Lecture Notes

MBF582
INTERNATIONAL FINANCIAL
MANAGEMENT
Dr. Umara Noreen
Assistant Professor
COM!AT!
Learnin" Mana"ement !#stem
Internationa$ Finan%ia$ Mana"ement
&Le%t're ( )2*
Learning Objectives
Goal of MNC
Theories of International Finance
International Business Methods
International Opportunities
Exposure to International Risk
Overview of an MNCs Cash Flows
International Business Methods
International opportunities
Overview of an MNCs Cash Flows
Exposure to International risk
I!pact of Financial Mana"e!ent and International Conditions on #alue
This chapter introduces the multinational corporation as having similar goals to the purely domestic
corporation, but a wider variety of opportunities. With additional opportunities come potential increased
returns and other forms of risk to consider. The potential benefits and risks are introduced. The
commonly accepted goal of an MNC is to maximie shareholder wealth. !inancial managers throughout
the MNC have a single goal of maximiing the value of the entire MNC.
The agency costs are normally larger for MNCs than purely domestic firms for the following reasons.
!irst, MNCs incur larger agency costs in monitoring managers of distant foreign subsidiaries.
"econd foreign subsidiary managers raised in different cultures may not follow uniform goals.
Third, the sheer sie of the larger MNCs would also create large agency problems.
#nternational $usiness Methods include the following%
#nternational trade involves exporting and&or importing.
'icensing allows a firm to provide its technology in exchange for fees or some other benefits.
!ranchising obligates a firm to provide a specialied sales or service strategy, support
assistance, and possibly an initial investment, in exchange for periodic fees.
!irms may also penetrate foreign markets by engaging in a (oint venture )(oint ownership and
operation* with firms that reside in those markets.
+c,uisitions of existing operations in foreign countries allow firms to ,uickly gain control
over foreign operations as well as a share of the foreign market.
!irms can also penetrate foreign markets by establishing new foreign subsidiaries.
Many MNCs use a combination of methods to increase international business.
#n general, any method of conducting business that re,uires a direct investment in foreign
operations is referred to as a direct foreign investment )-!#*.
.rowth in international business can be stimulated by )/* access to foreign resources which can reduce
costs, or )0* access to foreign markets which boost revenues. 1et, international business is sub(ect to
risks of exchange rate fluctuations, foreign exchange restrictions, a host government takeover, tax
regulations, etc.
The constraints faced by financial managers attempting to maximie shareholder wealth are%
2nvironmental constraints3countries impose environmental regulations such as building codes
and pollution controls, which increase costs of production.
4egulatory constraints3host governments can impose taxes, restrictions on earnings remittances,
and restrictions on currency convertibility, which may reduce cash flows to be received by the
parent.
2thical constraints35. ".6based MNCs may be at a competitive disadvantage if they follow a
worldwide code of ethics, because other firms may use tactics that are allowed in some foreign
countries but considered illegal by 5. ". standards.
T+e Internationa$ Monetar# !#stem
&Le%t're ,*
Learning Objectives
Evolution of the International Monetar$ %$ste!
Current Exchan"e Rate &rran"e!ents
European Monetar$ %$ste!
Euro and the European Monetar$ 'nion
The Mexican (eso Crisis
The &sian Currenc$ Crisis
Fixed versus Flexi)le Exchan"e Rate Re"i!es
$imetallism% $efore /789% + :double standard; in the sense that both gold and silver were used as
money. "ome countries were on the gold standard, some on the silver standard, some on both. $oth gold
and silver were used as international means of payment and the exchange rates among currencies were
determined by either their gold or silver contents. .resham<s 'aw implied that it would be the least
valuable metal that would tend to circulate.
Classical .old "tandard% /7896/=/>% During this period in most major countries:
.old alone was assured of unrestricted coinage
There was two6way convertibility between gold and national currencies at a stable ratio.
.old could be freely exported or imported.
The exchange rate between two country<s currencies would be determined by their relative gold contents.
