01 Jun Explain the chosen international finance topic in general terms AND cover how it is implemented in the students chosen pretend business. 5. Paper will be a minimum of 750 and
Any Topic from Chapters 1-4
2. APA format, minimum 4 sources
3. Explain the chosen international finance topic in general terms AND cover how it is implemented in the student’s chosen pretend business.
5. Paper will be a minimum of 750 and a maximum of 900 words. (This includes title section, content, and references…in other words the entire paper)
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
International Financial Management
11th Edition
by Jeff Madura
1
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Part 1
The International Financial Environment
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1 Multinational Financial Management: An Overview
Identify the management goal and organizational
structure of the Multinational Corporation (MNC).
Describe the key theories that justify international
business
Explain the common methods used to conduct
international business
Provide a model for valuing the MNC
3
Chapter Objectives
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Managing the MNC
1. Managers are expected to make decisions that
will maximize the stock price.
2. Focus of this text: MNCs whose parents fully
own foreign subsidiaries (U.S. parent is sole
owner of subsidiary.)
3. Finance decisions are influenced by other
business discipline functions:
Marketing
Management
Accounting and information systems
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Agency Problems
The conflict of goals between managers and
shareholders
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Agency Costs
1. Definition: Cost of ensuring that managers
maximize shareholder wealth
2. Costs are normally higher for MNCs than for purely
domestic firms for several reasons:
Monitoring managers of distant subsidiaries in foreign
countries is more difficult.
Foreign subsidiary managers raised in different cultures
may not follow uniform goals.
Sheer size of larger MNCs can create large agency
problems.
Some non-U.S. managers tend to downplay the short-term
effects of decisions.
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Control of Agency Problems
1. Parent control of agency problems Parent should clearly communicate the goals for each subsidiary
to ensure managers focus on maximizing the value of the
subsidiary.
2. Corporate control of agency problems Entire management of the MNC must be focused on maximizing
shareholder wealth.
3. Sarbanes-Oxley Act (SOX) Ensures a more transparent process for managers to report on the
productivity and financial condition of their firm.
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SOX Methods to Improve Reporting
Establishing a centralized database of information
Ensuring that all data are reported consistently
among subsidiaries
Implementing a system that automatically checks for
unusual discrepancies relative to norms
Speeding the process by which all departments and
subsidiaries have access to all the data they need
Making executives more accountable for financial
statements
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Management Structure of MNC
1. Centralized (See Exhibit 1.1a)
Allows managers of the parent to control
foreign subsidiaries and therefore reduce the
power of subsidiary managers
2. Decentralized (See Exhibit 1.1b)
Gives more control to subsidiary managers
who are closer to the subsidiary’s operation
and environment
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Exhibit 1.1a Management Styles of MNCs
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Exhibit 1.1b Management Styles of MNCs
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Why Firms Pursue International Business
1. Theory of Competitive Advantage: specialization
increases production efficiency.
2. Imperfect Markets Theory: factors of production are
somewhat immobile providing incentive to seek out
foreign opportunities.
3. Product Cycle Theory: as a firm matures, it
recognizes opportunities outside its domestic
market.
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Exhibit 1.2 International Product Life Cycles
13
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How Firms Engage in International Business
1. International trade
2. Licensing
3. Franchising
4. Joint Ventures
5. Acquisitions of existing operations
6. Establishing new foreign subsidiaries
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International Trade
Relatively conservative approach that can be used
by firms to
penetrate markets (by exporting)
obtain supplies at a low cost (by importing).
Minimal risk – no capital at risk
The internet facilitates international trade by
allowing firms to advertise their products and
accept orders on their websites.
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Licensing
Obligates a firm to provide its technology
(copyrights, patents, trademarks, or trade names)
in exchange for fees or some other specified
benefits.
Allows firms to use their technology in foreign
markets without a major investment and without
transportation costs that result from exporting
Major disadvantage: difficult to ensure quality
control in foreign production process
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Franchising
Obligates firm to provide a specialized sales or
service strategy, support assistance, and possibly
an initial investment in the franchise in exchange
for periodic fees.
Allows penetration into foreign markets without a
major investment in foreign countries.
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Joint Ventures
A venture that is jointly owned and operated by
two or more firms. A firm may enter the foreign
market by engaging in a joint venture with firms
that reside in those markets.
Allows two firms to apply their respective
cooperative advantages in a given project.
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Acquisitions of Existing Operations
Acquisitions of firms in foreign countries allows
firms to have full control over their foreign
businesses and to quickly obtain a large portion of
foreign market share.
Subject to the risk of large losses because of larger
investment.
Liquidation may be difficult if the foreign
subsidiary performs poorly.
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Establishing New Foreign Subsidiaries
Firms can penetrate markets by establishing new
operations in foreign countries.
Requires a large investment
Acquiring new as opposed to buying existing
allows operations to be tailored exactly to the
firms needs.
May require smaller investment than buying
existing firm.
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Summary of Methods
Any method of increasing international business
that requires a direct investment in foreign
operations is referred to as direct foreign
investment (DFI)
International trade and licensing usually not
included
Foreign acquisition and establishment of new
foreign subsidiaries represent the largest portion of
DFI.
