legal protection of
shareholders is weak or virtually non-existing.
No matter what the other goals, they cannot be
achieved in the long term if the maximization of
shareholder wealth is not given due consideration.
Globalization of the World Economy:
Major Trends: the buzzword.
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Emergence of Globalized Financial Markets
Emergence of the Euro as a Global Currency
Trade Liberalization and Economic Integration
Privatization
Emergence of Globalized Financial Markets
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Deregulation of Financial Markets
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27 Oct, 1986 “big bank” elimination of fixed brokerage commissions in LSE like May Day in
1975 in the US
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coupled with
Advances in technology have greatly reduced information and
transactions costs (cost index of computing power 100 in 1960 0.5
in 1999) which has led to:
Financial Innovations, such as
 Currency futures and options
 Multi-currency bonds
 Cross-border stock listings
 International mutual funds
Emergence of Globalized Financial Markets
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Tokyo Stock Exchange(1985), LSE (1986) began
admitting foreign firms as full members to their capital
markets.
Major changes allowed London to be the financial center.
Glass Steagall Act, in the USA, restricted commercial
banks from investment banking activities. Not in Europe
Developing countries started to allow foreigners to
directly invest in their financial markets.
Technology allowed cross border listing, facilitating
international invesment. (order processing and
settlement internationally)
Emergence of the Euro as a Global Currency
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A momentous event in the history of world
financial systems.
Currently more than 300 million Europeans in 16
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.
Euro Area (Mundell, OCA)
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Austria,
Belgium,
Cyprus,
Finland,
France,
Germany,
Greece,
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Ireland,
Italy,
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Luxembourg,
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Malta,
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The Netherlands,
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Portugal,
Slovenia,
Spain
Slovakia ( 1
Ocak 1999)
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Value of the Euro in U.S. Dollars
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Economic Integration
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Over the past 50 years, international trade
increased about twice as fast as world GDP.
There has been a sea 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.
Mercantilism suggests that the ruling government should advance these goals by playing a protectionist role in the
economy; by encouraging exports and discouraging imports, notably through the use of tariffs and subsidies
Protectionist countries are now increasingly pursuing free market and open economy policies because of the gains from
international trade. (specialization in the production, David Ricardo, theory of comparative advantage.)
Liberalization of Protectionist Legislation
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The General Agreement on Tariffs and Trade
(GATT,1947) a multilateral agreement among member
countries has reduced many barriers to trade.
(continuing with rounds, now Doha)
WTO replaced the GATT.
The World Trade Organization (WTO) 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 (dimensions).
NAFTA
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The North American Free Trade Agreement calls
for phasing out impediments (barriers) to trade
between Canada, Mexico and the United States over
a 15-year period beginning in 1994.
For Mexico, the ratio of export to GDP has
increased dramatically from 2.2% in 1973 to 29% in
2006.
The increased trade has resulted in increased
numbers of jobs and a higher standard of living for
all member nations.
Privatization
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The selling off state-run enterprises to investors is also
known as “De-nationalization”.
Often seen in socialist economies in transition to market
economies.
By most estimates this increases the efficiency of the
enterprise.
Often spurs (drives) a tremendous increase in crossborder investment.
Benefits: brings hard currency to pay debts+increase in
the productivity
Multinational Corporations
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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.
Top 10 MNCs
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1
General Electric
United States
2
Vodafone Group PLC
United Kingdom
3
General Motors
United States
4
British Petroleum Co. PLC
United Kingdom
5
Royal Dutch/Shell Group
UK/Netherlands
6
ExxonMobile Corporation
United States
7
Toyota Motor Corporation
Japan
8
Ford Motor Company
United States
9
Total
France
10
Eléctricité de France
France
Multinational Corporations
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They obtain financing from major money centers
around the world in many different currencies to finance
their operations.
They create job opportunities around the world. They
benefit from economy of scale by
spreading R&D,
pooling global purchasing power over suppliers
utilizing their know how globally
So, they can use cheap labor while they gain access to
special R&D in advanced countries.
End Chapter One
…the following slides cover the appendix to
chapter 1.