There are shortcomings% The supply of newly minted gold is so restricted that the growth of world trade
and investment can be hampered for the lack of sufficient monetary reserves. 2ven if the world returned
to a gold standard, any national government could abandon the standard.
#nterwar ?eriod% /=/96/=>>% 2xchange rates fluctuated as countries widely used :predatory;depreciations
of their currencies as a means of gaining advantage in the world export market. +ttempts were made to
restore the gold standard, but participants lacked the political will to :follow the rules of the game;. The
result for international trade and investment was profoundly detrimental.
!lexible exchange rates were declared acceptable to the #M! members. Central banks were allowed to
intervene in the exchange rate markets to iron out unwarranted volatilities. .old was abandoned as an
international reserve asset. Non6oil6exporting countries and less6developed countries were given greater
access to #M! funds.
Free F$oat
The largest number of countries, about >7, allow market forces to determine their currency<s value.
Mana"e- F$oat
+bout 09 countries combine government intervention with market forces to set exchange rates.
Pe""e- to anot+er %'rren%#
"uch as the 5.". dollar or euro )through franc or mark*.
No nationa$ %'rren%#
"ome countries do not bother printing their own, they (ust use the 5.". dollar. !or example, 2cuador has
recently dollaried.
2leven 2uropean countries maintain exchange rates among their currencies within narrow bands, and
(ointly float against outside currencies. @b(ectives were to establish a one of monetary stability in
2urope and to coordinate exchange rate policies vis6A6vis non62uropean currencies and to pave the way
for the 2uropean Monetary 5nion.
Ba$an%e of Pa#ments
&Le%t're .*
Learning Objectives
Balance of (a$!ents
International Trade Flows
Factors affectin" International Trade Flows
Correctin" a Balance of Trade *eficit
International Capital Flows
&"encies that facilitate international flows
+ow international trade affects MNCs
This chapter provides an overview of the international environment surrounding MNCs. The chapter is
macro6oriented in that it discusses international payments on a country6by6country basis. This macro
discussion is useful information for an MNC since the MNC can be affected by changes in a country<s
current account and capital account positions.
The current account balance is composed of )/* the balance of trade, )0* the net amount of payments of
interest to foreign investors and from foreign investment, )B* payments from international tourism, and
)>* private gifts and grants. The capital account is composed of all capital investments made between
countries, including both direct foreign investment and purchases of securities with maturities exceeding
one year.
+ high inflation rate tends to increase imports and decrease exports, thereby increasing the current
account deficit, other things e,ual. .overnments can place tariffs or ,uotas on imports to restrict imports.
They can also place taxes on income from foreign securities, thereby discouraging investors from
purchasing foreign securities. #f they loosen restrictions, they can encourage international payments
among countries. Ma(or #M! ob(ectives are to )/* promote cooperation among countries on international
monetary issues, )0* promote stability in exchange rates, )B* provide temporary funds to member
countries attempting to correct imbalances of international payments, )>* promote free mobility of capital
funds across countries, and )9* promote free trade.
The #M! in involved in international trade because it attempts to stabilie international payments, and
trade represents a significant portion of the international payments. The euro allowed for a single
currency among many 2uropean countries. #t could encourage firms in those countries to trade among
each other since there is no exchange rate risk. This would possibly cause them to trade less with the 5.".
The euro can increase trade within 2urope because it eliminates the need for several 2uropean countries
to exchange currencies when trading with each other.
Internationa$ Finan%ia$ Mar/ets
&Le%t're 5*
Learning Objectives
To descri)e the )ack"round and corporate use of the followin" international financial
!arkets,
Forei"n exchan"e !arket
International !one$ !arket-
International credit !arket
International )ond !arket- and
International stock !arkets.
