Lecture 1: Valuation Models for
MNCs and Global Investors
Combined with Observations
on Exchange Rate Impacts
Fall Semester 2012
Professor Michael Palmer
Leeds School of Business
Where is this International
Financial Center?
Defining A Financial Center

A Financial Center is a location:


That has a heavy concentration of financial institutions
providing a wide range of financial services (including
banking, insurance, cash management, asset
management). London, New York, and Tokyo are regarded
as the world's three premier financial centers.
An Offshore Financial Center is a location:

That provides financial services to nonresidents on a scale
that is disproportionately larger in comparison to the size
and the financing of its domestic economy (IMF definition).

Examples include: The Cayman Islands, Gibraltar, Bahrain, and
Hong Kong


The Cayman Islands, with a domestic population of 52,000, has 250
banks, with approximately $415 billion in deposits (making it one of
the largest financial centers in the world).
Is London an offshore financial center?
Objective of Lecture 1


In order to understand and appreciate the
international forces which multinational firms
and global investors face, we need to
develop valuation models for global
companies and investors.
The models which we will develop are
patterned after the Anglo-Saxon model of
corporate behavior and investment
valuations.
Valuation Concepts

Anglo-Saxon Approach:

Firm Evaluation: Consider the value of the firm
and corporate behavior in terms of (maximizing)
the market value of the firm for shareholders.


Capital budgeting techniques evaluate projects and
corporate investments on the basis of the present value
of their cash flows.
Financial Asset Evaluation: Consider the present
value of the anticipated future income stream from
a particular financial asset.
Anglo-Saxon Valuation Model for
Corporation: Present Value of Future
Cash Flow
 E CF$,t 
V 
t 
t 1  1  k  
n




Where E(CF$,t) represents expected cash flows to be
received at the end of period t,
N represents the number of periods into the future in
which cash flows are received, and
K represents the required rate of return by investors.
Note: Changes in V occur because of changes in
E(CF$,t) and/or changes in K
6
Measuring the International Cash
Flows for a U.S. Based MNC
E C F$ ,t  


 E C F   E S 
m
j 1
j ,t
j ,t
Where CFj,t represents the amount of cash flow
denominated in a particular foreign currency j at the
end of period t,
Where Sj,t represents the exchange rate at which the
foreign currency can be converted into U.S. dollars at
the end of period t.

Measured in U.S. dollars per unit of the foreign currency.
7
Changes in the Value of a MNC
V changes result from:
MNC Valuation
Model


 E CF j ,t xE ( S j , t ) 
V 

t
1  k  
t 1 
n
(1) Changes in foreign market conditions: Will
impact on foreign currency earnings and thus on
foreign currency cash flows (CF).
(2) Changes in political environment and political
risk (policy of foreign government towards MNC):
Will impact on foreign currency earnings and thus
on foreign currency cash flows (CF).
(3) Changes in the MNC’s cost of capital, i.e.,
the required return (k).
(4) Changes in the exchange rate resulting from
exposure to exchange rate risk (S); noting that:
–
Stronger foreign currency will increase U.S.
dollar equivalent of cash flows.
–
Weaker foreign currency will decrease U.S.
dollar equivalent of cash flows.
MNCs Concentration on Foreign
Markets (CF in Valuation Model)
S&P 500 Companies
 Percent of Total Sales
from Overseas Markets
 2005:
43.3%
 2006:
43.6%
 2007:
45.8%
 2008:
47.0%
 2009:
46.6%
 2010:
46.3%
 2011:
46.1%







