Chp 1 notes - the School of Economics and Finance

What’s Special about
• Why do we need international finance?
What’s Special about “International” Finance?
« Foreign Exchange Risk
The risk that foreign currency profits may evaporate in
dollar terms due to unanticipated unfavorable exchange
rate movements.
• Suppose $1 = U100 and you buy 10 shares of Toyota at
U10,000 per share.
• One year later the investment is worth ten percent more
in yen: U110,000
• But, if the yen has depreciated to $1 = U120, your
investment has actually lost money in dollar terms.
« Market Imperfections
Legal restrictions on movement of goods, people, and
• Transactions costs
• Shipping costs
• Tax arbitrage
« 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
« Expanded Opportunity Set
It doesn’t make sense to play in only one corner of the
• True for corporations as well as individual investors.
Globalization of the World Economy: Major Trends
« 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
« Emergence of the Euro as a Global Currency
Currently more than 300 million Europeans are using the
common currency on a daily basis.
• The “transaction domain” of the euro may become larger
than the U.S. dollar’s in the near future.
« Trade Liberalization and Economic Integration
Over the past 50 years, international trade increased
about twice as fast as world GDP.
• Many of the world’s governments have embraced free
trade as the surest route to prosperity for their citizenry.
« Privatization
Often seen in socialist economies in transition to market
• By most estimates this increases the efficiency of the
• Often spurs a tremendous increase in cross-border
Multinational Corporations
A firm that has operating subsidiaries, branches or
affiliates located in foreign countries. There are about
60,000 MNCs around the world.
• The ownership of some MNCs is so dispersed
internationally that they are known as transnational
• The transnationals are usually managed from a global
perspective rather than from the perspective of any single
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.
While multinational business finance emphasizes
MNCs, purely domestic firms also often have
significant international activities:
Import & export of products, components and services
• Licensing of foreign firms to conduct their foreign business
• Exposure to foreign competition in the domestic market
• Indirect exposure to international risks through
relationships with customers and suppliers
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The big Mac index
Eating a burger in a different country?
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