BF 464: International Finance

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BF 464 International Finance

• Instructor M. Nihat Solakoglu
• Office LC105
• Email nsolakoglu_at_bilkent.edu.tr
• Office Phone [phone]

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Why is IF important?

• Will GE India Unit Catch Eyes of Citi, B of
  A?By  Will WadeAmerican Banker , September 20,
  2004Bank of America Corp. and Citigroup Inc. may
  emerge as bidders for a big Indianoutsourcing
  operation that General Electric Co. is said to be
  trying to sell.
• ....
• The Wall Street Journal reported Friday that GE
  is hoping to sell all or part of GE Capital
  International Services, and that the price tag
  could reach 1billion. The operation has 12,000
  employees in India and 5,000 in Hungary, Mexico,
  and China.

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Why is IF important?

• What does this mean for us?
• Markets at Risk for Additional Shocks (WSJ
  021108)
• By Michael M. Phillips and Yuka Hayashi TOKYO --
  Global financial markets may suffer a relapse
  into the turmoil sparked by last year's collapse
  of securities backed by U.S. subprime mortgages,
  the world's top banking authorities warned.
• The U.S. Federal Reserve and other central banks
  have pumped enough money into the banking system
  to help alleviate the worst of the initial phase
  of the credit crunch, and major banks have now
  accounted for tens of billions of dollars in
  losses that had been moldering in
  off-balance-sheet entities. But the U.S.-led
  economic slowdown and continued uncertainty about
  securities may lead banks to further reduce
  lending and choke off ...

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Why is IF important?

• US Federal Reserve verdict to set markets toneBy
  Chris Flood (Financial Times)
• Published September 19 2004 1728 Last
  updated September 19 2004 1728
• The central event for investors worldwide will
  be tomorrows meeting of the Federal Open Markets
  Committee, where US interest rates are widely
  expected to be increased to 1.75 per cent from
  1.5 per cent.
• Philip Shaw of Investec, the banking group, said
  All eyes will be trained on the accompanying
  statement to see whether the FOMC hints at a rate
  pause before the end of the year.

Sterling slips on soft housing dataBy Steve
Johnson in London (Financial Times) Published
September 20 2004 1128 Last updated September
20 2004 1128Sterling weakened in European
morning trade on Monday amid fresh signs that the
UK housing market is slowing. ....... This adds
to the case for the Bank of England leaving rates
unchanged for at least another month, said James
Knightley, economist at ING Financial Markets.
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Why is IF important?

• Europeans still take a dim view of the euro
• By Ralph Atkins in Frankfurt (Financial Times
  Jan 29th, 2007)
• An overwhelming majority of citizens in the big
  eurozone countries believe the euro has damaged
  their national economies, highlighting the
  popular scepticism that still surrounds Europes
  eight-year-old monetary union.
• More than two-thirds of the French, Italians and
  Spanish and more than half of Germans believe
  the single currency has had a negative impact,
  according to an FT-Harris poll. In France, just 5
  per cent said the euro has had a positive effect
  on the French economy.

Yen and sterling share the spotlight By Peter
Garnham Published January 26 2007 1111 Last
updated January 26 2007 1703 The yen and
sterling shared the spotlight this week as
speculation over the future path of interest
rates in Japan and the UK drove the currency
markets. Early in the week, the yen fell to a
near-four year low against the dollar, an
all-time low against the euro and a fourteen-year
low against the pound. The yen also dropped to a
nine-year low against the Australian
dollar. Analysts said the decision by the Bank of
Japan to leave interest rates on hold at 0.25 per
cent earlier in the month still weighed on the
Japanese currency as investors continued to put
on carry trades funding long positions in
high-yielding currencies by selling the
low-yielding yen.
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INTRODUCTIONTHE RISE OF THE MULTINATIONAL
CORPORATION

• Today, companies operate within a global
  marketplace and faces with global competitors.
• I. The MNC
• A. Definition
• a company with production and distribution
  facilities in more than one country. Ordinarily,
• - a parent company at home country and
• - multiple foreign subsidiaries

