International Finance Lecture Slides Chp. 1

Multinational Business Finance
Fifteenth Edition, Global Edition
Chapter 1
Multinational Financial
Management: Opportunities
and Challenges
Copyright © 2021 Pearson Education Ltd. All Rights Reserved
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Learning Objectives
1.1 Explore the global financial marketplace—players and
playing field
1.2 Consider how the theory of comparative advantage
applies to multinational business
1.3 Examine how international financial management
differs from domestic financial management
1.4 Discover the steps and stages of the globalization
process

The Multinational Enterprise (MNE)
• The October–December 2014 quarter was a challenging one with
unprecedented currency devaluations. Virtually every currency in the world
devalued versus the U.S. dollar, with the Russian Ruble leading the way.
While we continue to make steady progress on the strategic transformation
of the company—which focuses P&G on about a dozen core categories and
70 to 80 brands, on leading brand growth, on accelerating meaningful
product innovation and increasing productivity savings—the considerable
business portfolio, product innovation, and productivity progress was not
enough to overcome foreign exchange.
—P&G News Release, January 27, 2015
• A multinational enterprise (MNE) has operating branches, subsidiaries, or
affiliates located in foreign countries.
• Today, digital startups can become multinational enterprises in hours

The Global Financial Marketplace
• Assets, institutions, and linkages comprise one method to
map global capital markets (see Exhibit 1.1).
• Assets are debt securities issued by governments (e.g.,
U.S. Treasury Bonds). These form the baseline for other
forms of financing.
• Institutions are the central banks, commercial, and
investment banks. Their health keeps the global financial
system stable.
• Linkages are the interbank networks using currency.
Without ready exchange of currencies the market is hard-
pressed to operate efficiently.

Exhibit 1.1 Global Capital Markets
The global capital market is a collection of institutions (central banks, commercial banks,
investment banks, not-forprofit financial institutions like the IMF and World Bank) and
securities (bonds, mortgages, derivatives, loans, etc.), which are all linked via a global
network-the Interbank Market. This interbank market, in which securities of all kinds are
traded, is the critical pipeline system for the movement of capital.
For long description, see slide 30: Ap
pendix 1
The exchange of securities-the movement of capital in the global financial system-must all
take place through a vehicle-currency. The exchange of currencies is itself the largest of
the financial markets. The interbank market, which must pass-through and exchange
securities using currencies, bases all of its pricing through the single most widely quoted
interest rate in the world-LIBOR (the London Interbank Offered Rate).

The Market for Currencies
• Most currencies are quoted against the dollar as in “so
many units per dollar.”
• Computer symbols (ISO-4217 codes) are used in digital
networks.
• Some currencies are known by more than one name.
• Exhibit 1.2 provides selected currency exchange rate
quotes.

Exhibit 1.2 Selected Global Currency
Exchange Rates for January 2, 2018 (1 of 2)
For long description, see slide 31: Appendix 2

Exhibit 1.2 Selected Global Currency
Exchange Rates for January 2, 2018 (2 of 2)
Note that a number of different currencies use the same symbol (for example both China
and Japan have traditionally used the ¥ symbol, which means “round” or “circle,” for yen
and yuan respectively. All quotes are mid-rates, and are drawn from the Financial Times.

Financial Globalization and Risk (1 of 2)
• Back in the halcyon pre-crisis days of the late 20th
and
early 21st
centuries, it was taken as self evident that
financial globalization was a good thing. But the subprime
crisis and Eurozone dramas are shaking that belief…
[W]hat is the bigger risk now—particularly in the
Eurozone—is that financial globalization has created a
system that is interconnected in some dangerous ways.
—“Crisis Fears Fuel Debate on Capital
Controls” Financial Times, December 15,
2011

Financial Globalization and Risk (2 of 2)
• Risks must be explored, considered, and managed
– International monetary system is under constant scrutiny
– Large fiscal deficits can result in negative interest rates
– Exchange rates are constantly in flux
– Ownership and governance vary dramatically across the
world, particularly for the privately held or family-owned
business
– Global capital markets have become less open and
accessible
– Increasingly complicating financial management with
capital flows

