MULTINATIONAL FINANCE

Multinational Enterprise, Multinational Financial Management and the Global Environment (Chapter 1 & 3)

Multinational Financial Management

The Multinational Enterprise

A Multinational Enterprise (MNE) (Definition)
Has operating subsidiaries, branches or affiliates (i.e. production) located in foreign countries. World-wide dispersion of sales, assets and profits. The ownership of MNEs is dispersed internationally. They are managed from a global perspective (global allocation of resources).

Multinational Financial Management

The Multinational Enterprise

A multinational enterprise (MNE)
Exports products or services Produces overseas
creating a new production structure buying an existing production structure Through licensing Alone joint venture
Multinational Financial Management

Motives for MNE

Exploit raw materials in foreign countries Enter new markets Minimized cost of production

Multinational Financial Management

Underlying motive
INCREASING RETURNS More powerful position :
economies of scale technological advantages managerial expertise about local conditions information network product differentiation tailor products for different markets financial strength more financing alternatives

Better position to identify market imperfections :

less expensive labor force raw material sources diversified financial assets legal rules and taxes

Multinational Financial Management

Macro Economic Factors

The rapid growth of MNE over the last 30 years fuled by: Massive deregulation of trade and capital barriers
Increased global competition

Integration of economies The spread of the free-market system

Collapse of communism

Revolution in information and communication technologies Country differences in market conditions (market imperfections) Advances in research and new technologies
Decreasing importance of raw materials

Multinational Financial Management

Example: Foreign Direct Investment, USA

300 250 Billions of $ 200 150 100 50 0 1960 1966 1972 1978 1984 1990 1996
FDI: Acquisition abroad of companies, property or physical assets such as plants and equipment
Multinational Financial Management

U.S investment abroad FDI in U.S

Overall
THE MULTINATIONAL FIRM HAS A STRONG ECONOMIC AND BUSINESS REASONS FOR BECOMMING MNE. FOR THE HOST COUNTRIES, THEY ARE AGENTS OF TECHNOLOGY TRANSFER AND GAIN FROM ECONOMIC DEVELOPMENT AND GROWTH.
Multinational Financial Management

The Global Manager

The key for corporate success in an increasing competitive world: Flexibility, Adaptability, Speed
Depends on the managements ability to adjust to change and adjust to volatile markets conditions

The global manager

Thinks global
regarding financing regarding investment
Multinational Financial Management

The Global Manager

Need global knowledge about:
Production
where raw materials and parts comes from Labor costs the global alternatives

Financing
where do funds come from the global alternatives

Political environment
How political decisions affect operations

Economic environment
How different economic environments affect operations

Need to constantly update information as the world changes

Multinational Financial Management

Global Financial Management

There are significant differences between international and domestic financial management (theme of the course):
Cultural issues Corporate governance issues Foreign exchange risks Political risk Modification of domestic finance theories Modification of domestic financial instruments
Multinational Financial Management

Goal of Management
Shareholder Wealth Maximization
Maximize the return to shareholders, as measured by the sum of capital gains and dividends, for a given level of risk. Minimize the level of risk to shareholders for a given rate of return. dominant goal of management in the Anglo- American world.

Corporate Wealth Maximization

Continental European and Japanese markets maximize corporate wealth. Treat shareholders together with other corporate interest groups (management, labor, the local community, suppliers, creditors and even the government). The definition of corporate wealth is much broader than just financial wealth (includes technical, market and human resources).

Multinational Financial Management

Financial theories
Theoretical foundation for international corporate finance (shareholder wealth maximization) - modern financial theories:
Diversification and Portfolio Theory Capital Asset Pricing Model (CAPM) Optimal Capital Structure Arbitrage Market efficiency
Multinational Financial Management

Arbitrage
Ability to make risk-free profits Purchase of assets/commodities on one market for immediate resale on another market in order to profit from a price discrepancy Leads to equalization of prices across markets/countries The No-arbitrage condition crucial for many theoretical economic relationships (particular in international finance) regarding:
Domestic and international financial markets Exchange rates Interest rates Inflation rates (Option pricing )

Multinational Financial Management

Market efficiency
A market is said to be efficient if it fully and correctly reflects all relevant information in determining prices New information is quickly incorporated into the price. Price changes is driven by new information
Multinational Financial Management

Capital Asset Pricing

Risk is defined as the added risk that the firms shares bring to a diversified portfolio. The total operational risk of the firm (firm specific) can be eliminated through portfolio diversification by the investors. Therefore, this unsystematic risk, the risk of the individual security, should not be a prime concern for management unless it increases the prospect of bankruptcy. Systematic risk, the risk of the market in general, cannot be eliminated. This reflects risk that the share price will be a function of the stock market. The CAPM specifies the price (expected return) of systematic risk demanded by investors to hold a certain asset. Defines a relationship between expected return and systematic risk.

Multinational Financial Management

The International Monetary System

Important part of the global environment IMS refers to the set of policies, institutions, practices, regulations and mechanisms that determine the rate at which one currency is exchanged for another Exchange rate volatility central factor in multinational finance depends on the monetary system Important for financial managers to understand:
the international monetary system how the choice of system affects currency values

Multinational Financial Management

Alternative Exchange Rate Systems

Fixed versus freely floating exchange rate
choice between stable (fixed) versus volatile (freely floating) exchange rate Preferable with stable exchange rate Economic shocks absorbed more easily with freely floating exchange rates Fixed rate systems demands sound governmental financial policies

Multinational Financial Management

Alternative Exchange Rate Systems

Free float (clean float)
Supply and demand determines the exchange rate No central bank interventions

Managed float (dirty float)

floating currency, but with a degree of central bank interventions to smooth out fluctuations

Fixed-rate system
government commit to maintain target exchange rates Central banks actively intervenes (buy and sell) in order to maintain the committed exchange rate economic development (inflation) can not deviate to much among committed countries
Multinational Financial Management

History International Monetary System

Gold standard (1821-1914)
Gold used as medium of exchange far back in history Value of money determined by how much gold it represented Central banks would always exchange money to gold Exchange rates between currencies determined by the different relationships between money and gold in the different countries (kronor/ounce of gold, dollar/ounce of gold)

Gold standard (1925-1944)

United states and England held only gold reserves other nations held both gold and pound/dollar as reserves competitive devaluations by a number of countries lead to trade wars system broke down

Multinational Financial Management

History International Monetary System

The Bretton Woods system (1946-1971)
to avoid destructive economic policies (previous trade war) in the future, the Allied nations agreed to a new post war monetary system each government committed to maintain a fixed (pegged) exchange rate for its currency towards the dollar/gold. exchange rates were allowed to fluctuate only a small percentage around the pegged value Fixed rates maintained by central banks through interventions (buy and sell currencies) Most countries revalued their currencies (devaluation) during the period (12 countries more than 30 percent) System collapsed mainly due to high inflation in United states (financing of Vietnam war) and because of a disagreement upon a common inflation rate for the countries in the system

Multinational Financial Management

History International Monetary System

The Post-Bretton Woods System (1971-present)
Major currencies (dollar, pound, yen) mainly some type of floating currency system Most undeveloped countries some type of fixed exchange rate system (usually fixed in regard to US dollar) European Monetary System (EMS) 1979
Fixed exchange rates that could be adjusted between countries Collapsed in 1992-93, due to the different economic developments among the participating countries and to the deregulation of capital markets

European monetary union (EMU) 1999

Common currency in practice 2002

Multinational Financial Management