Me
Graw
Hill

1.1 Globalization 2
Political and Socioeconomic Factors Influencing
Globalization 2
Technology, Innovation, and
Globalization 4
1.2 Theories of International Trade and Industry
Location 5
Classical and Neoclassical Theories of
Trade 6
Other Theories of International Trade 7
Theories of Industry Location 8
1.3 MNCs, Foreign Direct Investment Strategy, and
Globalization 9 *
Dunning's OLI Model 9
Knowledge Capital 9
MNCs as Facilitators of Globalization 10
MNC Activity: The Intel Example 11
1.4 Special Risks Faced by MNCs 11
Currency Risk 11
Economic Risk 12
Political and Regulatory Risk 12
Variation in Business Practices 13
1.5 Corporate Governance of MNCs 13
MNC Goals and the Agency
Problem 13
Internal Governance and Monitoring
Mechanisms 14
External Monitoring Mechanisms 14
U.S. or Anglo-Saxon Governance
Model 15
Governance Practices in European and Asian
Countries 16
1.6 International Financial Management
Issues 17
Summary 18
Questions 18
Extensions 19
Case: Clover Machines: Determining a
Global Strategy 20
Appendix 1. Example of Comparative
Advantage 21
Chapter 2
2.1 Foreign Exchange Markets 25
MNC Participation in Foreign Exchange Markets 26
Other Participants in Foreign Exchange Markets 26
Market Characteristics: Size and Currencies 27
Market Structure 28
Foreign Exchange Quotations 29
Bid-Ask Spread and Transaction Costs 31
Currency Cross Rates 32
Foreign Exchange Markets: 24-Hour Trading 33
Foreign Exchange Market Trends 33
2.2 International Money Markets 34
International Banking: Classifying Transactions 34
Eurodollars and LIBOR 35
Eurocurrency Markets: Origin and Instruments 36
Calculating Returns on a Eurodollar Deposit 37
2.3 International Debt Markets 37
Eurocredits 38
Eurobonds: Origins 39
Features of Eurobonds and Their Markets 41
Recent Developments in Debt Markets 42
2.4 Global Equity Markets 43
U.S. Equity Markets 43
Other Exchanges 43
Trading and Liquidity 44
Cross-Border Listing 44
Recent Developments in Global Equity Markets 44
Summary 45
Questions 45
Problems 46
Extension 48
Case: Clover Machines: Dabbling in
International Markets? 48
Appendix 2. Autodealing: Technology and
Innovation in Currency Markets 49
Chapter 3
3.1 What Are Derivatives? 52
Instruments: Basic Building Blocks 52
Risk Management and Demand for Derivatives 53
The Wide World of Derivatives 53
3.2 Currency Forwards 54
Cash Flows and Settlement 54
Market Structure 55 ix

Contents
Forward Price 55
Counterparty Risk in Forward Contracts 57
3.3 Currency Futures 57
Market Structure 58
Daily Settlement 59
3.4 Currency Options 64
Options Parameters and Terminology 64
Market Structure 65
Option Exercise and Cashflows 66
Summary of Option Payoffs and Profits 67
Factors Affecting Call Option Prices 67
Currency Call Option Pricing Formula 69
Pricing Put Options 71
3.5 Eurocurrency Derivatives 71
Eurodollar Futures 71
Short-Term Interest Rate Futures 75
Summary 75
Questions 76
Problems 77
Extensions 79
Case: Clover Machines: Building Derivatives
Capability 80
Appendix 3 A. Forward Pricing Theory 81
Appendix 3B. Option Delta 82
4.1 A Brief History of Monetary Regimes 85
Gold Standard 86
Bretton Woods Agreement 88
Smithsonian Agreement 89
The European Monetary Union 90
4.2 Contemporary Currency Systems 92
IMF Classification of Currency Systems 92
Floating Currency Systems 93
Pegged Currency Systems 96
Conditions Fostering the Use of a Pegged Currency
System 97
4.3 Currency Valuation Basics 98
Currency Demand 98
Currency Supply 99
Currency Equilibrium 100
Calculating the Change in a Currency's
Value 100
4.4 Factors Affecting Currency Values 101