Eurocurrencies and Eurocurrency
Interest Rates (1 of 2)
• Eurocurrencies (a major linkage in the global and capital
markets)
– These are domestic currencies of one country on deposit in
a second country
– The Eurocurrency markets serve two valuable purposes:
▪Eurocurrency deposits are an efficient and convenient
money market device for holding excess corporate
liquidity
▪The Eurocurrency market is a major source of short-term
bank loans to finance corporate working capital needs
(including export and import financing)

Eurocurrencies and Eurocurrency
Interest Rates (2 of 2)
• The eurocurrency market is relatively free from governmental
regulation and interference.
• Interest rate is referred to as the LIBOR.
– Oftentimes a low spread exists with deposit and loan rates.

The Theory of Comparative
Advantage (1 of 7)
• The theory of comparative advantage provides a basis
for explaining and justifying international trade in a model
world assumed to enjoy:
– free trade;
– perfect competition;
– no uncertainty;
– costless information; and
– no government interference.

Advantage (2 of 7)
• The theory contains the following features:
– Exporters in Country A sell goods or services to
unrelated importers in Country B
– Firms in Country A specialize in making products that
can be produced relatively efficiently, given Country
A’s endowment of factors of production, that is, land,
labor, capital, and technology
– Firms in Country B do likewise, given the factors of
production found in Country B
– In this way the total combined output of A and B is
maximized

Advantage (3 of 7)
– Because the factors of production cannot be moved
freely from Country A to Country B, the benefits of
specialization are realized through international trade
– The way the benefits of the extra production are
shared depends on the terms of trade, the ratio at
which quantities of the physical goods are traded
– Each country’s share is determined by supply and
demand in perfectly competitive markets in the two
countries
– Neither Country A nor Country B is worse off than
before trade, and typically both are better off, albeit
perhaps unequally

Advantage (4 of 7)
• Although international trade might have approached the
comparative advantage model during the nineteenth
century, it certainly does not today, for the following
reasons:
– Countries do not appear to specialize only in those
products that could be most efficiently produced by
that country’s particular factors of production (as a
result of government interference and ulterior
motivations)
– At least two factors of production – capital and
technology – now flow directly and easily between
countries

Advantage (5 of 7)
– Modern factors of production are more numerous than in
this simple model
– Although the terms of trade are ultimately determined by
supply and demand, the process by which the terms are set
is different from that visualized in traditional trade theory
– Comparative advantage shifts over time, as less developed
countries become developed and realize their latent
opportunities
– The classical model of comparative advantage did not really
address certain other issues, such as the effect of
uncertainty and information costs, the role of differentiated
products in imperfectly competitive markets, and economies
of scale

Advantage (6 of 7)
• Comparative advantage is however still a relevant theory
to explain why particular countries are most suitable for
exports of goods and services that support the global
supply chain of both MNEs and domestic firms.
• The comparative advantage of the 21st century, however,
is one based more on services, and their cross-border
facilitation by telecommunications and the Internet.
• The source of a nation’s comparative advantage is still
created from the mixture of its own labor skills, access to
capital, and technology.

Advantage (7 of 7)
• Many locations for supply chain outsourcing exist today.
• It takes a relative advantage in costs, not just an absolute
advantage, to create comparative advantage.
• Clearly, the extent of global outsourcing is reaching out to
every corner of the globe.

