INTERNATIONAL

FINANCIAL
MANAGEMENT

Fifth Edition

EUN / RESNICK

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights res
 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.
1-2
 Chapter One Outline
 What’s Special about “International” Finance?
 Goals for International Financial Management
 Globalization of the World Economy
 Multinational Corporations
 Summary

1-3
 Why do we need to study “international”
financial management.
 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.

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 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?.......
 Foreign Exchange Risk
 Political Risk
Sovereign nations have
 Market Imperfections the right and power to
issue currencies,
 Expanded Opportunity Set formulate their own
economic policies,
impose taxes, regulate
movement of people,
goods and capital.

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 What’s Special about
“International” Finance?
 Foreign Exchange Risk
 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.

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 What’s Special about
“International” Finance?
 Foreign Exchange Risk: Why Flactuation?
 Since the early 1970s, when fixed exchange rates
were abandoned.

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 What’s Special about
“International” Finance?
 Political Risk
 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.

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 What’s Special about
“International” Finance?
 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.

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 The Example of Nestlé’s Market Imperfection
 Nestlé used to issue two different classes of
common stock bearer shares and registered
shares.
 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.

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 Nestlé’s Foreign Ownership Restrictions

12,000

10,000
Bearer share
8,000
6,000
SF

4,000
Registered share
2,000

0
11 20 31 9 18 24
Source: Financial Times, November 26, 1988 p.1. Adapted with permission.

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 The Example of Nestlé’s Market Imperfection
 Following this, the price spread between the two
types of shares narrowed dramatically.
 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.

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 What’s Special about
“International” Finance?
 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)

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 Goals for International Financial
Management
 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?

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 Maximize Shareholder Wealth
 Long accepted as a goal in the Anglo-Saxon
countries, but complications arise.
 Who are and where are the shareholders?

 Inwhat currency should we maximize their

wealth?

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 Other Goals
 In other countries shareholders are viewed as merely one
among many “stakeholders” of the firm including:
 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.

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 An example of keiretsu
Namee Bank Major group companies
Mitsubishi Mitsubishi Bank (until 1996) Mitsubishi Corporation,
Bank of Tokyo-Mitsubishi(1996– Kirin Brewery,
2005) Mitsubishi Electric,
Bank of Tokyo-Mitsubishi UFJ Mitsubishi Fuso,
(2006– ) 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
 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

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 Other Goals
 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.

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 Globalization of the World Economy:
Major Trends: the buzzword.
 Emergence of Globalized Financial Markets
 Emergence of the Euro as a Global Currency

 Trade Liberalization and Economic Integration

 Privatization

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 Emergence of Globalized Financial Markets
 Deregulation of Financial Markets
 27 Oct, 1986 “big bank” elimination of fixed brokerage commissions in LSE like May Day in 1975 in the US
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

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 Emergence of Globalized Financial Markets
 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)

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 Emergence of the Euro as a Global Currency
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.

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 Euro Area (Mundell, OCA)

 Austria,  Ireland,
 Belgium,  Italy,
 Luxembourg,
 Cyprus,
 Malta,
 Finland,  The Netherlands,
 France,  Portugal,
 Germany,
 Slovenia,
 Spain
 Greece,
 Slovakia ( 1
Ocak 1999)

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 Value of the Euro in U.S. Dollars

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 Economic Integration
 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.)

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 Liberalization of Protectionist Legislation
 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).

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 NAFTA
 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.

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 Privatization
 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 cross-border
investment.
 Benefits: brings hard currency to pay debts+increase in the
productivity

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 Multinational Corporations
 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.

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 Top 10 MNCs
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

1-31
 Multinational Corporations
 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.

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 End Chapter One

…the following slides cover the appendix to

chapter 1.

1-34
 The Theory of Comparative Advantage
(comparative vs. relative advantage)
 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
 Free trade between nations
 Factors of production (land, labor, technology, and capital)
are relatively immobile.

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 The Geometry of Comparative Advantage
 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.

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 The Geometry of Comparative Advantage
Textiles 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.
180 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.
Food
300 Country A can produce any combination of
food and textiles between these two points.
1-37
 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

1-38
 The Geometry of Comparative Advantage
Textiles
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
240
into the production of food, they could produce as much
180 as 900 million pounds of food.

60
Food
200 300 900 1,200

1-39
 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
200 300 600 900 1,200

1-40
 The Geometry of Comparative Advantage
Textiles 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
240 at a lower rate than A when making more food.
180 Geometrically, a comparative advantage exists
80 because the slopes of the production
60 possibilities differ.
Food
200 300 600 900

1-41
 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
200 300 600 900

1-42
 The Geometry of Comparative Advantage
Textiles Before trade, if both countries made only textiles, the
combined production would be 420 million yards of
textiles = 240 + 180.
420 Before trade, if both countries made only food, the
combined production would be 1,200 million
pounds of food = 900 + 300.
240
180

80
60
Food
200 300 600 900 1,200

1-43
 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
200 300 600 900 1,200

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 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
200 300 600 800 900 1,200

1-45
 The Geometry of Comparative Advantage
Textiles County B can produce food at a lower opportunity cost, so
let B produce the first 900 million pounds of food.

420 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
200 300 600 800 900 1,200

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 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
200 300 600 800 900 1,200

1-47
 The Geometry of Comparative Advantage
Textiles
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
420 the pre-trade consumption.

240
180
140
80
60
Food
200 300 600 800 900 1,200

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 Arguments in Favor of Free Trade
 Both partners gain from trade: we have more
material goods.
 “Freedom” in a good thing in itself.
 In this case consumers freedom to choose imported
goods and producers freedom to choose to sell to
foreigners.

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 End Appendix One

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