Current Account Analysis 101
Financial Account Analysis 102
4.5 How Governments Intervene in Currency
Markets 103
Sterilized and Nonsterilized Intervention 103
Other Methods of Intervention 104
Challenges in Implementing Intervention 104
4.6 Currency Crises^n Emerging Markets 105
Causes 105
Consequences 106
Response 107
4.7 Currency Trends 107
Summary 108
Questions 109
Extensions 110
Case: Clover Machines: Effects of Emerging
Market Currencies 110
5.1 Basic Arbitrage in Currency Markets 113
Locational Arbitrage 114
Triangular Arbitrage 115
5.2 Money Markets and Currency Markets 116
Covered Interest Arbitrage 116
Interest Rate Parity 118
5.3 Product Markets and Currency Markets 121
Law of One Price 121
Purchasing Power Parity (PPP) 122
5.4 Eurocurrency Futures Markets and Currency
Markets 125
5.5 International Fisher Effect: Real Rates of Return and Inflation 127
National Fisher Effect 128
International Fisher Effect 128
5.6 Currency Forecasting 129
Using the Spot or Forward Rates 129
Forecasting Future Spot Rates Using Parity
Conditions- 130
Forward Interest Rates and Currency
Forecasting 131
Fundamental Forecasting 131
Technical Forecasting 133
Assessing Forecast Accuracy 133
Summary 135
Questions 136
Problems 136
Extensions 139
Case: Clover Machines: Currency Arbitrage 140
6.1 Variation in Foreign Exchange 144
The Standard Deviation of a Currency 144
Currency Volatility and Firm Performance:
Overview 147
6.2 Transaction Exposure 148
Definition of Transaction Exposure 148
Scenario Analysis 149
Markowitz Portfolio Approach 150
Netting Currency Flows 152
Value at Risk 154

Contents xi
6.3 Economic and Operating Exposure 156
Operating Exposure: Overview 157
Operating Exposure: A Closer Look at Contributing
Factors 157
Estimating Operating Exposure 159
6.4 Translation Exposure 161
6.5 Firm Type and the Nature of Currency
Exposure 162
Summary 163
Questions 163
Problems 164
Extensions 166
Case: Clover Machines: Estimating Currency
Risk 167
Appendix 6. Sales Index 169
Chapter 7
7.1 Why Manage Currency Risk? 171
The Need to Execute the Firm's Strategic Plan 172
Tax Advantages to Reducing Currency
Exposure 173
Other Managerial Reasons for Reducing Currency
Exposure 173
Comparison of Currency Risk with Other Risks 175
7.2 Actual Hedging Behavior by Firms 175
General Hedging Activity 175
Currency Hedging 176
7.3 Hedging Techniques 176
Operational Issues 177
Forward Hedge 178
Money Market Hedge 180
Option Hedge 181
7.4 Maturity Mismatches 186
7.5 Operating Decisions to Mitigate Transaction
Exposure 188
Invoice Currency 188
Leading and Lagging Contractual Cash Flows 188
Netting 189
Risk-Sharing Contracts 189
7.6 Operating Decisions to Mitigate Operating
Exposure 190
Geographically Dispersed Suppliers 190
' Geographically Dispersed Customers 191
Product Differentiation 191
Summary 191
Questions 192
Problems 192
Extensions 196
Case: Clover Machines: Hedging Currency
Risk 197
Appendix 7. Delta Hedging Using
Options- 198
Chapter 8
8.1 The MNC Capital Budgeting
Process 199
8.2 Competitive Advantage Offered by International
Projects 200
8.3 Types of Overseas Projects 202
8.4 Overview of International Capital Budgeting 203
Project NPV 203
Special Considerations in International Projects 203
Project Cash Flow Equation 205
Cash Flow Inputs 205
8.5 Net Present Value of an International
Project 206
Forecasted Data 206
Foreign Currency Cash Flows 207
Domestic Currency Cash Flows and NPV
(Approach I) .207
Foreign Currency Cash Flows and Net Present Value
(Approach II) 208 -
Comparing Approach I and Approach II 209