What Is Different About International
Financial Management?
• Exhibit 1.3 summarizes the differences.
– Culture and history differ among countries
– Corporate governance
– Greater levels of foreign exchange and political risks
– Financial theory and applications are modified in the
global versus domestic marketplace
– Specialized and complicated financial instruments
become tools of the trade

Exhibit 1.3 What Is Different About
International Financial Management?
Concept International Domestic
Culture, history, and
institutions
Each foreign country is unique and not
always understood by MNE management
Each country has a known base case
Corporate governance Foreign countries’ regulations and institutional
practices are all uniquely different
Regulations and institutions are well
known
Foreign exchange risk MNEs face foreign exchange risks due to
their subsidiaries, as well as import/export
and foreign competitors
Foreign exchange risks from
import/export and foreign competition
(no subsidiaries)
Political risk MNEs face political risk because of their
foreign subsidiaries and high profile
Negligible political risks
Modification of domestic
finance theories
MNEs must modify finance theories like
capital budgeting and the cost of capital
because of foreign complexities
Traditional financial theory applies
Modification of domestic
financial instruments
MNEs utilize modified financial instruments
such as options, forwards, swaps, and letters
of credit
Limited use of financial instruments
and derivatives because of few foreign
exchange and political risks

Market Imperfections: A Rationale for the
Existence of the Multinational Firm (1 of 2)
• MNEs strive to take advantage of imperfections in
national markets for products, factors of production, and
financial assets.
• Imperfections in the market for products translate into
market opportunities for MNEs.
• Large international firms are better able to exploit such
competitive factors as economies of scale, managerial
and technological expertise, product differentiation, and
financial strength than their local competitors.

Market Imperfections: A Rationale for the
Existence of the Multinational Firm (2 of 2)
• Strategic motives drive the decision to invest abroad and
become a MNE and can be summarized under the
following categories:
– Market seekers
– Raw material seekers
– Production efficiency seekers
– Knowledge seekers
– Political safety seekers
• These categories are not mutually exclusive.

The Globalization Process
• Stage I: early domestic phase growing into the
international trade phase (Exhibit 1.4)
• Stage II: A successful firm will continue to grow from
simple international trade to the multinational phase
characterized by production and investment both at
home and abroad (Exhibit 1.5)
• The increase in foreign subsidiaries increases currency
risks and exposures (Exhibit 1.6)
• Growth may be limited by the twin agency problems of
corporate insiders and the rulers of sovereign states
(Exhibit 1.7)

Exhibit 1.4 Aidan Corp: Initiation of
the Globalization Process

Exhibit 1.5 Aidan’s Foreign Direct
Investment Sequence

Exhibit 1.6 Selected Consolidated
Income Results for Aidan (Ireland)
As an Ireland-based multinational company, Aidan must consolidate the financial
results (in this case, sales and earnings from the income statements) of foreign
subsidiaries. This requires converting foreign currency values into euros.
For long descri
ption, see slide
36: Appendix 6
Aidan, for the year shown, generated 61.3% of its global sales in Ireland, with those sales
making up 58.9% of its consolidated profits. From quarter to quarter and year to year,
both the financial performance of the individual subsidiaries will change in addition to
exchange rates.
* This is a simplified consolidation. Actual consolidation accounting practices require a
number of specific line item adjustments not shown here.

Exhibit 1.7 The Limits of Financial
Globalization
There is a growing debate over whether many of the insiders and rulers of organizations
with enterprises globally are taking actions consistent with creating firm value or
consistent with increasing their own personal stakes and power.
If these influential insiders are building personal wealth over that of the firm, it will indeed
result in preventing the flow of capital across borders, currencies, and institutions to
create a more open and integrated global financial community.
Source: Constructed by authors based on “The Limits of Financial Globalization,” Rene
M. Stulz, Journal of Applied Corporate Finance, Vol. 19, No. 1, Winter 2007, pp. 8–15.

