1. International Financial Management
International Financial Markets
UNITS
Madura & Fox International Financial Management*
1. International monetary system
Ch 2
2. The market for foreign exchange
Chs 3, 4, 6, 7 & 8
3. The derivative market and hedging strategies
Ch 5
Financial Management and the Multinational Firm
4. Globalisation and the multinational firm
Ch 1
5. Foreign investment
Chs 13, 14 & 15
6. Multinational treasury management
Chs 17,18 & 19
7. Review
Ch 20 1

2. Foreign direct investment - definition
An investment of at least 10% made by a company based in one country into a company based in another country
Often need to buy into or set up a legal entity e.g. Renault (UK) ltd, Spar (UK) ltd
These companies pay UK taxes
Their exports count as UK exports
Their purchases as UK purchases
Their imports as UK imports
Renault and Spar receive dividends (France and Holland respectively)
Totals appear on the Balance of payments (see next slide)
Not the same as portfolio investment 2

3. Foreign direct investment - definition3

4. Foreign direct investment – motives, Dunning’s eclectic model
advantages of internationalization
Firm specific advantages:
i) proprietary technology
ii) managerial/ marketing skills
iii) trademarks
iv) economies of scale
v) large capital requirements
Internalization advantages:
i) High enforcement costs
ii) Buyer uncertainty over value
iii) Need to control production
iv) Tax
Foreign direct investment – motives, Dunning’s eclectic model
3) Country Specific Advantages:
i) Natural resources
ii) Labour force
iii) Trade barriers
Plus: Greater profits,
monopolistic advantages
Reducing exchange rate exposure …. 4

5. Foreign direct investment – reducing exchange rate exposure
Increase in value
BPs
Scenario 1
Decrease in value
foreign sales
cost $s
BPs
cost
foreign profits
Increase in value
Scenario 2
foreign profits
Decrease in value $s
foreign profits
cost

6. Foreign direct investment – reducing exchange rate exposure
UK $1.5:£1
UK $1.9:£1
US $1.5:£1
US $1.9:£1
Sales
£1,000
£789
$1,500
Costs
£800
profit
£200
(£11)
$1,200
£158
$300
Scenario 1
Scenario 2
Foreign factories
The variation of UK profits is less in scenario 2 as less is converted 6

7. Foreign direct investment – barriers
Restrict ownership
Red tape
Local links with government
Political instability
Government requirements - local content 7

8. Foreign direct investment – country risk analysis
Problems:
Blocked funds
Currency inconvertibility
War
Corruption
New Zealand / Denmark / Singapore / Sweden /Switzerland…Japan / UK / US / …France / …Venezuela…Iran… Sudan… Somalia 8

9. Foreign direct investment – country risk analysis9

10. ✔ Foreign direct investment – country risk analysis debt crises
Actually reschedules
Does not reschedule
Predict reschedule ✔
Type II error
Predict not reschedule
Type I error
reduce Type II by decreasing reschedule predictions
reduce Type I by increasing reschedule predictions
Which is the more expensive error? 10

11. Foreign direct investment – country risk analysis significant factors (p.516 )
Most critical risk factor
% respondents (2004)
Govt regulations / legal decisions 64
Country financial risk 60
Currency interest rate volatility 51
Political and social disturbances 46
Corporate governance 30
Absence of the rule of law 29
Theft of intellectual property 28 11

12. Foreign direct investment – is FDI the new foreign aid…discuss
AT Kearney FDI confidence index forecasts EMs to rise relative to developed countries December 15, 2011 Thursday LENGTH: 1054 words A foreign direct investment (FDI) rebound will be slow at best and the focus of corporate investments is increasingly on developing markets, according to the 2011 A T Kearney Foreign Direct Investment Confidence Index, a regular measure of senior executive sentiment at the world`s largest companies.
Conducted regularly over the last 13 years by global management consulting firm A T Kearney, the index provides a look at the present and future prospects for international direct investment flows.
While 55% of corporate investors surveyed said their FDI budgets had returned to the levels they were prior to the economic crisis, more than one-fifth said they don`t expect their FDI to return to pre-crisis levels until 2014 or later. 12

