Multinational Business Finance
Sixteenth Edition
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
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The Multinational Enterprise (MN E)
• M NE s have operations in more than one country and conduct
their business through branches, foreign subsidiaries, or joint
ventures with host country firms.
• It is now possible for digital startups to become M NE s in
hours.
• The most challenging competitors are arising from emerging
markets.
• Managers and leaders all over the world to identify and
navigate the prospective returns and risks of the global
financial marketplace.
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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
The global capital market is a collection of institutions (central banks,
commercial banks, investment banks, not-for-profit financial institutions like
the I M F and World Bank) and securities (bonds, mortgages, derivatives,
loans, etc.), which are all linked via a global network—the Interbank Market.
This interbank market is the critical pipeline system for the movement of
capital.
For long description, see slide 31: App
endix 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 use currencies, bases its pricing through the single most widely
quoted interest rate in the world—L I B O R (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 (I S O-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.
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Exhibit 1.2 (1 of 4)
Selected Global Currency Exchange Rates for June 18, 2021
Country Currency Symbol Code Currency to Currency to Currency to
equal 1 Dollar equal 1 Euro equal 1 Pound
Argentina nuevo peso Ps AR S 95.3800 113.1875 131.8533
Australia dollar A$ AU D 1.3342 1.5833 1.8444
Brazil real R$ BR L 5.0522 5.9949 6.9800
Canada dollar C$ CA D 1.2406 1.4722 1.7150
Chile peso $ CL P 743.68 882.53 1,028.06
¥
Yen
China yuan CN Y 6.4500 7.6542 8.9165
Czech Republic koruna Kc CZ K 21.5280 25.5470 29.7600
Denmark krone Dkr DK K 6.2649 7.4346 8.6606
€
Euro
Eurozone euro EU R 0.8424 1.0000 1.1645
Hong Kong dollar HK$ HK D 7.7643 9.2116 10.7295
Hungary forint Ft HU F 299.730 355.760 414.240
India rupee Rs IN R 74.083 87.914 102.412
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Exhibit 1.2 (2 of 4)
Selected Global Currency Exchange Rates for June 18, 2021
Country Currency Symbol Code Currency to Currency to Currency to
equal 1 Dollar equal 1 Euro equal 1 Pound
Indonesia rupiah Rp ID R 14,495.25 17,052.88 19,865.09
Israel shekel Shk IL S 3.2795 3.8889 4.5266
¥
Yen
Japan yen JP Y 110.38 130.99 152.59
Kuwait dinar KD KW D 0.2971 0.3524 0.4104
Malaysia ringgit RM MY R 4.1370 4.9123 5.7190
Mexico new peso $ MX N 20.6905 24.5534 28.6025
Morocco dirham DH MA D 8.7967 10.4350 12.1501
New Zealand dollar NZ$ NZ D 1.4397 1.7095 1.9905
Norway krone NKr NO K 8.6678 10.2861 11.9824
Pakistan rupee Rs PK R 153.1770 181.7477 211.5997
Philippines peso ? PH P 47.8400 56.7228 66.0317
Peru new sol Sl PE N 3.7814 4.4856 5.2229
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Exhibit 1.2 (3 of 4)
Selected Global Currency Exchange Rates for June 18, 2021
Country Currency Symbol Code Currency to Currency to Currency to
equal 1 Dollar equal 1 Euro equal 1 Pound
Poland zloty zl PL N 3.8335 4.5519 5.3002
Russia ruble R RU B 72.4350 86.0093 100.1470
Saudi Arabia riyal — SA R 3.7117 4.4009 5.1231
Singapore dollar S$ SG D 1.3441 1.5960 1.8584
South Africa rand R ZA R 14.2702 16.9344 19.7271
South Korea won W KR W 1,134.93 1,347.12 1,568.35
Sweden krona SKr SE K 8.6176 10.2310 11.9147
Switzerland franc Fr. CH F 0.9217 1.0938 1.2742
Taiwan dollar T$ TW D 27.8020 33.0121 38.4390
Thailand baht B TH B 31.4700 37.3675 43.5100
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Exhibit 1.2 (4 of 4)
Selected Global Currency Exchange Rates for June 18, 2021
Country Currency Symbol Code Currency to Currency to Currency to
equal 1 Dollar equal 1 Euro equal 1 Pound
Turkey lira YTL TR Y 8.7136 10.3465 12.0474
United Arab Emirates dirham — AE D 3.6726 4.3583 5.0770
£
Pound
United Kingdom pound GB P 0.7236 0.8582 1.0000
United States dollar $ US D 1.0000 1.1867 1.3824
Vietnam dong d VN D 22,450.00 26,618.45 30,986.89
Note that a number of different currencies use the same symbol. (For example, both
China and Japan have traditionally used the ¥ symbol, yen or yuan, meaning “round”
or “circle.”) All quotes are mid-rates and are drawn from the Financial Times.