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Appendix 1
Long Description for a diagram of global capital markets linked through the
Interbank market.
The diagram is of the global capital markets and the London Interbank Market
or LIBOR in which all kinds of securities are traded.
• The Interbank market is in the center with three bank boxes around it.
• There is an inverse triangle, titled currency, linking the three bank boxes with
LIBOR.
• The bank on the left has three arrows emanating from it, toward boxes
named mortgage loan, corporate loan and corporate bond.
• The bank on the right has three arrows springing toward boxes titled public
debt, private debt and private equity.
• The bank at the bottom has two arrows headed toward boxes titled central
banks and institutions.
Return to presentation

Appendix 2 (1 of 2)
Long Description for a table displaying selected global currency exchange rates.
The table displays selected global currency exchange rates as of January 2, 2018. There are seven columns titled
country, currency, symbol, code, currency equal to one dollar, currency equal to one euro, currency equal to one
pound.
The data from the table are presented below:
A table has 21 rows and 7 columns. The columns have the following headings from left to right. Country, Currency,
Symbol, Code, Currency to equal 1 Dollar, Currency to equal 1 Euro, Currency to equal 1 Pound, . The row entries are
as follows. Row 1. Country, Argentina. Currency, peso. Symbol, Ps. Code, ARS. Currency to equal 1 Dollar, 18.535.
Currency to equal 1 Euro, 22.3254. Currency to equal 1 Pound, 25.1697. Row 2. Country, Australia. Currency, dollar.
Symbol, A dollar sign. Code, AUD. Currency to equal 1 Dollar, 1.2769. Currency to equal 1 Euro, 1.538. Currency to
equal 1 Pound, 1.734. Row 3. Country, Brazil. Currency, real. Symbol, R Dollar sign. Code, BRL. Currency to equal 1
Dollar, 3.2634. Currency to equal 1 Euro, 3.9307. Currency to equal 1 Pound, 4.4315. Row 4. Country, Canada.
Currency, dollar. Symbol, C Dollar sign. Code, CAD. Currency to equal 1 Dollar, 1.2505. Currency to equal 1 Euro,
1.5062. Currency to equal 1 Pound, 1.6981. Row 5. Country, Chile. Currency, peso. Symbol, Dollar sign. Code, CLP.
Currency to equal 1 Dollar, 607.145. Currency to equal 1 Euro, 731.3062. Currency to equal 1 Pound, 824.4772. Row
6. Country, China. Currency, yuan. Symbol, The yuan symbol is a capital Y with 2 horizontal bars across the Y’s vertical
bar.. Code, CNY. Currency to equal 1 Dollar, 6.4967. Currency to equal 1 Euro, 7.8253. Currency to equal 1 Pound,
8.8222. Row 7. Country, Czech Republic. Currency, koruna. Symbol, Kc. Code, CZK. Currency to equal 1 Dollar,
21.1802. Currency to equal 1 Euro, 25.5115. Currency to equal 1 Pound, 28.7617. Row 8. Country, Denmark.
Currency, krone. Symbol, Dkr. Code, DKK. Currency to equal 1 Dollar, 6.18. Currency to equal 1 Euro, 7.4439.
Currency to equal 1 Pound, 8.3922.