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INTRODUCTIONTHE RISE OF THE MULTINATIONAL
CORPORATION

• Most MNE activity can be classified into two
  major categories (1) trade (exports and
  imports) and (2) foreign direct investment
  (FDI) 80 of all FDI is made by the worlds
  largest 500 MNEs

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INTRODUCTIONTHE RISE OF THE MULTINATIONAL
CORPORATION

• Trade consists of exports and imports
• Exports Goods and services produced in one
  country and then sent to another country
• Imports Goods and services produced in one
  country and bought in another country
• Foreign Investment Consists of companies
  investing funds to start or improve operations in
  another country.

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INTRODUCTIONTHE RISE OF THE MULTINATIONAL
CORPORATION (2002 values)
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THE RISE OF THE MULTINATIONAL CORPORATION

• FDI is the ownership and control of foreign
  assets.
• FDI usually involves the ownership, whole or
  partially, of a company in a foreign country a
  foreign subsidiary.
• FDI is different from portfolio investment, which
  is the purchase of financial securities in other
  firms for the purpose of realizing a financial
  gain when these marketable assets are sold.

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THE RISE OF THE MULTINATIONAL CORPORATION

• Reasons for FDI
• Increase sales and profits.
• Enter rapidly growing markets.
• Reduce costs.
• Gain a foothold in economic blocs.
• Protect domestic markets.
• Protect foreign markets.
• Acquire technological and managerial know-how.

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THE RISE OF THE MULTINATIONAL CORPORATION
FDI flows (1998 values)
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THE RISE OF THE MULTINATIONAL CORPORATION

• Common misconceptions about MNEs
• MNEs have far-flung operations or earn most of
  their revenues overseas.
• MNEs are globally monolithic and excessively
  powerful in political terms.
• MNEs produce homogeneous products for the world
  market and through their efficient techniques are
  able to dominate local markets everywhere.

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THE RISE OF THE MULTINATIONAL CORPORATION

• In fact,
• MNEs earn most of their revenues in their
  home-regions.
• The largest 500 MNEs are not spread around the
  world but clustered around the triad.
• These MNEs engage not in global competition but
  in triad/regional competition this rivalry
  effectively eliminates enduring political
  advantage.
• MNEs adapt their products for the local market.

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THE RISE OF THE MULTINATIONAL CORPORATION

• Rise of multinational corporation was not
  anticipated by classical trade theory (Smith,
  Ricardo)
• Comparative Advantage - Each nation should
  specialize in the production and export of those
  goods that it can produce with highest relative
  efficiency and import those goods that other
  nations can produce relatively more efficiently.
  
• Underlying assumption Goods and services can
  move internationally, but factors of production
  (e.g. Capital, land and labor) are relatively
  immobile.
• aExistence of MNCs is based on international
  mobility of certain factors of production.
• aPrime transmitter of competitive forces is the
  MNCs (E.g. China)

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THE RISE OF THE MULTINATIONAL CORPORATION

• B. EVOLUTION OF THE MNC
• Reasons to Go Global
• 1. Raw materials
• 2. More markets
• 3. Minimize costs of production

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THE RISE OF THE MULTINATIONAL CORPORATION

• 1. RAW MATERIAL SEEKERS
• exploit markets in other countries
• historically first to appear
• modern-day counterparts
• Anaconda Copper
• Standard Oil
• Exxon- Mobil

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THE RISE OF THE MULTINATIONAL CORPORATION

• 2. MARKET SEEKERS
• produce and sell in foreign markets
• heavy foreign direct investors
• representative firms
• IBM
• Nestle
• Levi Strauss

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THE RISE OF THE MULTINATIONAL CORPORATION

• 3. COST MINIMIZERS
• Seek lower-cost production abroad
• Motive to remain cost competitive
• Representative firms
• Texas Instruments
• Intel
• Motorola