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Percentage Change in Spot Exchange
Rates
• Percentage change can be calculated based on foreign or
home currency price.
• Foreign Currency Terms
Begin rate End rate
% 100
End rate
• Home Currency Terms
End rate Begin rate
% 100
Begin rate
For long description, see slide 34: Appendix 2
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Financial Globalization and Risk (1 of 2)
• Back in the halcyon pre-crisis days of the late 20th and early
21st centuries, it was taken as self-evident that financial
globalization was a good thing. But the subprime crisis and
Eurozone dramas are shaking that belief…[W]hat is the bigger
risk now—particularly in the Eurozone—is that financial
globalization has created a system that is interconnected in
some dangerous ways.
—“Crisis Fears Fuel Debate on Capital Controls”
Financial Times, December 15, 2011
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Financial Globalization and Risk (2 of 2)
• Risks must be explored, considered, and managed
– International monetary system is under constant scrutiny
– Large fiscal deficits can result in negative interest rates
– Exchange rates are constantly in flux
– Ownership and governance vary dramatically across the
world, particularly for the privately held or family-owned
business
– Global capital markets have become less open and
accessible
– Increasingly complicating financial management with capital
flows
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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 LI BO R.
– Oftentimes a low spread exists with deposit and loan rates.
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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
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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
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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
M NE s 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
(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
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Exhibit 1.3
What Is Different About International Financial Management?
Concept International Domestic
Culture, history, and Each foreign country is unique and not Each country has a known base
institution always understood by MN E management case
Corporate governance Foreign countries’ regulations and Regulations and institutions are
institutional practices are all uniquely well known
different
Foreign exchange risk MNE s face foreign exchange risks due to Foreign exchange risks from
their subsidiaries, as well as import/export and foreign
import/export and foreign competitors competition (no subsidiaries)
Political risk MNE s face political risk because of their Negligible political risks
foreign subsidiaries and high profile
Modification of domestic MNE s 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 MNE s utilize modified financial Limited use of financial instruments
financial instruments instruments such as options, forwards, and derivatives because of few
swaps, and letters of credit foreign exchange and political risks
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Market Imperfections: A Rationale for
the Existence of the Multinational Firm
(1 of 2)
• M NE s 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 M NE s.
• 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
(2 of 2)
• Strategic motives drive the decision to invest abroad and
become a M N E 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)
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Exhibit 1.4
Ganado Corp: Initiation of the Globalization Process
For long description, see slide 35: Appendix 3
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Exhibit 1.5
Ganado’s Foreign Direct Investment Sequence
For long description, see slide 36: Appendix 4
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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, se
e slide 37: Appendix 5
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 6
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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Appendix 1
Long Description for Exhibit 1.1
The diagram shows the global capital markets and the London
Interbank Market or LI BO R trading various kinds of securities.
The Interbank market, with an inverse triangle titled currency,
links the various banks. The bank on the left branches to
mortgage loan, corporate loan, and corporate bond. The bank on
the right branches to public debt, private debt, and private equity.
The bank at the bottom branches to central banks and
institutions.
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Appendix 2
Long Description for equation
Foreign currency terms show percentage delta equals fraction
numerator begin rate minus end rate over denominator end rate,
the whole multiplied by 100.
Home currency terms show percentage delta equals fraction
numerator end rate minus begin rate over denominator begin
rate the whole multiplied by 100.
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Appendix 3
Long Description for Exhibit 1.4
The diagram represents the globalization process as occurring in
two phases. Phase 1 consists of domestic operations. The
domestic U.S. suppliers provide materials to Ganado
Corporation in Los Angeles, California, and Ganado sends
products to U.S. buyers, who represent the domestic customers.