Motives for 5sing #nternational !inancial Markets are that he markets for real or financial assets are
prevented from full integration by barriers like tax differentials, tariffs, ,uotas, labor immobility,
communication costs, cultural and financial reporting differences. 1et, such market imperfections also
create uni,ue opportunities for specific geographic markets, helping these markets attract foreign
creditors and investors. #nvestors invest in foreign markets%
to take advantage of favorable economic conditionsC
when they expect foreign currencies to appreciate against their ownC and
to reap the benefits of international diversification.
Creditors provide credit in foreign markets%
to capitalie on higher foreign interest ratesC
when they expect foreign currencies to appreciate against their ownC and
to reap the benefits of diversification.
$orrowers borrow in foreign markets%
to capitalie on lower foreign interest ratesC
and when they expect foreign currencies to depreciate against their own.
The foreign exchange market allows currencies to be exchanged in order to facilitate international trade or
financial transactions. The system for exchanging foreign currencies has evolved from the gold standard,
to agreements on fixed exchange rates, to a floating rate system. The market for immediate exchange is
known as the spot market. Trading between banks occurs in the interbank market. Within this market,
brokers sometimes act as intermediaries.
The growing standardiation of global banking regulations has contributed towards the globaliation of
the industry.
The "ingle 2uropean +ct opened up the 2uropean banking industry and increased its efficiency.
The $asel +ccord outlined risk6weighted capital ade,uacy re,uirements for banks. The proposed
$asel ## +ccord attempts to account for operational risk.
C'rren%# Deri0ati0es
&Le%t're 1 ) 2*
Learning Objectives
To differentiate a!on" forward- futures and option contracts.
To explain how forward contracts are used for hed"in" )ased on anticipated exchan"e
rate !ove!ents/
To explain how currenc$ futures contracts and currenc$ options contracts are used for
hed"in" or speculation )ased on anticipated exchan"e rate !ove!ents.
+ed"in" strate"ies usin" future and options.
+ forward contract is an agreement between a firm and a commercial bank to exchange a specified
amount of a currency at a specified exchange rate )called the forward rate* on a specified date in the
future. !orward contracts are often valued at D/ million or more, and are not normally used by
consumers or small firms. When MNCs anticipate a future need for or future receipt of a foreign
currency, they can set up forward contracts to lock in the exchange rate. The E by which the forward
rate )! * exceeds the spot rate )" * at a given point in time is called the forward premium )p *.
! F " )/ G p *
! exhibits a discount when p H I.
Currency futures contracts specify a standard volume of a particular currency to be exchanged on a
specific settlement date. They are used by MNCs to hedge their currency positions, and by
speculators who hope to capitalie on their expectations of exchange rate movements. The contracts
can be traded by firms or individuals through brokers on the trading floor of an exchange )e.g.
Chicago Mercantile 2xchange*, automated trading systems )e.g. .'@$2J*, or the over6the6counter
market. $rokers who fulfill orders to buy or sell futures contracts typically charge a commission.
2nforced by potential arbitrage activities, the prices of currency futures are closely related to their
corresponding forward rates and spot rates. Currency futures contracts are guaranteed by the
exchange clearinghouse, which in turn minimies its own credit risk by imposing margin
re,uirements on those market participants who take a position.
Currency options provide the right to purchase or sell currencies at specified prices. They are
classified as calls or puts. "tandardied options are traded on exchanges through brokers. Customied
options offered by brokerage firms and commercial banks are traded in the over6the6counter market.
@ption owners can sell or exercise their options, or let their options expire.
Call option premiums will be higher when%
)spot price K strike price* is largerC the time to expiration date is longerC and the variability of the
currency is greater.
!irms may purchase currency call options to hedge payables, pro(ect bidding, or target bidding.
@ne possible speculative strategy for volatile currencies is to purchase both a put option and a call
option at the same exercise price. This is called a straddle. $y purchasing both options, the speculator
may gain if the currency moves substantially in either direction, or if it moves in one direction
followed by the other.
2uropean6style currency options are similar to +merican6style options except that they can only be
exercised on the expiration date. !or firms that purchase options to hedge future cash flows, this loss
in flexibility is probably not an issue. Lence, if their premiums are lower, 2uropean6style currency
options may be preferred.
