Chapter 1

Multinational
Financial
Management:
Opportunities and
Challenges

The Multinational Enterprise

(MNE)
Have operations in more than one country
Include for profit, non-profit firms, and NGOs
Reliance on emerging markets for
New world markets:
BRICs (Brazil, Russia, India, and China)
BIITS (Brazil, India, Indonesia, Turkey, and South Africa)
MINTs (Mexico, Indonesia, Nigeria, and Turkey)

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Exhibit 1.1 Global Capital

Markets

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The Global Financial

Marketplace
Links among three items
Assets Government-issued debt securities
Institutions
Central banks
Commercial banks
Other financial institutions
Linkages the interbank networks that provide the
actual medium for exchange e.g. LIBOR

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The Market for Currencies

Foreign currency exchange rate is the price of any
one countrys currency in terms of another
countrys currency
US Dollar ($ or USD) / European euro ( or EUR)
exchange rate stated as 1.3654 dollars per euro
or as $1.3654/

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The Market for Currencies

Rates quoted in exhibit 1.2 are currency midrates because they are midway between the
average bid and offer rates among currency
traders
Most currency quotes follow a convention as a
result of some history or tradition
E.g., euros per dollar and dollars per pound

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Eurocurrencies and LIBOR

Eurocurrencies
Eurocurrencies are domestic currencies of one country on
deposit in a second country
Any convertible (exchangeable) currency can exist in
Euro- form (do not confuse this term with the European
Euro)
Eurocurrency markets serve two valuable purposes
Money market device for excess corporate liquidity
Source of short-term bank loans

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Eurocurrencies and LIBOR

The modern eurocurrency market was born shortly
after World War II
Eastern European fear of US banks led to deposits in
Western Europe
While economic efficiencies helped spurn the growth
of this market, institutional events were also
important

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Eurocurrencies and LIBOR

Eurocurrency Interest Rates: LIBOR
Reference rate of interest is LIBOR- The London
Interbank Offered Rate
Used in standardized quotations, loan agreements, or
financial derivatives valuations
Officially defined by the British Bankers Association
U.S. dollar LIBOR is the mean of 16 multinational banks
interbank offered rates as sampled at 11am London time
in London
Yen LIBOR, EURO LIBOR and all other LIBOR rates are calculated the
same way

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The Theory of Comparative

Advantage
The theory of competitive advantage provides a
basis for explaining and justifying international
trade in a model assumed to enjoy

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Free trade
Perfect competition
No uncertainty
Costless information
No government interference

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The Theory of Comparative

Advantage
The features of the theory are as follows;
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 As
endowment of factors of production (land, labor, capital,
and technology)
Country B does the same with different products (based
on different factors of production)

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The Theory of Comparative

Advantage
Because the factors of production cannot be transported,
the benefits of specialization are realized through
international trade
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
Example: assume Thailand is more efficient than
Brazil at producing both sports shoes and stereo
equipment
With one unit of production (a mix of land, labor,
capital, and technology), Thailand can produce
either 12 shipping containers of shoes or 6
shipping containers of stereo equipment
Brazil, being less efficient in both, can produce
only 10 containers of shoes or 2 containers of
stereo equipment with one unit of input

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The Theory of Comparative

Advantage
A production unit in Thailand has an absolute
advantage over a production unit in Brazil in both
shoes and stereo equipment
Thailand has a larger relative advantage over Brazil
in producing stereo equipment (6 to 2) than shoes
(12 to 10)
As long as these ratios are unequal, comparative
advantage exists

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The Theory of Comparative

Advantage
Clearly the world in total is better off because
there are now 10,000 containers of shoes plus
6,000 containers of stereo equipment
However, the goods are not distributed across
international boundaries!
Trade can resolve that distribution problem

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The Theory of Comparative

Advantage
While total production of goods has increased with
the specialization process, international trade at a
certain range of prices (containers of shoes for a
container of stereo equipment) can distribute
goods between the countries
This exchange ratio will determine how the output
is distributed

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The Theory of Comparative

Advantage
Although international trade might have
approached the comparative advantage model
during the 19th century, it certainly does not today;
Countries do not appear to specialize only in those
products that could be most efficiently produced by that
countrys particular factors of production
Capital and technology flow easily between countries
Modern factors of production are numerous
Comparative advantage shifts over time

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The Theory of Comparative

Advantage
Comparative advantage still explains why some
countries are better for export
21st century comparative advantage is based on
services

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Exhibit 1.3 What is Different About

International Financial Management?

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Market Imperfections: A Rationale

for the Existence of the MNE
Firms become multinational for one or several of
the following reasons:

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Market seekers
Raw material seekers
Production efficiency seekers
Knowledge seekers
Political safety seekers

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The Globalization Process

The globalization process is the structural and
managerial changes and challenges experienced
by a firm as it moves from domestic to global in
operations
We will examine the case of Trident
Tridents initial strategy is to develop a sustainable
competitive advantage in the U.S. market
Trident is currently constrained by its small size, other
competitors, and lack of access to cheap capital

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Exhibit 1.4 Trident Corp: Initiation

of the Globalization Process

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The Globalization Process

In Phase One, Trident is not itself international or
global in its operations
However, some of its competitors, suppliers or
buyers may be
This is one of the key drivers pushing Trident into
Phase Two, the first transition of the globalization
process
This is the Global Transition I: from The Domestic
Phase to The International Trade Phase

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The Globalization Process

In the International Trade Phase, Trident responds
to globalization factors by importing inputs from
Mexican suppliers and making exports sales to
Canadian buyers
Exporting and importing products and services
increases the demands of financial management
over and above the traditional requirements of the
domestic-only business

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The Globalization Process

First, direct foreign exchange risks are now borne
by the firm
Pricing and payments may be in different currencies
The value of these foreign currency receipts and
payments can change, creating a new source of risk

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The Globalization Process

Second, the evaluation of the credit quality of
foreign buyers and sellers is now more important
than ever; this is known as credit risk
management
Potential for non-payment of exports and non-delivery of
imports
Differences in business and legal systems and practices

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The Globalization Process

If Trident is successful in its international trade
activities, it will soon need to establish foreign
sales and service affiliates
This step is often followed by establishing
manufacturing operations abroad or by licensing
foreign firms to produce and service Tridents
products
This is the Global Transition II: from The
International Trade Phase to The Multinational
Phase

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Exhibit 1.5 Tridents Foreign

Direct Investment Sequence

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The Globalization Process

Tridents continued globalization will require it to
identify the sources of it competitive advantages
This variety of strategic alternatives available to
Trident is called the foreign direct investment
sequence which include the creation of foreign
sales offices, licensing agreements,
manufacturing, etc.

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The Limits to Financial

Globalization
Once Trident owns assets and enterprises in
foreign countries it has entered the multinational
phase of globalization
The growth in the influence and self-enrichment of
corporate insiders
The next exhibit illustrates the agency problems

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Exhibit 1.6 The Potential Limits

of Financial Globalization

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