Sensitivity Analysis 210
8.6 Currency Risk 211
Currency Risk Break-Even Analysis 211
Integrating Capital Budgeting and Exposure
Management 212
8.7 Country Risk 212
Incorporating Country Risk in the Project NPV: Two
Approaches 213
Political Risk Insurance 215
Summary 215
Questions 216
Problems 216
Extensions 220
Case: Clover Machines: Evaluating a Foreign
Project 221
Chapter 9
223
9.1 Parent versus Subsidiary Asymmetry: Main
Reasons 223
Example of Cash Flow Asymmetry: Taxes 225
Example of Cash Flow Asymmetry: Restricted
Remittances 227
Example of Cash Flow Asymmetry: Local
Financing 229
Identifying the Various Components of Value 230
9.2 Differing Real Cost of Capital for Parent and
Subsidiary 230
Parity Violation and Parent Financing 231
9.3 Managerial Response to Value Differences between
Parents and Subsidiaries 232

xii Contents
9.4 International Projects and Real Options 232
Overview of Real Options 233
Valuation of Option to Expand 234
Valuation of Option to Abandon 237
Volatility and the Valuation of Real Options 240
Summary 240
Questions 241
Problems 241
Extensions 244
Case: Clover Machines: Advanced Project
Analysis 246
Appendix 9A. Currency Arbitrage 247
Appendix 9B. Using Option Pricing Theory to
Value Projects 249
Appendix 9C. Inflation and the Depreciation Tax
Shield 250
10.1 Financing MNCs' Activities 253
MNCs Need Continuous Access to Capital
Markets 253
Advantages Enjoyed by MNCs 254
Constraints That MNCs Face 254
10.2 MNC Debt Financing 255
Bank Loans 255
Bond Financing 256
10.3 MNC Equity Financing 257
Venture Capital and IPO Financing 257
Internal Equity 258
External Equity 258
Dual Listing 258
10.4 Cost of Capital and Optimal Financing 259
Cost of Debt 260
Cost of Equity 261
Weighted Average Cost of Capital 263
10.5 Strategic Issues in Financing MNCs 264
Mitigation of Agency Costs 265
Mitigation of Country Risk 265
Exploiting Lack of Integration in Capital
Markets 266
Mitigating Currency Exposure 266
10.6 The Use of Derivatives in Financing
Activities 267
MNC Use of Interest Rate Swaps 267
MNC Use of Currency Swaps 269
MNC Use of Structured Notes 270
10.7 How Foreign MNCs Use U.S. Equity
Markets 270
Summary 272
Questions 273
Problems 273
Extensions 276
Case: Clover Machines: Global Financing 276
Appendix 10. Calculating the ICAPM Beta 277
11.1 Overview of Working Capital Issues 279
11.2 Cash Management 280
Optimal Cash Balances 280
Short-Term Investment Alternatives 281
11.3 Receivables 283
Risk Factors 283
Credit Terms 283
Monetizing Receivables 284
Expediting Net Receipts of Cash 286
11.4 Bank Financing 288
Types of Bank Loans 288
Eurobank Loans 289
11.5 Market Financing 291
Commercial Paper 291
Euro Commercial Paper 292
Notes Facilities 292
11.6 Financing Strategies to Minimize Cost 293
Short-Term versus Long-Term Financing 293
Currency Considerations 294
Use of Forwards 297
Financial Slack 298
Summary 298
Questions 299
Problems 300
Extensions 303
Case: Clover Machines: Credit and Short-Term
Financing 304
Appendix 11. Netting in Action: Alstom Takes
Netting to New Level 305
12.1 Overview of Alliances and Acquisitions 309
Licensing Agreements 310
Procurement and Outsourcing Agreements 310
Distribution Agreements 311
Strategic Alliances 312
Joint Ventures 312
Minority Ownership 313
Mergers and Acquisitions 313
12.2 Motives for International Acquisitions and
Alliances 314
Penetrating New Markets 314
Obtaining New Technology 315
Overcoming Adverse Regulation 315
Achieving Economies of Scale or Avoiding
Redundancies 316

Contents xiii
Offering More Comprehensive Solutions to
Customers 316
