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
Whats Special about International Finance?
Goals for International Financial Management
Globalization of the World Economy
Multinational Corporations
Organization of the Text
Summary

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 Initially, MNC firms may merely attempt to export products
to a particular country or import supplies from a foreign
manufacturer. Over time, however, many of them recognize
additional foreign opportunities and eventually establish
subsidiaries in foreign countries.
Dow Chemical, IBM, Nike, and many other firms have more
than half of their assets in foreign countries. Some
businesses, such as ExxonMobil, Fortune Brands, and
Colgate-Palmolive, commonly generate more than half of
their sales in foreign countries.
A prime example is the Coca-Cola Co., which distributes its
products in more than 160 countries and uses 40 different
currencies. Over 60 percent of its total annual operating
income is typically generated outside the United States.
 Whats Special about
International Finance?
Foreign Exchange Risk
Political Risk

Market Imperfections

Expanded Opportunity Set

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 Whats Special about International
Finance?
Foreign Exchange Risk
The risk that foreign currency profits may evaporate in
Rupee terms due to unanticipated unfavorable exchange
rate movements.
Suppose $1 = Rs. 60 and you buy 1000 shares of Toyota at
$ 100 per share. Investment of $ 1,00,000(Rs. 60,00,000).
One year later the investment is worth ten percent more in
$ 1,10,000.
But, if the $ has depreciated to $1 = 54 Rs., your
investment has actually lost money in rupees terms. Rs.
59,40,000. ($1,10,000*54)
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 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.
Enron Development Corporation had invested $300
million in Maharashtra for a power project. In 1995
Shivsena had rejected a project and company faced a loss.
The largest Russian oil company Yukos was forced to
declared bankrupt after the arrest of Mikhail
Khodorkovsky.

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 Whats Special about
International Finance?
MarketImperfections
Legal restrictions on the movement of goods,
people, and money
Transactions costs
Shipping costs

Tax arbitrage

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 The Example of Nestls Market Imperfection
Nestl
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.
The bearer stock was more expensive.
On November 18, 1988, Nestl lifted restrictions
imposed on foreigners, allowing them to hold
registered shares as well as bearer shares.

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 Nestls 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 Nestls 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 Nestl bearer shares were
exposed to political risk in a country that is widely
viewed as a haven from such risk.
The Nestl episode illustrates both the importance
of considering market imperfections and the peril of
political risk.

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 Whats Special about
International Finance?
Expanded Opportunity Set
It doesnt make sense to play in only one corner of the
sandbox.
True for corporations as well as individual investors.

MNCs such as the Gap and Nike often capitalize on a foreign

countrys resources.
Some countries, such as Japan and the United States, have a
technology advantage. MNCs such as Oracle, Intel, and IBM
have grown substantially in foreign countries because of their
technology advantage

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 Goals for International Financial
Management
Maximization of shareholder wealth?
or
Other Goals?
Shareholoder wealth Maximization means that the firm
makes all business decisions and investments with an eye
towards making the owner of the firms better off
financially, or more wealthy, than they were before.
Japanese companies prefer to maximise market share,
rather than shareholder wealth.
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 Maximize Shareholder Wealth
Long accepted as a goal in the Anglo-Saxon
countries like Australia, Canada and UK, 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 keiretsua family of firms to which the
individual firms belongs.

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 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 firms management and its
shareholders.

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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
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 coupled with
Advances in Technology
have greatly reduced information and
transactions costs, which has led to:
Financial Innovations, such as
Currency futures and options
Multi-currency bonds
Cross-border stock listings IBM, GM, Toyota, Fiat, KLM
International mutual funds

On October 27, 1986 London had deregulated the market. LSE had
eliminated fixed brokerage commission.
In Europe FI are allowed to perform role of investment banking and
commercial banking
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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 15
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. dollars in the near future.
Currently there are 28 nations in EU.

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Euro Area - The EU was not always as big as it is today. When
European countries started to cooperate economically in 1951, only
Belgium, Germany, France, Italy, Luxembourg and the Netherlands
participated.
Poland
Austria, Germany,
Portugal,
Belgium, Greece,
Romania
Bulgaria Hungary
Slovakia
Croatia Ireland,
Slovenia,
Czech Italy,
Republic Spain
Latvia
Cyprus, Sweden
Lithuania
Denmark UK
Luxembourg,
Estonia Malta,
Finland The
France Netherlands,
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Value of the Euro in U.S. Dollars
 What is Brexit?
A referendum will be held on Thursday, June 23, to decide
whether Britain should exit (Britain's exit, hence the term Brexit)
or remain in the European Union.
Referendum are votes in which everyone (or nearly everyone) of
voting age can take part, normally giving a 'Yes' or 'No' answer
to a question. The side which gets more than half of all votes cast
is declared a winner.
Britain will not able to continue its 63% foreign trade freely.
Financial services will affected more in short term. Need to
depend on developing nations.
Need to change rules and regulations of export and import from
EU nations.
 The Leave Campaign argues that Britain is losing out a big deal by
staying in the EU: it has to pay millions of pounds each week as a
contribution to the European budget; the extremely bureaucratic
nature of the European parliament is hurting British exporters; and
finally, that unmitigated migration from the European Union into
Britain is creating an imbalance in the welfare schemes of the UK
government.
If Brexit does happen, global financial market volatility can be
readily expected. Markets across the world will tank. The pound will
depreciate against most major economies. India cannot remain
immune to this. Sensex and Nifty will tumble in the short-run.
India is presently the second biggest source of FDI (Foreign Direct
Investment) for Great Britain. Indian companies that would set up
their factories in the UK could sell their products to the rest of
Europe under the European free market system. However, if Britain
exits the EU, it will not be as attractive a destination for Indian FDI
as before.
 Britain is one of the most important destinations for Indians who
want to study abroad. Presently, British universities are forced to
offer subsidized rates for citizens of the UK and EU. With Brexit,
however, the universities will no longer be obliged to provide
scholarships to EU citizens, which will free up funds for students
from other countries.
The Sensex opened lower by 635 points and went down by 1,091
points before bottom fishing brought some stability. Even as the
index recovered 486 points from the day's low, it still closed the
day with a deep cut of 605 points or 2.24%.
 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 worlds governments who have
abandoned mercantilist views and embraced free
trade as the surest route to prosperity for their
citizenry.

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 Liberalization of Protectionist Legislation
The General Agreement on Tariffs and Trade
(GATT) a multilateral agreement among member
countries has reduced many barriers to trade.
The World Trade Organization 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.

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 NAFTA
The North American Free Trade Agreement
(NAFTA) calls for phasing out impediments 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.
Theory of Comparative advantage.

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 Privatization
The selling off state-run enterprises to investors is
also known as Denationalization.
Often seen in socialist economies in transition to
market economies.
By most estimates this increases the efficiency of
the enterprise.
Often spurs a tremendous increase in cross-border
investment.

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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 Elctricit de France France

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