Phase 1 involves all U.S. dollar-denominated transactions under
U.S. credit laws and practices. Phase 2 consists of expansion
into international trade. Ganado receives materials from
international suppliers in Mexico, and Ganado sends products to
international customers in Canada. Ganado must determine if
transactions will be carried out in the Mexican peso, Canadian
dollar, or U.S. dollar. Ganado must also determine if suppliers
and customers are creditworthy.
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Appendix 4
Long Description for Exhibit 1.5
Ganado’s foreign direct investment sequence consists of five stages. Each
new stage requires greater foreign investment, which requires putting more
and more capital at risk. Each new stage also requires a greater foreign
presence, which requires a higher level of managerial intensity. During each
stage, Ganado has two alternatives. The following list outlines the five stages.
For each stage, the alternatives are in order of increasing foreign presence.
First stage: Change competitive advantage or exploit existing advantage
abroad. Second stage: Exploit an existing advantage abroad by exporting
goods produced at home or having production abroad. Third stage: Start
production abroad through licensed manufacturing or by controlling and
owning assets abroad. Fourth stage: Control and own assets abroad through
a joint venture or through a wholly owned subsidiary. Fifth stage: Launch a
wholly owned subsidiary through greenfield investment or through acquisition
of a foreign enterprise.
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Appendix 5
Long Description for Exhibit 1.6
The table for sales has columns for the following values from left to right: country, currency, sales
in millions of the local currency, average exchange rate, sales in millions of U.S. dollars, and
percent of total. The table reads as follows. Row 1. Country, United States. Currency, U.S. dollar.
Sales in Local Currency, 300. Average Exchange Rate, blank. Sales in U.S. Dollars, 300.
Percentage of Total, 57. Row 2. Country, Europe. Currency, European euro. Sales in Local
Currency, 120. Average Exchange Rate, 1.12 dollars is equal to 1 euro. Sales in U.S. Dollars,
134.4. Percentage of Total, 26. Row 3. Country, China. Currency, Chinese renminbi. Sales in
Local Currency, 600. Average Exchange Rate, renminbi 6.60 is equal to 1 dollar. Sales in U.S.
Dollars, 90.9. Percentage of Total, 17. Row 4. Country, Totals. Currency, blank. Sales in Local
Currency, blank. Average Exchange Rate, blank. Sales in U.S. Dollars, 525.3. Percentage of
Total, 100. The table for earnings has columns for the following values from left to right: country,
currency, earnings in millions of the local currency, average exchange rate, earnings in millions of
U.S. dollars, and percent of total. The table reads as follows. Row 1. Country, United States.
Currency, U.S. dollar. Earnings in Local Currency, 28.6. Average Exchange Rate, blank. Earnings
in U.S. Dollars, 28.6. Percentage of Total, 0.56. Row 2. Country, Europe. Currency, European
euro. Earnings in Local Currency, 10.5. Average Exchange Rate, 1.12 dollars is equal to 1 euro.
Earnings in U.S. Dollars, 11.8. Percentage of Total, 0.23. Row 3. Country, China. Currency,
Chinese renminbi. Earnings in Local Currency, 71.4. Average Exchange Rate, renminbi 6.60 is
equal to 1 dollar. Earnings in U.S. Dollars, 10.8. Percentage of Total, 0.21. Row 4. Country, Totals.
Currency, blank. Earnings in Local Currency, blank. Average Exchange Rate, blank. Earnings in
U.S. Dollars, 51.2. Percentage of Total, 100.
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Appendix 6
Long Description for Exhibit 1.7
A rectangle in the middle is labeled, “The Twin Agency Problems Limiting
Financial Globalization.” The bottom-left corner of the rectangle is labeled
“Lower Firm Value (possibly higher insider value).” The top-right corner of the
rectangle is labeled, “Higher Firm Value (possibly lower insider value).” The
top-left corner of the rectangle is labeled, “Actions of Rulers of Sovereign
States.” The bottom right corner of the rectangle is labeled, “Actions of
Corporate Insiders.” Two arrows extend from Lower Firm Value along the
edges of the rectangle. The first arrow extends upward from Lower Firm
Value to Actions of Rulers of Sovereign States. The second arrow extends
rightward from Lower Firm Value to Actions of Corporate Insiders. Two arrows
extend from Higher Firm Value along the edges of the rectangle. The first
arrow extends downward from Higher Firm Value to Actions of Corporate
Insiders. The second arrow extends leftward from Higher Firm Value to
Actions of Rulers of Sovereign States.
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