Go0ernment Inf$'en%e On E3%+an"e Rates
&Le%t're 8*
Learning Objectives
To descri)e the exchan"e rate s$ste!s used )$ various "overn!ents/
To explain how "overn!ents can use direct and indirect intervention to influence
exchan"e rates/ and
To explain how "overn!ent intervention in the forei"n exchan"e !arket can affect
econo!ic conditions.
Explain wh$ )onds are issued.
2xchange rate systems can be classified according to the degree to which the rates are controlled by
the government%
fixed
freely floating
managed float
pegged
!ixed 2xchange 4ate "ystem 4ates are held constant or allowed to fluctuate within very narrow
bands only.
!reely !loating 2xchange 4ate "ystem% 4ates are determined by market forces without governmental
intervention.
2ach country is more insulated from the economic problems of other countries. Central bank
interventions (ust to control exchange rates are not needed. .overnments are not constrained by the
need to maintain exchange rates when setting new policies.
?egged 2xchange 4ate "ystem% The currency<s value is pegged to a foreign currency or to some unit
of account, and thus moves in line with that currency or unit against other currencies.
-ollariation refers to the replacement of a foreign currency with 5.". dollars. -ollariation goes
beyond a currency board, as the country no longer has a local currency.
Within the euro one, there is neither exchange rate risk nor foreign exchange transaction cost.
This means more comparable product pricing, and encourages more cross6border trade and capital
flows. #t will also be easier to conduct and compare valuations of firms across the participating
2uropean countries. 2ach country has a central bank that may intervene in the foreign exchange
market to control its currency<s value.
+ central bank may also attempt to control the money supply growth in its country.
-irect intervention refers to the exchange of currencies that the central bank holds as reserves for
other currencies in the foreign exchange market. -irect intervention is usually most effective when
there is a coordinated effort among central banks and when the central banks have high levels of
reserves that they can use.
Fore%astin" E3%+an"e Rates
&Le%t're 4*
Learning Objectives
To explain how fir!s can )enefit fro! forecastin" exchan"e rates/
To descri)e the co!!on techni0ues used for forecastin"/ and
To explain how forecastin" perfor!ance can )e evaluated
MNCs need exchange rate forecasts for their%
hedging decisions,
short6term financing decisions,
short6term investment decisions,
capital budgeting decisions,
earnings assessments, and
long6term financing decisions.
The numerous methods available for forecasting exchange rates can be categoried into four general
groups%
technical,
fundamental,
market6based, and
mixed.
Technical forecasting involves the use of historical data to predict future values. e.g. time series
models. !undamental forecasting is based on the fundamental relationships between economic
variables and exchange rates. 2.g. sub(ective assessments, ,uantitative measurements based on
regression models and sensitivity analyses. Market6based forecasting uses market indicators to
develop forecasts. The current spot&forward rates are often used, since speculators will ensure that the
current rates reflect the market expectation of the future exchange rate. MNCs are likely to have more
confidence in their forecasts as they measure their forecast error over time. !orecast accuracy varies
among currencies. + more stable currency can usually be more accurately predicted. #f the forecast
errors are consistently positive or negative over time, then there is a bias in the forecasting procedure.
Meas'rin" E35os're To E3%+an"e Rate F$'%t'ations
&Le%t're (6*
Learning Objectives
To discuss the relevance of an MNCs exposure to exchan"e rate risk/
To explain how transaction exposure can )e !easured/
To explain how econo!ic exposure can )e !easured/ and
To explain how translation exposure can )e !easured.
This chapter distinguishes among three forms by which MNCs are exposed to exchange rate risk% )/*
transaction exposure, )0* economic exposure, and )B* translation exposure. #t should be emphasied
that a firm sometimes benefits due to exposure. 1et, it typically would prefer to control its own
destiny and therefore be insulated from exposure. 2ach firm differs in degree of exposure. + firm
should be able to measure its degree of each type of exposure as described in this chapter. Then, it
can decide how to cover that exposure using methods described in the following two chapters.