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Exhibit 1.3 Cash Flow Diagrams for MNCs
22
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Exhibit 1.3 Cash Flow Diagrams for MNCs
The first diagram reflects an MNC that engages in
international trade. International cash flows result from
paying for imports or receiving cash flow from exports.
The second diagram reflects an MNC that engages in some
international arrangements. Outflows include expenses
such as expenses incurred from transferring technology or
funding partial investment in a franchise or joint venture.
Inflows are receipts from fees.
The third diagram reflects an MNC that engages in direct
foreign investment. Cash flows exist between the parent
company and the foreign subsidiary.
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Uncertainty Surrounding MNC Cash Flows
1. Exposure to international economic conditions – If
economic conditions in a foreign country weaken, purchase
of products decline and MNC sales in that country may be
lower than expected.
2. Exposure to international political risk – A foreign
government may increase taxes or impose barriers on the
MNC’s subsidiary.
3. Exposure to exchange rate risk – If foreign currencies
related to the MNC subsidiary weaken against the U.S.
dollar, the MNC will receive a lower amount of dollar cash
flows than was expected.
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How Uncertainty Affects the MNC’s cost of Capital
A higher level of uncertainty increases the return on
investment required by investors and the MNC’s
valuation decreases.
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Exhibit 1.5 Organization of Chapters
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Summary
The main goal of an MNC is to maximize shareholder
wealth. When managers are tempted to serve their own
interests instead of those of shareholders, an agency
problem exists. MNCs tend to experience greater agency
problems than do domestic firms. Proper incentives and
communication from the parent may help to ensure that
subsidiary managers focus on serving the overall MNC.
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Summary
International business is justified by three key theories.
1. The theory of comparative advantage suggests that each
country should use its comparative advantage to
specialize in its production and rely on other countries to
meet other needs.
2. The imperfect markets theory suggests that because of
imperfect markets, factors of production are immobile,
which encourages countries to specialize based on the
resources they have.
3. The product cycle theory suggests that after firms are
established in their home countries, they commonly
expand their product specialization in foreign countries.
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Summary
The most common methods by which firms conduct
international business are international trade, licensing,
franchising, joint ventures, acquisitions of foreign firms, and
formation of foreign subsidiaries. Methods such as licensing
and franchising involve little capital investment but
distribute some of the profits to other parties. The
acquisition of foreign firms and formation of foreign
subsidiaries require substantial capital investments but offer
the potential for large returns.
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Summary
The valuation model of an MNC shows that the MNC’s
value is favorably affected when its expected foreign cash
inflows increase, the currencies denominating those cash
inflows increase, or the MNC’s required rate of return
decreases. Conversely, the MNC’s value is adversely
affected when its expected foreign cash inflows decrease,
the values of currencies denominating those cash flows
decrease (assuming that they have net cash inflows in
foreign currencies), or the MNC’s required rate of return
increases.
,
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
International Financial Management 11th Edition
by Jeff Madura
1
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
2
3 International Financial Markets
Describe the background and corporate use of the following International Financial Markets:
Foreign exchange market
International money market
International credit market
International bond market
International stock markets
2
Chapter Objectives
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3
Foreign Exchange Market
1. Allows for the exchange of one currency for another.
2. Exchange rate specifies the rate at which one currency can be exchanged for another.
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4
History of Foreign Exchange
1. Gold Standard (1876 – 1913) Each currency was convertible into gold at a specified rate. When World War I began in 1914, the gold standard was suspended.
2. Agreements on Fixed Exchange Rates a.Bretton Woods Agreement 1944 – 1971
b.Smithsonian Agreement 1971 – 1973
3. Floating Exchange Rate System Widely traded currencies were allowed to fluctuate in accordance with market forces
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5
Foreign Exchange Transactions
1. The over-the-counter market is the telecommunications network where companies normally exchange one currency for another.
2. Foreign exchange dealers serve as intermediaries in the foreign exchange market
3. A foreign exchange transaction for immediate exchange is said to trade in the spot market. The exchange rate in the spot market is the spot rate.
4. Trading between banks occurs in the interbank market.
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6
Spot Market
1. The U.S. Dollar is the commonly accepted medium of exchange in the spot market.
2. Spot market time zones – Foreign exchange trading is conducted only during normal business hours in a given location. Thus, at any given time on a weekday, somewhere around the world a bank is open and ready to accommodate foreign exchange requests.
3. Spot market liquidity: More buyers and sellers means more liquidity.
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7
Attributes of Banks That Provide Foreign Exchange
1. Competitiveness of quote
2. Special relationship with the bank
3. Speed of execution
4. Advice about current market conditions
5. Forecasting advice
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8
Foreign Exchange Quotations
rateAsk
rate Bid rateAsk spreadask / Bid
1. At any given point in time, a bank’s bid (buy) quote for a foreign currency will be less than its ask (sell) quote.
2. The bid/ask spread covers the bank’s cost of conducting foreign exchange transactions
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9
Exhibit 3.1 Computation of the Bid Ask Spread
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