1-33
The Theory of Comparative Advantage
(comparative vs. relative advantage)
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Definition: a comparative advantage exists when
one party can produce a good or service at a lower
opportunity cost than another party.
Underlying theory’s assumptions of
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Free trade between nations
Factors of production (land, labor, technology, and capital)
are relatively immobile.
The Geometry of Comparative Advantage
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Consider the example given in appendix 1A.
There are two countries, A and B, who can each
produce only food and textiles.
Initially they do not trade with one another.
The Geometry of Comparative Advantage
Textiles
180
A production possibilities curve shows the various amounts
of food or textiles that each country can make.
The production possibilities of country A are such that if
they concentrated 100% of their resources into the
production of textiles, they could produce 180 million
yards of textiles.
If country A chose to concentrate 100% of their resources
into the production of food, they could produce as much
as 300 million pounds of food.
300
1-36
Food
Country A can produce any combination of
food and textiles between these two points.
The Geometry of Comparative Advantage
Textiles
As a practical matter, the citizens of country A must
choose a point along their production possibilities curve;
initially they choose 200 million pounds of food, and 60
million yards of textiles.
180
60
Food
200 300
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The Geometry of Comparative Advantage
Textiles
240
180
The production possibilities of country B are such that if
they concentrated 100% of their resources into the
production of textiles, they could produce 240 million
yards of textiles.
If country B chose to concentrate 100% of their resources
into the production of food, they could produce as much
as 900 million pounds of food.
60
Food
200 300
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900
1,200
The Geometry of Comparative Advantage
Textiles
As a practical matter, the citizens of country B must
choose a point along their production possibilities curve;
initially they choose 600 million pounds of food, and 80
million yards of textiles.
240
180
80
60
Food
200 300
1-39
600
900
1,200
The Geometry of Comparative Advantage
Textiles
240
180
80
60
1-40
Country A enjoys a comparative advantage in textiles
because they have to give up food at a lower rate than B
when making textiles.
Put another way, country B enjoys a comparative
advantage in food because they have to give up textiles
at a lower rate than A when making more food.
Geometrically, a comparative advantage exists
because the slopes of the production
possibilities differ.
Food
200 300
600
900
The Geometry of Comparative Advantage
Textiles
If the countries specialize according to their comparative
advantage, then country A should make textiles and trade
for food, while country B should grow food and trade for
textiles.
240
180
80
60
Food
200 300
1-41
600
900
The Geometry of Comparative Advantage
Textiles
420
240
180
Before trade, if both countries made only textiles, the
combined production would be 420 million yards of
textiles = 240 + 180.
Before trade, if both countries made only food, the
combined production would be 1,200 million
pounds of food = 900 + 300.
80
60
Food
200 300
1-42
600
900
1,200
The Geometry of Comparative Advantage
Textiles
The combined production possibilities curve of country
A and B without trade are shown in the green line.
420
240
180
80
60
Food
200 300
1-43
600
900
1,200
The Geometry of Comparative Advantage
Textiles
Before trade, the combined production is 800 million lbs
of food and 140 million yards of textiles.
420
240
180
140
80
60
Food
200 300
1-44
600
800 900
1,200
The Geometry of Comparative Advantage
Textiles
420
County B can produce food at a lower opportunity cost, so
let B produce the first 900 million pounds of food.
Country A can produce textiles at a lower
opportunity cost, so let them produce the first 180
million yards of textiles.
240
180
140
80
60
Food
200 300
1-45
600
800 900
1,200
The Geometry of Comparative Advantage
Textiles
The combined production possibilities curve with trade
is composed of the original curves joined as shown.
420
240
180
140
80
60
Food
200 300
1-46
600
800 900
1,200
The Geometry of Comparative Advantage
Textiles
420
The gains from trade are shown by the increase in
consumption available—an extra 100 million pounds of food
and 40 million yards of textiles are now available in excess of
the pre-trade consumption.
240
180
140
80
60
Food
200 300
1-47
600
800 900
1,200
Arguments in Favor of Free Trade
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Both partners gain from trade: we have more
material goods.
“Freedom” in a good thing in itself.
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In this case consumers freedom to choose imported
goods and producers freedom to choose to sell to
foreigners.
End Appendix One
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