8/10/2019 AFC3240 Topic 01 S2 2010

1/18

1

AFC3240 International FinanceTopic 1: Multinational Enterprise and

Multinational Financial Management(Shapiro, Chapter 1)

Financial Management is concerned withmaking optimal financing and investmentdecisions.

International Financial Management= Domestic Financial Management

+ International issues

8/10/2019 AFC3240 Topic 01 S2 2010

2/18

2

WHAT IS INTERNATIONAL FINANCIALMANAGEMENT?

Foreign Exchange Risk Political Risk Market Imperfections Expanded Opportunity Set

8/10/2019 AFC3240 Topic 01 S2 2010

3/18

3

Foreign Exchange Risk The risk that foreign currency profits may

evaporate due to unanticipated unfavorableexchange rate movements. Eg., assume an

Australian exporter has US$100,000

receivables in six months. Say, the currentexchange rate is A$1.00 = US$0.9000.

What will happen if A$ appreciates to

US$1.0000? What will happen if A$ depreciates toUS$0.8000?

8/10/2019 AFC3240 Topic 01 S2 2010

4/18

4

Political Risk Sovereign governments have the right to

regulate the movement of goods, capital,and people across their borders.

These laws sometimes change inunexpected ways. For example:- Implementation of capital control

- Restrictions on foreign direct investment(FDI).

8/10/2019 AFC3240 Topic 01 S2 2010

5/18

5

Market Imperfections

- Legal restrictions on movement ofgoods, people, and money

- Transactions costs

- Shipping costs- Tax arbitrage possibilities

8/10/2019 AFC3240 Topic 01 S2 2010

6/18

6

Expanded Opportunity Set Globally, there are much more opportunities

as compared to a single country. At timesthe opportunities may be to exploit themarket imperfections. Does it make senseto invest in your home country alone if youhave better opportunities elsewhere? True for corporations as well as individual

investors. True for direct investment as well as

portfolio investments.

8/10/2019 AFC3240 Topic 01 S2 2010

7/18

7

Emergence of Globalized FinancialMarkets

Deregulation of financial markets andadvances in technology have greatly reducedinformation and transactions costs.

We notice Financial Innovations, such as: Cross-border stock listings International mutual funds Currency futures and options

Multi-currency bonds Internet trading of securities issued in

foreign countries.

8/10/2019 AFC3240 Topic 01 S2 2010

8/18

8

Economic Integration Evidence shows substantial increase in the

ratio of merchandise exports to GDP For some countries, international trade has

grown much faster than others. Eg, China,

India, Brazil, South Korea, compared to theUS. Overall, over the past 50 years, international

trade increased about twice as fast as worldGDP

8/10/2019 AFC3240 Topic 01 S2 2010

9/18

9

Trade Liberalization A big change in the attitudes of many of the

worlds governments. Even, once -protectionist countries are now pursuing free-market and open-economy policies

There are International trade organizations andagreements:- WTO (World Trade Organization) is an

international organization that has thepower to enforce the rules of internationaltrade.

8/10/2019 AFC3240 Topic 01 S2 2010

10/18

10

- GATT (General Agreement on Tariffs andTrade) is a multilateral agreement amongmember countries that has reduced manybarriers to trade.

- Bilateral Free Trade agreements

Privatization The selling off state-run enterprises to investors.

Also known as Denationalization. By most estimates, privatisation increases the

efficiency of the enterprises. Often spurs a tremendous increase in cross-

border investment.

8/10/2019 AFC3240 Topic 01 S2 2010

11/18

11

THE CLASSICAL THEORY OFINTERNATIONAL TRADE

Also known as the doctrine of comparativeadvantage. First developed by Adam Smithand David Ricardo, this theory says that:

It is mutually beneficial for countries if theyspecialize in the production of those goodsthey can produce most efficiently and tradethose goods among them. (Shapiro, page 4,53-56)

(see tutorial question for a typical example ofthe principle of comparative advantage)

8/10/2019 AFC3240 Topic 01 S2 2010

12/18

12

An important implication is that liberalization ofinternational trade will enhance the welfare ofthe worlds citizens. Is this a valid argument? Why an opposition

to globalization? Limitations

This theory assumes that goods andservices are internationally movable, butfactors of production (e.g. capital, labor andland) are immobile.

Ignores the roles of uncertainty,transportation costs etc.

8/10/2019 AFC3240 Topic 01 S2 2010

13/18

13

THE RISE OF THE MULTINATIONALCORPORATIONS (MNCs)

MNCs supercede theory mobility of factors, e.g. capital, labor are

mobile better position to exploit the different

costs/skills between nations prime transmitter of competitive forces

8/10/2019 AFC3240 Topic 01 S2 2010

14/18

8/10/2019 AFC3240 Topic 01 S2 2010

15/18

15

Main reasons to go Global

To seek raw materials exploit markets in other countries;historically first to appear. E.g. British

Petroleum To seek more markets

produce and sell in foreign markets; heavyforeign direct investors. E.g. Nestle, CocaCola

To minimize costs of production seek lower-cost production abroad with a

motive to remain cost competitive. E.g.Texas Instruments

8/10/2019 AFC3240 Topic 01 S2 2010

16/18

16

MULTINATIONAL FINANCIALMANAGEMENT

Characteristics of an effective global manager Understands political and economic

differences among nations; Searches for most cost- effective suppliers; Responds quickly to changes that may

affect the value of the firm so on.

8/10/2019 AFC3240 Topic 01 S2 2010

17/18

17

Objectives of a firm may be one or acombination of:

Maximisation of shareholders wealth Maximisation of share price Maximisation of accounting profits

Maximisation of sales Minimisation of costs Minimisation of risk

Maximisation of resource utilisation Social responsibility, employee welfare,etc

8/10/2019 AFC3240 Topic 01 S2 2010

18/18

18

What goal should an effective globalmanager be working toward?

Maximization of shareholder wealth orsome other goals? In some countries shareholders are

viewed as merely one among manystakeholders of the firm, e.g. employees,suppliers, customers.