1. International Finance
Ivar Bredesen Associate Professor
South-Western/Thomson Learning © 2003

2. Course contents The course is divided into four parts:
The International Financial Environment
Exchange Rate Behaviour
Exchange Rate Risk Management
Workload – 10 ECTS
8 course work
2 assignments

3. Required Reading

4. Required Reading
Jeff Madura: International Financial Management, 7th ed.
Excellent intermediate level textbook in international finance
Textbooks home page

5. Part I The International Financial Environment
Multinational Corporation (MNC)
Foreign Exchange Markets
Dividend
Remittance
& Financing
Exporting
& Importing
Investing
& Financing
Product Markets
Subsidiaries
International
Financial
Markets

6. What’s Special about “International” Finance?
Foreign Exchange Risk
Political Risk
Market Imperfections
Expanded Opportunity Set

7. What’s Special about “International” Finance?
Foreign Exchange Risk
The risk that foreign currency profits may evaporate in home currency terms due to unanticipated unfavorable exchange rate movements.
Suppose $1 = ¥100 and you buy 10 shares of Toyota for ¥100,000 (i.e. $100 per share = ¥10,000 per share).
One year later the investment is worth ten percent more in yen: ¥110,000
But, if the yen has depreciated to $1 = ¥120, your investment has actually lost money in dollar terms.
Your $1,000 investment is only worth $916.67

8. Exposure to International Risk
2000
2001
U.S. Firm’s Cost of Obtaining £100,000

9. What’s Special about “International” Finance?
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.
Statoil has invested 43.3 billion NOK in countries like Venezuela, Angola, Algerie, Iran, Aserbajdsjan

10. What’s Special about “International” Finance?
Market Imperfections
Legal restrictions on movement of goods, people, and money
Transactions costs
Shipping costs
Tax arbitrage

11. The Example of Nestlé’s Market Imperfection
Nestlé 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, Nestlé lifted restrictions imposed on foreigners, allowing them to hold registered shares as well as bearer shares.

12. Nestlé’s Foreign Ownership Restrictions
12,000
10,000
8,000
6,000
4,000
2,000 11 20 31 9 18 24
Bearer share SF
Registered share
Source: Financial Times, November 26, 1988 p.1. Adapted with permission.

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

14. What’s Special about “International” Finance?
Expanded Opportunity Set
It doesn’t make sense to play in only one corner of the sandbox.
True for corporations as well as individual investors.

15. Goals for International Financial Management
The focus of the text is to equip the reader with the “intellectual toolbox” of an effective global manager—but what goal should this effective global manager be working toward?
Maximization of shareholder wealth? or
Other Goals?

16. Maximize Shareholder Wealth
Long accepted as a goal in the Anglo-Saxon countries, but complications arise.
Who are and where are the shareholders?
In what currency should we maximize their wealth?

17. 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 keiretsu—a family of firms to which the individual firms belongs.

18. 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 firm’s management and its shareholders.

19. Conflicts Against the MNC Goal
For corporations with shareholders who differ from their managers, a conflict of goals can exist - the agency problem.
Agency costs are normally larger for MNCs than for purely domestic firms.
The sheer size of the MNC.
The scattering of distant subsidiaries.
The culture of foreign managers.
Subsidiary value versus overall MNC value.

20. The Agency Problem at Enron
Enron had about 3,500 subsidiaries and affiliates
Many of these were run and partly owned by Enron executives.
In retrospect, conflict of interest should have been an obvious concern.
The partnerships did hundreds of millions of dollars of transactions with Enron itself, in some cases buying assets from the company or selling assets to it.
The problem is this: Where did the executives' loyalties lie? Are they trying to negotiate the best deal for the company that employs them and the shareholders who own the company, or the best deal for the partnership where they had an ownership stake?

21. Globalization of the World Economy: Recent Trends
Emergence of Globalized Financial Markets
Advent of the Euro
Trade Liberalization and Economic Integration
Privatization

22. 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
International mutual funds

23. Advent of the Euro
A momentous event in the history of world financial systems.
Currently more than 300 million Europeans in 12 countries are using the common currency on a daily basis.
By 2004, up to 10 more countries may join the European Union and adopt the euro.
The “transaction domain” of the euro may become larger than the U.S. dollar’s in the near future.

24. Value of the Euro in U.S. Dollars

25. 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 world’s governments who have abandoned mercantilist views and embraced free trade as the surest route to prosperity for their citizenry.

26. 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.

27. Top 10 MNCs 1 General Electric United States 2 ExxonMobile Corporation3
Royal Dutch/Shell Group
Netherlands/ UK 4
General Motors 5
Ford Motor Company 6
Toyota Motor Corporation
Japan 7
DaimlerChrysler AG
Germany 8
TotalFina SA
France 9
IBM 10 BP
United Kingdom

28. Theories of International Business
Why are firms motivated to expand their business internationally?
Theory of Comparative Advantage
Specialization by countries can increase production efficiency.
Imperfect Markets Theory
The markets for the various resources used in production are “imperfect.”

29. Theories of International Business
Why are firms motivated to expand their business internationally?
Product Cycle Theory
As a firm matures, it may recognize additional opportunities outside its home country.

30. The International Product Life Cycle
 Firm creates product to accommodate local demand.
 Firm exports product to accommodate foreign demand.
 Firm establishes foreign subsidiary to establish presence in foreign country and possibly to reduce costs.
a. Firm differentiates product from competitors and/or expands product line in foreign country.
b. Firm’s foreign business declines as its competitive advantages are eliminated. or

31. Valuation Model for an MNC
Domestic Model
E (CF$,t ) = expected cash flows to be received at the end of period t
n = the number of periods into the future in which cash flows are received
k = the required rate of return by investors

32. Valuation Model for an MNC
Valuing International Cash Flows
E (CFj,t ) = expected cash flows denominated in currency j to be received by the U.S. parent at the end of period t
E (ERj,t ) = expected exchange rate at which currency j can be converted to dollars at the end of period t
k = the weighted average cost of capital of the U.S. parent company

33. Valuation Model for an MNC
An MNC’s financial decisions include how much business to conduct in each country and how much financing to obtain in each currency.
Its financial decisions determine its exposure to the international environment.

34. Valuation Model for an MNC
Impact of New International Opportunities
on an MNC’s Value
Exchange Rate Risk
Political Risk
Exposure to
Foreign Economies

35. How Chapters Relate to Valuation
Background on International Financial Markets (Chapters
2-5)
Exchange Rate Behavior (Chapters 6-8)
Long-Term Investment and Financing Decisions (Chapters 13-18)
Short-Term Investment and Financing Decisions (Chapters 19-21)
Exchange Rate Risk Management (Chapters 9-12)
Risk and Return of MNC
Value and Stock Price of MNC