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INTERNATIONAL FINANCE
Dr DUC VO
Multinational Business Finance
Chapter 1
Multinational Financial
Management: Opportunities
and Challenges
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Learning Objectives
1.1 Explore the global financial marketplace—players and
playing field
1.2 Consider how the theory of comparative advantage
applies to multinational business
1.3 Examine how international financial management
differs from domestic financial management
1.4 Discover the steps and stages of the globalization
process
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.
—P&G News Release, January 27, 2015
• A multinational enterprise (MNE) has operating branches, subsidiaries, or
affiliates located in foreign countries.
• Today, digital startups can become multinational enterprises in hours
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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.
Exhibit 1.1 Global Capital Markets
The global capital market is a collection of institutions (central banks, commercial banks,
investment banks, not-forprofit financial institutions like the IMF and World Bank) and
securities (bonds, mortgages, derivatives, loans, etc.), which are all linked via a global
network-the Interbank Market. This interbank market, in which securities of all kinds are
traded, is the critical pipeline system for the movement of capital.
For long description, see slide 30:
Appendix 1
The exchange of securities-the movement of capital in the global financial system-must all
take place through a vehicle-currency. The exchange of currencies is itself the largest of
the financial markets. The interbank market, which must pass-through and exchange
securities using currencies, bases all of its pricing through the single most widely quoted
interest rate in the world-LIBOR (the London Interbank Offered Rate).
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The Market for Currencies
• Most currencies are quoted against the dollar as in “so
many units per dollar.”
• Computer symbols (ISO-4217 codes) are used in digital
networks.
• Some currencies are known by more than one name.
• Exhibit 1.2 provides selected currency exchange rate
quotes.
Exhibit 1.2 Selected Global Currency
Exchange Rates for January 2, 2018 (1 of 2)
For long description, see slide 31: Appendix 2
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Exhibit 1.2 Selected Global Currency
Exchange Rates for January 2, 2018 (2 of 2)
For long description, see slide 33: Appendix 3
Note that a number of different currencies use the same symbol (for example both China
and Japan have traditionally used the ¥ symbol, which means “round” or “circle,” for yen
and yuan respectively. All quotes are mid-rates, and are drawn from the Financial Times.
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Eurocurrencies and Eurocurrency
Interest Rates (1 of 2)
• 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 Eurocurrency
Interest Rates (2 of 2)
• The eurocurrency market is relatively free from governmental
regulation and interference.
• Interest rate is referred to as the LIBOR.
– Oftentimes a low spread exists with deposit and loan rates.
The Theory of Comparative
Advantage (1 of 7)
• 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 (2 of 7)
• 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
The Theory of Comparative
Advantage (3 of 7)
– 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 (4 of 7)
• 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
The Theory of Comparative
Advantage (5 of 7)
– 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 (6 of 7)
• 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.
The Theory of Comparative
Advantage (7 of 7)
• 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
Exhibit 1.3 What Is Different About
International Financial Management?
Concept International Domestic
Culture, history, and Each foreign country is unique and not always Each country has a known base case
institutions understood by MNE management
Corporate governance Foreign countries’ regulations and institutional Regulations and institutions are well
practices are all uniquely different known
Foreign exchange risk MNEs face foreign exchange risks due to Foreign exchange risks from
their subsidiaries, as well as import/export import/export and foreign competition
and foreign competitors (no subsidiaries)
Political risk MNEs face political risk because of their Negligible political risks
foreign subsidiaries and high profile
Modification of domestic MNEs must modify finance theories like Traditional financial theory applies
finance theories capital budgeting and the cost of capital
because of foreign complexities
Modification of domestic MNEs utilize modified financial instruments Limited use of financial instruments
financial instruments such as options, forwards, swaps, and letters and derivatives because of few foreign
of credit exchange and political risks
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Market Imperfections: A Rationale for the
Existence of the Multinational Firm (1 of 2)
• 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.
Market Imperfections: A Rationale for the
Existence of the Multinational Firm (2 of 2)
• 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)
• The increase in foreign subsidiaries increases currency
risks and exposures (Exhibit 1.6)
• Growth may be limited by the twin agency problems of
corporate insiders and the rulers of sovereign states
(Exhibit 1.7)
Exhibit 1.4 Ganado Corp: Initiation
of the Globalization Process
For long description, see slide 34: Appendix 4
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Exhibit 1.5 Ganado’s Foreign Direct
Investment Sequence
For long description, see slide 35: Appendix 5
Exhibit 1.6 Selected Consolidated
Income Results for Ganado (U.S.)
As a U.S.-based multinational company, Ganado must consolidate the financial results
(in this case, sales and earnings from the income statements) of its foreign subsidiaries.
This requires converting foreign currency values into U.S. dollars.
For long
description, see
slide 36:
Appendix 6
Ganado, for the year shown, generated 57% of its global sales in the United States, with
those U.S. sales making up 56% of its consolidated profits. From quarter to quarter and
year to year, both the financial performance of the individual subsidiaries will change in
addition to exchange rates.
* This is a simplified consolidation. Actual consolidation accounting practices require a
number of specific line item adjustments not shown here.
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Exhibit 1.7 The Limits of Financial
Globalization
There is a growing debate over whether many of the insiders and rulers of organizations
with enterprises globally are taking actions consistent with creating firm value or
consistent with increasing their own personal stakes and power.
For long description, see slide 38: Appendix 7
If these influential insiders are building personal wealth over that of the firm, it will indeed
result in preventing the flow of capital across borders, currencies, and institutions to
create a more open and integrated global financial community.
Source: Constructed by authors based on “The Limits of Financial Globalization,” Rene
M. Stulz, Journal of Applied Corporate Finance, Vol. 19, No. 1, Winter 2007, pp. 8–15.
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