Appendix 2 (2 of 2)
Row 9. Country, Egypt. Currency, pound. Symbol, The pound symbol is a capital cursive letter L with a horizontal line
going across it’s middle.. Code, EGP. Currency to equal 1 Dollar, 17.713. Currency to equal 1 Euro, 21.3714. Currency to
equal 1 Pound, 24.0942. Row 10. Country, Euro. Currency, euro. Symbol, the euro symbol is a capital c with 2 horizontal
bars across its middle.. Code, EUR. Currency to equal 1 Dollar, 0.8302. Currency to equal 1 Euro, 1. Currency to equal 1
Pound, 1.1274. Row 11. Country, India. Currency, rupee. Symbol, Rs. Code, INR. Currency to equal 1 Dollar, 63.4468.
Currency to equal 1 Euro, 76.4216. Currency to equal 1 Pound, 86.158. Row 12. Country, Indonesia. Currency, rupiah.
Symbol, Rp. Code, IDR. Currency to equal 1 Dollar, 13517.5. Currency to equal 1 Euro, 16281.8453. Currency to equal 1
Pound, 18356.2021. Row 13. Country, Israel. Currency, shekel. Symbol, Shk. Code, ILS. Currency to equal 1 Dollar,
3.4585. Currency to equal 1 Euro, 4.1658. Currency to equal 1 Pound, 4.6965. Row 14. Country, Japan. Currency, yen.
Symbol, The yen symbol is a capital Y with 2 horizontal bars across the Y’s vertical bar.. Code, JPY. Currency to equal 1
Dollar, 112.15. Currency to equal 1 Euro, 135.08. Currency to equal 1 Pound, 152.29. Row 15. Country, Kenya. Currency,
shilling. Symbol, K S h. Code, KES. Currency to equal 1 Dollar, 103.25. Currency to equal 1 Euro, 124.3646. Currency to
equal 1 Pound, 140.2091. Row 16. Country, Malaysia. Currency, ringgit. Symbol, RM. Code, MYR. Currency to equal 1
Dollar, 4.0195. Currency to equal 1 Euro, 4.8415. Currency to equal 1 Pound, 5.4583. Row 17. Country, Mexico.
Currency, new peso. Symbol, Dollar sign. Code, MXN. Currency to equal 1 Dollar, 19.515. Currency to equal 1 Euro,
23.5058. Currency to equal 1 Pound, 26.5005. Row 18. Country, New Zealand. Currency, dollar. Symbol, NZ Dollar sign.
Code, NZD. Currency to equal 1 Dollar, 1.4066. Currency to equal 1 Euro, 1.6942. Currency to equal 1 Pound, 1.9101.
Row 19. Country, Nigeria. Currency, naira. Symbol, N equal sign. Code, NGN. Currency to equal 1 Dollar, 359.5.
Currency to equal 1 Euro, 433.0178. Currency to equal 1 Pound, 488.1858. Row 20. Country, Norway. Currency, krone.
Symbol, NKr. Code, NOK. Currency to equal 1 Dollar, 8.1381. Currency to equal 1 Euro, 9.8023. Currency to equal 1
Pound, 11.0511. Row 21. Country, Philippines. Currency, peso. Symbol, P. Code, PHP. Currency to equal 1 Dollar, 49.92.
Currency to equal 1 Euro, 60.1286. Currency to equal 1 Pound, 67.7892.

Appendix 3
Long Description for a diagram of global capital markets linked through the
Interbank market.
The diagram is of the global capital markets and the London Interbank Market
or LIBOR in which all kinds of securities are traded.
• The Interbank market is in the center with three bank boxes around it.
• There is an inverse triangle, titled currency, linking the three bank boxes with
LIBOR.
• The bank on the left has three arrows emanating from it, toward boxes
named mortgage loan, corporate loan and corporate bond.
• The bank on the right has three arrows springing toward boxes titled public
debt, private debt and private equity.
• The bank at the bottom has two arrows headed toward boxes titled central
banks and institutions.

Appendix 4
Long Description for a diagram represents Aidan Corporation’s entry into
the globalization process.
The diagram represents the globalization process as occurring in two
phases. Phase 1 consists of domestic operations. The domestic Irish
suppliers provide materials to Aidan Corporation in Cork, Munster, and
Aidan sends products to Irish buyers, who represent the domestic
customers. Phase 1 involves all euro-denominated transactions under
European credit laws and practices. Phase 2 consists of expansion into
international trade. Aidan receives materials from international suppliers
in Norway, and Aidan sends products to international customers in
Iceland. Aidan must determine if transactions will be carried out in the
Norwegian krone, Icelandic króna, or euro. Aidan must also determine if
suppliers and customers are creditworthy.

Appendix 5
Long Description for a diagram of Aidan’s foreign direct investment sequence.
Aidan’s foreign direct investment sequence consists of five stages. Each new stage requires greater
foreign investment, which requires putting more and more capital at risk. Each new stage also requires
a greater foreign presence, which requires a higher level of managerial intensity. During each stage,
Aidan has two alternatives. The following list outlines the five stages. For each stage, the alternatives
are in order of increasing foreign presence.
• First stage: Change competitive advantage, or exploit existing advantage abroad.
• Second stage: Exploit an existing advantage abroad by exporting goods produced at home or
having production abroad.
• Third stage: Start production abroad through licensed manufacturing or by controlling and owning
assets abroad.
• Fourth stage: Control and own assets abroad through a joint venture or through a wholly owned
subsidiary.
• Fifth stage: Launch a wholly owned subsidiary through greenfield investment or through acquisition
of a foreign enterprise.