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THE RISE OF THE MULTINATIONAL CORPORATION

• D. THE MNC A BEHAVIORAL VIEW
• Characterized by
• - its state of mind and
• - not by its size and worldwide dispersion of
  its assets
• Distinguishing characteristics from other firms
  is its commitment to seeking out, undertaking and
  integrating manufacturing, marketing, RD and
  financing opportunities on a global, not
  domestic, basis.
• Necessary complements to integration of worldwide
  operations are
• - flexibility
• - adaptability
• - speed

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THE RISE OF THE MULTINATIONAL CORPORATION

• Key to international competitiveness is the
  ability of management to adjust to change and
  volatility at an ever faster rate.
• I am not here to predict the world. I am here to
  be sure Ive got a company that is strong enough
  to respond whatever happens. Jack Welch, ex-CEO
  of GE

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THE RISE OF THE MULTINATIONAL CORPORATION

• E. THE GLOBAL MANAGER
• 1. Understands political and
• economic differences
• 2. Searches for most cost-
• effective suppliers
• 3. Evaluates changes on value of
  the firm.

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PART II.MULTINATIONAL FINANCIAL MANAGEMENT
THEORY AND PRACTICE

• I. THE MULTINATIONAL FINANCIAL SYSTEM
• A. Main Objective of MNC
• Maximize shareholder wealth as measured by share
  price. Hence, make financing and investment
  decisions that add as much value as possible
• - Shareholders are the legal owners
• - Minimize (hostile) takeover risks
• - It is the best (or maybe the only) way to
  maximize economic benefits of all stakeholders

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MULTINATIONAL FINANCIAL MANAGEMENT THEORY AND
PRACTICE

• II. FUNCTIONS OF FINANCIAL MANAGEMENT
• A. Two Basic Functions
• 1. Financing (Acquisition of funds)
• 2. Investing (Allocation of those funds over
  time so that shareholder wealth is maximized)
• B. Additional Factors Facing the MNC Executive
• 1. Political risk
• 2. Economic risk

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MULTINATIONAL FINANCIAL MANAGEMENT THEORY AND
PRACTICE

• III. THEORETICAL FOUNDATIONS
• A. Useful Concepts from Financial
  Economics
• 1. Arbitrage
• 2. Market Efficiency
• 3. Capital Asset Pricing

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MULTINATIONAL FINANCIAL MANAGEMENT THEORY AND
PRACTICE

• Arbitrage
• Definition Purchase of assets or commodities on
  one markets for immediate resale in another in
  order to profit from a price discrepancy.
• e.g., Tax arbitrage - shifting of gains or
  losses from one tax jurisdiction to another

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MULTINATIONAL FINANCIAL MANAGEMENT THEORY AND
PRACTICE

• Market Efficiency
• An efficient market is one in which the prices of
  traded securities readily incorporate new
  information.
• Hence, one cannot rely on historical prices or
  publicly available information to consistently
  benefit from trading.

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MULTINATIONAL FINANCIAL MANAGEMENT THEORY AND
PRACTICE

• Capital Asset Pricing Model (CAPM)
• Refers to the valuation of securities based on
  expected risks and return.
• Assumes a specific relationship between risk
  (measured by return variability) and required
  asset return a stocks required rate of return
  is equal to the risk-free rate of return plus a
  risk premium that reflects the riskiness of the
  stock after diversification.
• Two source of variability
• (a) Systematic (or non-diversifiable) risk
  Marketwide influences that affect all sources
  (e.g. State of the economy)
• - relevant even for diversified investor
• - investor must be compensated for bearing that
  risk
• (b) Unsystematic (or diversifiable) risk
  specific to given firm
• - irrelevant for diversified investor

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MULTINATIONAL FINANCIAL MANAGEMENT THEORY AND
PRACTICE

• Total risk is also important for the firm (not
  only systematic risk)
• 1. Adverse Impact on expected cash flow
• - lower sales and higher costs
• 2. Justifies hedging activities of MNC to
  reduce total risk
• 3. International diversification reduces total
  risk