13. International capital budgeting
Foreign production and real investment planning 13

14. International capital budgeting
Differences of international budgeting:
Foreign currency
Foreign inflation
Foreign interest rates 14

15. International capital budgeting
Illustrative problem:
ABC plc has the following budget
UK sales 5,000
Foreign sales 6,000
Variable costs
(UK) (3,000)
(Euro) (4,000)
Fixed costs
(UK) (1,000)
(Euro) (2,000)
Net 1,000
Budget prepared on the basis of 1.2€:£1
Revise the budget assuming an exchange rate of 1.3€:£1 and a 5% increase in euro prices. 15

16. International capital budgeting
Budget prepared on the basis of 1.2€:£1 Revise the budget assuming an exchange rate of 1.3€:£1 and a 5% increase in euro prices and a 1% volume increase.
Illustrative problem:
ABC plc has the following budget
£ £ €
UK sales 5, ,000
Foreign sales 6, ,636 (6K x 1.2 x 1.05 x 1.01)
Total Sales ,000
Variable costs
(UK) (3,000) (3,016) (3K x (1 + 6/11 x 0.01)
(Euro) (4,000) (4,826) (4K x 1.2 x (1 + 6/11 x 0.01)
Fixed costs
(UK) (1,000) (1,000)
(Euro) (2,000) (2,400) (2K x 1.2)
Net 1,000 16

17. International capital budgeting
Budget prepared on the basis of 1.2€:£1 Revise the budget assuming an exchange rate of 1.3€:£1 and a 5% increase in euro prices and a 1% volume increase.
Illustrative problem:
ABC plc has the following budget
£ £ € £
UK sales 5, , ,000
Foreign sales 6, , ,873
Variable costs
(UK) (3,000) (3,016) (3,016)
(Euro) (4,000) (4,826) (3,712)
Fixed costs
(UK) (1,000) (1,000) (1,000)
(Euro) (2,000) (2,400) (1,846)
Net 1, ,299
Note that the euro value falls by 7.69% 17

18. International portfolio investment and diversification
portfolio investment - buying shares for investment purposes only <10% ownership
RETURN …. R£ = R$ + e$
RISK….. var (R£) = var (R$) + var (e$)+ 2 cov (R$, e$)
Eg STDEV of (R$) & (e$) = 0.15 or 15% and 0 cov
= >> STDEV (R£) = (SQRT(0.045)) = 21% NOT 30%)
Eun and Resnick study:
US investing in varR$ vare$ cov (R$, e$)
UK % 32% 17%
France % 30% 8%
R$= local stock market return in this case the US stock market
E$ = % change in value of foreign currency 18

19. International portfolio investment and diversification
portfolio investment - buying shares for investment purposes only <10% ownership
RETURN …. R£ = R$ + e$
RISK….. var (R£) = var (R$) + var (e$)+ 2 cov (R$, e$) 19

20. International portfolio investment and diversification
Do more diversified firms have lower betas?
alternative approach:
Jacquillat and Solnick study:
1) Looked at betas of multinational companies based on domestic index.
beta i = cov(R i,R M)
var(R M)
2) Recalculated betas based on foreign indexes.
Think of it as Risk relative to the market 20

21. International portfolio investment and diversification
Do more diversified firms have lower betas?
alternative approach:
Jacquillat and Solnik study:
2) Recalculated betas based on foreign indexes.
multinationals betas
US Germany France UK US
Germany
France UK
no relationship with foreign markets – the market does not value diversification!!
"International Pricing of Risk, An Empirical Investigation of the World
Capital Market Structure," Journal of Finance, May 1974. 21

22. International portfolio investment and diversification
Do more diversified firms have lower betas?
►tests group shares into portfolios according to sales abroad.
►do shares with higher sales abroad have lower betas?
Madura quotes:
Portfolio %sales abroad beta
no clear indication 22

23. International portfolio investment size23