Appendix 6 (1 of 2)
Long Description for two tables illustrate consolidated sales and earnings for Aidan.
Each table shows a consolidation of the global sales and income earned. The table for
sales has columns for the following values from left to right: country, currency, sales in
millions of the local currency, average exchange rate, sales in millions of euros, and
percent of total. The table reads as follows.
A table has 4 rows and 6 columns. The columns have the following headings from left to
right. Country, Currency, Sales in Local Currency, Average Exchange Rate, Sales in
euros, Percentage of Total. The row entries are as follows. Row 1. Country, Ireland.
Currency, Euro. Sales in Local Currency, 400. Average Exchange Rate, blank. Sales in
euros, 400. Percentage of Total, 61.3. Row 2. Country, Malaysia. Currency, Malaysian
ringgit. Sales in Local Currency, 500. Average Exchange Rate, MYR 4.59 = €1.00. Sales
in euros, 108.9. Percentage of Total, 16.7. Row 3. Country, Turkey. Currency, Turkish lira.
Sales in Local Currency, 900. Average Exchange Rate, 6.28 = €1.00. Sales in euros,
₺
143.3. Percentage of Total, 22. Row 4. Country, Totals. Currency, blank. Sales in Local
Currency, blank. Average Exchange Rate, blank. Sales in euros, 652.2. Percentage of
Total, 100.

Appendix 6 (2 of 2)
The table for earnings has columns for the following values from left to right: country,
currency, earnings in millions of the local currency, average exchange rate, earnings in
millions of euros, and percent of total. The table reads as follows.
A table has 4 rows and 6 columns. The columns have the following headings from left to
right. Country, Currency, Earnings in Local Currency, Average Exchange Rate, Earnings in
euros, Percentage of Total. The row entries are as follows. Row 1. Country, Ireland.
Currency, Euro. Earnings in Local Currency, 38.1. Average Exchange Rate, blank.
Earnings in euros, 38.1. Percentage of Total, 58.9. Row 2. Country, Malaysia. Currency,
Malaysian ringgit. Earnings in Local Currency, 43.75. Average Exchange Rate, MYR 4.59
= €1.00. Earnings in euros, 9.53. Percentage of Total, 14.7. Row 3. Country, Turkey.
Currency, Turkish lira. Earnings in Local Currency, 107.1. Average Exchange Rate, 6.28
₺
= €1.00. Earnings in euros, 17.05. Percentage of Total, 26.4. Row 4. Country, Totals.
Currency, blank. Earnings in Local Currency, blank. Average Exchange Rate, blank.
Earnings in euros, 64.68. Percentage of Total, 100.

Appendix 7
The diagram consists of a rectangle labeled, “The Twin Agency Problems
Limiting Financial Globalization.” The bottom-left corner of the rectangle is
labeled “Lower Firm Value (possibly higher insider value).” The top-right corner
of the rectangle is labeled, “Higher Firm Value (possibly lower insider value).”
The top-left corner of the rectangle is labeled, “Actions of Rulers of Sovereign
States.” The bottom right corner of the rectangle is labeled, “Actions of
Corporate Insiders.” Two arrows extend from Lower Firm Value along the edges
of the rectangle. The first arrow extends upward from Lower Firm Value to
Actions of Rulers of Sovereign States. The second arrow extends rightward
from Lower Firm Value to Actions of Corporate Insiders. Two arrows extend
from Higher Firm Value along the edges of the rectangle. The first arrow
extends downward from Higher Firm Value to Actions of Corporate Insiders. The
second arrow extends leftward from Higher Firm Value to Actions of Rulers of
Sovereign States.

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