International Finance
Lecture 1
Page 1
International Finance
• Course topics
– Foundations of International Financial
Management
– World Financial Markets and Institutions
– Foreign Exchange Exposure
– Financial Management for a Multinational
Firm
Page 2
Foundations of International
Financial Management
• Globalization and the Multinational Firm
• International Monetary System
• Balance of Payments
• The Market for Foreign Exchange
• International Parity Relationships
Page 3
Globalization and the Multinational Firm
• International vs __________ finance
• Goals for international financial
management
• __________
• Multinationals
• Comparative advantage
Page 4
International vs Domestic Finance
• Foreign __________ and Political Risk
• Differences in regulations, tax laws,
__________ policies
• Greater opportunity set for production
and/or __________
Page 5
Additional Risks
• Foreign Exchange Risk
– Cost of __________ goods changes for you,
price of your product changes for foreign
customers as FX changes
• Political Risk: Macro, Micro
– Changes in foreign laws/taxes, __________
• Additional risks increase cost of capital of
multinational firms, __________ the required
rate of return by investors and third parties.
Page 6
Additional Opportunities
• __________ opportunities
• __________ costs for resources
• New product __________
Page 7
Managerial objectives
• Consensus in North America
– Long-run __________ wealth maximization
• In other countries
– Shareholder wealth
– __________ wealth
– Corporate wealth
– Market share, et c.
• Long-term owner wealth maximization is the
only sustainable _______ for running a business
– Who are the owners? Are home country owners’
interests superior to those of foreign country owners?
Page 8
Managerial objectives
• The goal of MNE should be shareholder
•
•
•
•
wealth maximization.
However in Europe and Asia some companies
follow __________ wealth maximization rule.
In France, Germany and Italy banks are the
major shareholders, also generally companies
are private __________.
In Japan Keiretsus are important.
All multinationals’ main operating objective
should be to maximize consolidated after tax
__________.
Page 9
Recent Trends in the World Economy
• Globalization
• Introduction of __________
• Trade liberalization
• __________
Page 10
Multinational Enterprise
• MNE: Multinational firm is a company that
has operating branches, subsidiaries and
affiliates located in __________ countries.
• It has both domestic and foreign
__________
• Go to World Investment Report and look for
the list of largest transnational corporations
(Largest TNCs).
• Multinationals face two __________ of risks
in addition to normal risks faced by domestic
companies. (Fx and political)
Page 11
Why do firms become multinational?
• __________ Seekers
• Raw __________ Seekers
• Production __________ Seekers
• __________ Seekers
• Political __________ Seekers
Page 12
Comparative advantage
• A brief overview of the theory is here
• Idea:
– Situation 1: countries try __________ by themselves
all products they need, no international trade occurs
– Situation 2: countries produce only what they can
produce __________ (efficiently as compared with
the other countries), sell their products, and buy what
they need but do not produce
– According to the theory of comparative advantage, in
Situation 2 all participating countries are _________
than in Situation 1, under a set of assumptions
Page 13
Comparative advantage
US
Japan
Workers,
millions
200
50
Productivity, # items / worker per day
Food
Clothing
2
1
3
9
US
Japan
Output per day if only 1 product produced
400
150
Constructing production possibilities frontier
Clothing
Food
0
400
200
0
USA
0
150
450
0
Japan
Page 14
200
450
No trade exists
Production Possibilities
500
450
Clothing (millions of units)
400
350
300
250
200
150
100
50
0
0
100
200
300
Food (m illions of units)
USA
Page 15
Japan
400
500
Terms of trade
Terms of trade:
1 unit of food =
2
unit of clothing
Exchange possibilities
USA
Maximum food produced =
Equivalent amount of clothing =
Maximum clothing produced =
Equivalent amount of food =
400
800
200
100
Japan
Maximum food produced =
Equivalent amount of clothing =
Maximum clothing produced =
Equivalent amount of food =
150
300
450
225
Consumption possibilities
Clothing
Page 16
Food
0
800
0
450
400
0
225
0
USA
Japan
Comparative advantage
Production and Counsumption Possibilities
for USA with Trade
900
Clothing (millions of units)
800
700
600
500
400
300
200
100
0
0
100
200
300
400
Food (m illions of units)
Page 17
Production and Trade
Consumption
500
Comparative advantage
Production and Consumption Possibilities
for Japan with Trade
500
450
Clothing (millions of units)
400
350
300
250
200
150
100
50
0
0
50
100
150
200
Food (m illions of units)
Page 18
Consumption
Production and Trade
250
Comparative advantage
• If countries specialize in producing certain goods
because they can do it more ___________ than the
others, they use their comparative advantage over the
other countries
• In general, countries that specialize and trade are
___________ than those that do not
– This effect is ___________ automatic, all depends on
the terms of trade (open the spreadsheet and see if
dashed lines are always ___________ the solid lines
for each country)
• A constant need for international transactions =
constant need for / interest in international finance
Page 19
Foundations of International
Financial Management
• Globalization and the Multinational Firm
• International Monetary System
• Balance of Payments
• The Market for Foreign Exchange
• International Parity Relationships
Page 20
International Monetary System
• … is the institutional
__________ within
which international payments are made,
movements of __________ are
accommodated and exchange rates among
currencies are determined.
Page 21
International Monetary System
• History of the international monetary
system
• Current currency __________
• Major events
Page 22
History of the International
Monetary System
• Bimetalism: Before __________
• The Gold Standard, __________
• The Interwar Years and World War II,
__________
• Bretton Woods and the International
Monetary Fund, __________
• Fixed Exchange Rates, 1945-1973
• 1973- Present
Page 23
Current Currency Regimes
• Exchange Arrangements with no separate
•
•
•
•
•
•
•
legal tender
Currency Board Arrangements
Fixed __________
Pegged Rate within Horizontal Bands
Crawling Pegs
Crawling __________
Managed Float
Independent Float
Page 24
Fixed versus Flexible Exchange Rate
• Fixed exchange rate brings foreign exchange,
trade, and investment __________, may be very
expensive to implement, creates currency
arbitrage __________.
• Flexible exchange rate allows to conduct
__________ monetary policy, is cheaper for the
government to implement, eliminates arbitrage
opportunities, but introduces __________ that
may adversely affect trade and investment.
Page 25
Major Events after 1973
• Oil Crisis
• Asian __________
• European __________ and the Euro
• Russian Crisis
• Emerging __________ Crisis
Page 26
The Economics and Currencies of
Asia, July–Nov 1997
Page 27
Daily Exchange Rates:
Russian Rubles per U.S. Dollar
Page 28
The European Union, 1999
Page 29
Financial Markets in the Brazilian Crisis,
January 11–15, 1999
Page 30
Daily Exchange Rates:
Brazilian Real per U.S. Dollar
Page 31