+lthough exchange rates cannot be forecasted with perfect accuracy, firms can at least measure their
exposure to exchange rate fluctuations.
2xposure to exchange rate fluctuations comes in three forms%
Transaction exposure
2conomic exposure
Translation exposure
The degree to which the value of future cash transactions can be affected by exchange rate
fluctuations is referred to as transaction exposure. MNCs can usually anticipate foreign cash flows for
an upcoming short6term period with reasonable accuracy. +fter the consolidated net currency flows
for the entire MNC has been determined, each net flow is converted into a point estimate )or range* of
a chosen currency. The exposure for each currency can then be assessed using the same measure.
2conomic exposure refers to the degree to which a firm<s present value of future cash flows can be
influenced by exchange rate fluctuations. "ome of these affected cash flows do not re,uire currency
conversion. 2ven a purely domestic firm may be affected by economic exposure if it faces foreign
competition in its local markets. The exposure of an MNC<s consolidated financial statements to
exchange rate fluctuations is known as translation exposure. #n particular, subsidiary earnings
translated into the reporting currency on the consolidated income statement are sub(ect to changing
exchange rates.
Mana"in" Transa%tion E35os're
&Le%t're ((*
Learning Objectives
To identif$ the co!!onl$ used techni0ues for hed"in" transaction exposure/
To show how each techni0ue can )e used to hed"e future pa$a)les and receiva)les/
To co!pare the pros and cons of the different hed"in" techni0ues/ and
To su""est other !ethods of reducin" exchan"e rate risk.
+ primary ob(ective of the chapter is to provide an overview of hedging techni,ues. 1et, transaction
exposure cannot always be hedged in all cases. 2ven when it can be hedged, the firm must decide
whether a hedge is feasible. While a firm will only know for sure whether hedging is worthwhile
after the period of concern, it can incorporate its expectations about future exchange rates, future
inflows and outflows, as well as its degree of risk aversion to make hedging decisions.
Transaction exposure exists when the future cash transactions of a firm are affected by exchange rate
fluctuations. When transaction exposure exists, the firm faces three ma(or tasks%
#dentify its degree of transaction exposure.
-ecide whether to hedge this exposure.
Choose a hedging techni,ue if it decides to hedge part or all of the exposure.
To identify net transaction exposure, a centralied group consolidates all subsidiary reports to
compute the expected net positions in each foreign currency for the entire MNC. Note that
sometimes, a firm may be able to reduce its transaction exposure by pricing its exports in the same
currency that it will use to pay for its imports. Ledging techni,ues include%
!utures hedge,
!orward hedge,
Money market hedge, and
Currency option hedge.
MNCs will normally compare the cash flows that would be expected from each hedging techni,ue
before determining which techni,ue to apply. + futures hedge uses currency futures, while a forward
hedge uses forward contracts, to lock in the future exchange rate. 4ecall that forward contracts are
commonly negotiated for large transactions, while the standardied futures contracts tend to be used
for smaller amounts.
To hedge future payables )receivables*, a firm may purchase )sell* currency futures, or negotiate a
forward contract to purchase )sell* the currency forward. The hedge6versus6no6hedge decision can be
made by comparing the known result of hedging to the possible results of remaining unhedged, and
taking into consideration the firm<s degree of risk aversion. #f the forward rate is an accurate predictor
of the future spot rate, the real cost of hedging will be ero. #f the forward rate is an unbiased
predictor of the future spot rate, the real cost of hedging will be ero on average.
#f the forward rate is an accurate predictor of the future spot rate, the real cost of hedging will be ero.
#f the forward rate is an unbiased predictor of the future spot rate, the real cost of hedging will be ero
on average. + money market hedge involves taking a money market position to cover a future
payables or receivables position.
!or payables%
$orrow in the home currency )optional*
#nvest in the foreign currency
!or receivables%
$orrow in the foreign currency
#nvest in the home currency )optional*
+ currency option hedge uses currency call or put options to hedge transaction exposure.