S&P 500 Companies
Geographic Breakdown
2011 2010 2009
Europe 24.0% 29.1% 25.5%
Asia
15.5% 13.1% 17.7%
N. Amer 9.5% 4.6% 7.8%
Africa
8.0% 6.5% 7.9%
S. Amer 5.7% 4.3% 5.4%
U.S. MNCs Involvement in Foreign
Markets (CF in Valuation Model)
Company
% Sales from
Overseas
Markets
Other Comments (Major markets, etc)
Intel
85%
Chips and Processors to Taiwan and China
McDonalds
66%
Europe and Asia (400 stores in China)
GE
54%
Europe and China
Ford
51%
Canada, Europe, and China
Nike
50%
1/3 of shoe manufacturing in China
Amazon
45%
Canada and Japan
Wal-Mart
26%
5,000 stores in 14 foreign countries
Starbucks
25%
Canada, UK and China account for 66%
Foreign MNCs Involvement in Foreign
Markets (CF in Valuation Model)
Company
% Sales from
Overseas
Markets
Other Comments (Major markets, etc)
Komatsu
81%
China accounts for 23%
Canon
80.5%
Europe accounts for 31.3%
Bridgestone
74%
North America accounts for 42%
Honda
66%
North America accounts for 37%
88%
United States accounts for 32%
81%
United States and China each account for 17%
Japanese:
U.K.:
Rolls Royce
Germany:
BMW
Chinese:
Haier
30%
Foreign Exchange Exposures for
Selected MNCs
Company
Selected F.X. Exposure
McDonalds (USA)
Revenues exposed to pounds, euros, yen and yuan
(renminbi)
Ford (USA)
Revenues exposed to Canadian dollars, pounds, euros
and yuan (renminbi)
Nike (USA)
Costs exposed to yuan (renminbi)
Komatsu (Japan)
Revenues exposed to yuan (renminbi)
Canon (Japan)
Revenues exposed to euros and pounds
Bridgestone (Japan)
Revenues exposed to U.S. dollars
Honda (Japan)
Revenues exposed to U.S. dollars; costs exposed to
U.S. dollars
Rolls Royce (U.K.)
Revenues exposed to U.S. dollars
BMW (Germany)
Revenues exposed to U.S. dollars and yuan
(renminbi); costs exposed to U.S. dollars
Exchange Rates Volatility (S in the
Valuation Formula)
Euro Exchange Rate; Daily Data:
1999 - Present
Yen Exchange Rate; Daily Data:
1971 - Present
Example: Exchange Rate Impacts
on Operating Profits
Japanese Multinationals


Sony, which generates
more than 70 percent of
revenue outside of Japan,
says it loses about 2 billion
yen of annual operating
profit for each yen gain
against the U.S. currency.
Toyota notes that every
one-yen gain in the
Japanese currency against
the dollar reduces Toyota’s
annual operating profit by
30 billion yen.
Yen in 2011
Valuation Models for Financial
Assets

Bonds: Present value of:

Coupon payments + Par Value (face or maturity value)



Stocks: Present value of:


In U.S., par value = $1,000
Discount rate (k) is adjusted for opportunity cost and risk
adjustments.
Future cash flow (Dividends, earnings)
Foreign currency denominated financial assets:
Valuation model adjustment needs to be made
for changes in exchange rates.
Do Bond Yields Vary Globally?
FT Data (August 24, 2012)
Do Equity Returns Vary Globally?
Country and
Stock Market
% Change in
Local Currency
Terms; Dec 31,
2011 to Aug 22,
2012
Country and
Stock Market
% Change in
Local Currency
Terms; Dec 31,
2011 to Aug 22,
2012
USA: DJIA
+7.8%
Greece: Athex
-6.0%
Japan: TOPIX
+4.7%
Spain: Madrid SE
-13.5%
U.K. FTSE100
+3.6%
Argentina: MERV
-1.1%
Canada: TSX
+1.4%
China: SSEA
-4.2%
France; CAC40
+9.6%
Israel: TA-100
-0.1
Germany: DAX
+19.0%
MSCI Data:
Singapore: STI
+15.2%
Developed Mkts
+8.9%
S. Africa: JSE
+11.4
Emerging Mkts
+5.8%
Do Exchange Rates Affect Equity
Returns? Data for 2010
Country
Local Currency Return
U.S. Dollar Return
Japan
- 1.6%
+10.0%
Australia
- 1.3%
+10.0%
Switzerland
- 0.4%
+ 6.6%
Canada
- 0.4%
+20.1%
Italy
-11.6%
-19.0%
Germany
+16.5%
+ 6.7%
United Kingdom
+11.7%
+ 6.9%
South Africa
+15.7%
+26.6%
Hong Kong
+ 8.6%
+ 8.4%
United States (DJIA)
+12.4%
+12.4%
Euro-Zone (17)
- 0.9%
- 9.2%
Memo:
Exchange Rates in 2010
JPY (Equity Market:
-LC1.6%; +USD10.0%)
GBP (Equity Market:
+LC11.7%; +USD6.9%)
Exchange Rates in 2010
EUR (Equity Market:
-LC0.9%; -USD9.2%)
HKD (Equity Market:
+LC8.6%; +USD8.4%)
Equity Returns, Dec 31, 2011 – Aug
22, 2012
Country
Local Currency Return
U.S. Dollar Return
Japan
+ 8.0%
+ 5.4%
Australia
+ 7.1%
+10.1%
Switzerland
+ 9.1%
+ 4.3%
Canada
+ 1.4%
+ 4.3%
Greece
- 6.0%
- 11.1%
Germany
+19.0%
+12.6%
United Kingdom
+ 3.6%
+ 4.7%
Hong Kong
+ 7.9%
+ 8.0%
Saudi Arabia
+ 9.7%
+ 9.7%
United States (DJIA)
+ 7.8%
+ 7.8%
Euro-Zone (17)
+ 7.3%
+ 1.5%
Memo:
And What About the BRICS?
2011
2012 to August 22
Country
Local
Currency
Return
USD
Return
Country
Local
Currency
Return
USD
Return
Brazil
-14.3%
-22.1%
Brazil
+ 4.6%
- 3.5%
Russia
-15.4%
-19.0%
Russia
+ 2.9%
+ 3.5%
India
-22.6%
-34.6%
India
+15.5%
+10.0%
China
-22.7%
-19.1%
China
- 4.2%
- 5.2%
S. Africa
+ 2.4%
-17.0%
S. Africa
+11.4%
+ 9.3%
U.S.
+ 7.3%
+ 7.3%
U.S.
+ 7.8%
+ 7.8%
Do Exchange Rates Affect Bond
Returns?
Exchange Rate Adjusted Bond
Exchange Rate Adjusted
Returns
Returns on Government
Return on German Bonds,
1994 - 1999
Year
Local Market
% Change
USD Return
Return*
in Local Currency**
1994
-1.8%
11.8%
10.0%
1995
16.3%
9.6%
25.9%
1996
7.3%
-7.7%
-0.4%
1997
6.2%
-15.2%
-9.0%
1998
10.9%
8.9%
19.8%
1999
-2.1%
-14.3%
-16.4%
* = Interest (coupon payment) +/- Change in market price
**1994 - 1998: % change in Deutschmark; 1999 % change in Euro
Bonds, 2005
Hong Kong as a Financial Center

After being ceded by China to the British (as a result of the Opium Wars) under the Treaty of Nanking in 1842, the
colony of Hong Kong rapidly became a regional center for financial and commercial services with China and South Asia.
During the Korean War, the U.N. imposed an embargo on mainland China (for its support of North Korea) and as a
result many “industrialist moved from the mainland to Hong Kong and set up light industry export companies. During
this period, Hong Kong grew as a shipping and textile export center.

However, China's open-door policy in 1978 was the year that marked the new era of Hong Kong and its re-birth as a
major economic and financial center. As manufacturing moved out of Hong Kong to mainland China, it was replaced by
services, and Hong Kong GDP boomed as trade and investment links with China exploded. Global financial services
also flourished because of Hong Kong’s British-style legal system and the fact that English is spoken fluently both of
which supported Hong Kong’s financial networks with London, New York and other leading global cities. In additional,
Hong Kong has had long existing stock market (since 1891).

Today it is an important market for IPO (second only to New York last year) and funds management. Today Hong Kong
is the world’s sixth largest foreign exchange trading center, with 4.7% of the world’s total trades (or $238 billion per day).
71 of the largest 100 banks in the world have an operation in Hong Kong. Hong Kong is the world's 9th largest
international banking center in terms of the volume of external transactions, and the second largest in Asia after Japan.
The banking sector plays a vital role in establishing Hong Kong as a major loan syndication center in the region. The
Hong Kong Stock Exchange is Asia's third largest stock exchange in terms of market capitalization behind the Tokyo
Stock Exchange and the Shanghai Stock Exchange and fifth largest in the world. As of 31 Dec 2010, the Hong Kong
Stock Exchange had 1,413 listed companies with a combined market capitalization of $2.7 trillion.

Hong Kong was hit hard by the Asian Financial Crisis that struck the region in mid-1997, just at the time of the handover
of the colony back to Chinese administrative control. The crisis prompted a collapse in share prices and the property
market. However, unlike most Asian countries, Hong Kong (as well as mainland China) maintained their currencies’
exchange rates with the U.S. dollar rather than devaluing.