Achieving Global Distribution or Sourcing
Capabilities 316
12.3 The Joint Venture: Description and Examples
Joint Ventures: Types and Examples 317
Challenges in Implementing and Sustaining a
Cross-Border JV 318
Valuing a JV or an Alliance 318
12.4 International Mergers 320
Conducting Large Cross-Border Mergers 321
Important Drivers for Recent Cross-Border
Mergers 322
Challenges for Cross-Border Mergers 324
Valuation of Cross-Border Mergers 325
Other Issues in Evaluating a Foreign Target
Summary 328
Questions 328
Problems 330
Extension 332
Case: Clover Machines: Chinese Joint
326
317
Venture 333
Appendix 12. Valuation of Real Options in
Cross-border Mergers 334
337
13.1 Import and Export: Shipment and
Payment 337
Risk Factors 338
Payment Methods Not Involving an
Intermediary 339
Payment Methods Involving an Intermediary 340
Letters of Credit versus Documentary Collections 343
The Banker's Acceptance 344
13.2 Import and Export Financing 345
Import Financing with Letters of Credit 345
Export Financing with Letter of Credit and Banker's
Acceptance 346 ,
Loans and Guarantees from Export-Import
Banks 346
Other Trade-Financing Techniques 347
13.3 Measuring International Trade 347
The Balance of Payments Accounting System 348
Trends in International Trade 349
13.4 Trading Blocks and Agreements 350
General Agreement on Tariffs and Trade and World
Trade Organization Agreements 350
The North American Free Trade Agreement and
Other Regional Agreements 352
13.5 Global Organizations Influencing International
Trade 353
World Trade Organization 354
International Monetary Fund 354
World Bank 355
G8 356
Summary 356
Questions 357
Problems 358
Case: Clover Machines: Eyes on the Doha
Round 359
Appendix 13. A Primer on U.S. International
Transactions 360
Chapter 14
14.1 Taxation of MNCs: An Overview 365
Jurisdiction and Taxable Entities 366
Various Types of Taxes MNCs Face 366
14.2 Tax Harmonization 369
International Tax Treaties 369
Foreign Tax Credits 370
Alternative Tax Scenarios and Effective Tax
Rates 371
14.3 Tax Minimization Strategies 373
Transfer Pricing 373
Other Methods to Minimize Taxes 374
14.4 International Accounting Overview 375
Accounting as a Corporate Control
Mechanism 376
Differences in Accounting Standards and
Incentives 376
Accounting in Emerging Markets 377
International Financial Reporting Standards
14.5 Currency-Related Accounting Issues 379
Issues MNCs Face in Accounting for Foreign
Operations 379
U.S. Regulations: SFAS 52 380
14.6 Derivatives Accounting 382
Accounting Issues 382
Types of Derivatives Hedges 382
Effects of SFAS 133 383
Summary 383
Questions 384
Problems 385
Extension 388
Case: Clover Machines: Minimizing Global
Taxes 388
377
Chapter 15
15.1 Why Invest Internationally? 391
Profit Motive 392
Risk-Reduction Motive 393
Graphical Depiction of International
Diversification 395
Currency Diversification Considerations 395

xiv Contents
15.2 Barriers to International Diversification 396
Currency Risk 396
Government Controls and Taxes 399
Informational Asymmetry 399
Corporate Governance 400
Global Crises and Contagion 401
15.3 International Equity Investments 402
Depository Receipts 402
Mutual Funds 402
Exchange-Traded Funds 405
Derivatives 406
U.S. MNCs 407
Hedge Funds and Private Equity Funds 407
15.4 International Bond and Money Market
Investments 408
15.5 What the Future Holds 409
The Rise of Equity Culture 409
The Rapid Fall of Barriers to Financial
Globalization 410
The Globalization of the Financial Services
Industry 410
Summary 411
Questions 411
Problems 412
Case: Clover Machines: Deliberations at
Brickleys 414