"ince options need not be exercised, they can insulate a firm from adverse exchange rate movements,
and yet allow the firm to benefit from favorable movements. Currency options are also useful for
hedging contingent exposure. "ome international transactions involve an uncertain amount of foreign
currency, such that over hedging may result. @ne solution is to hedge only the minimum known
amount. +dditionally, the uncertain amount may be hedged using options. #n the long run, the
continual short6term hedging of repeated transactions may have limited effectiveness too.
Mana"in" E%onomi% E35os're An- Trans$ation
E35os're &Le%t're(2*
Learning Objectives
To explain how an MNCs econo!ic exposure can )e hed"ed/ and
To explain how an MNCs translation exposure can )e hed"ed.
2conomic exposure refers to the impact exchange rate fluctuations can have on a firm<s future cash
flows. 4ecall that corporate cash flows can be affected by exchange rate movements in ways not
directly associated with foreign transactions.
The economic impact of currency exchange rates on us is complex because such changes are often
linked to variability in real growth, inflation, interest rates, governmental actions, and other factors.
These changes, if material, can cause us to ad(ust our financing and operating strategies. +n MNC
can determine its exposure by assessing the sensitivity of its cash inflows and outflows to various
possible exchange rate scenarios. The MNC can then reduce its exposure by restructuring its
operations to balance its exchange6rate6sensitive cash flows. Note that computer spreadsheets are
often used to expedite the analysis. 4estructuring to reduce economic exposure involves shifting the
sources of costs or revenue to other locations in order to match cash inflows and outflows in foreign
currencies.
The proposed structure is then evaluated by assessing the sensitivity of its cash inflows and outflows
to various possible exchange rate scenarios.
4estructuring operations is a long6term solution to reducing economic exposure. #t is a much more
complex task than hedging any foreign currency transaction. MNCs must be very confident about the
long6term potential benefits before they proceed to restructure their operations, because of the high
reversal costs. 4estructuring may involve%
increasing&reducing sales in new or existing foreign markets,
increasing&reducing dependency on foreign suppliers,
establishing&eliminating production facilities in foreign markets, and&or
increasing&reducing the level of debt denominated in foreign currencies.
?ossible Ledging "trategies%
?ricing policy K 4educe prices when the euro depreciates.
Ledging with forward contracts K "ell euros forward to hedge against the adverse effects of a
weak euro.
?urchasing foreign supplies K Costs will be reduced during a weak6euro period.
!inancing with foreign funds K Costs will be reduced during a weak6euro period.
4evising the operations of other units K "o as to offset the exposure of 5nit C.
When an MNC has fixed assets )such as buildings or machinery* in a foreign country, the cash flows
to be received from the sale of these assets is sub(ect to exchange rate risk. + sale of fixed assets can
be hedged by creating a liability that matches the expected value of the assets at the point in the future
when they will be sold.
Dire%t Forei"n In0estment
&Le%t're (,*
Learning Objectives
To descri)e co!!on !otives for initiatin" direct forei"n invest!ent 1*FI2/ and
To illustrate the )enefits of international diversification.
The main purpose of this chapter is to illustrate why MNCs often use -!# and to suggest the various
factors involved in the -!# decision. The specifics involved in ,uantifying costs and benefits of -!# are
discussed in the following chapter. Thus, this chapter should be covered in general terms as to the costs
and benefits of -!#. The chapter implicitly suggests that each firm may benefit from -!# by capitaliing
on some uni,ue perceived advantages of the foreign market. 1et, all -!# decisions relate to the MNC<s
overall risk and return ob(ectives.
M MNCs commonly consider -!# because it can improve their profitability and enhance
shareholder wealth.
M #n most cases, MNCs engage in -!# because they are interested in boosting revenues, reducing
costs, or both.
The 2uropean 5nion<s recent expansion enables members to transport products throughout 2urope at
reduced tariffs. New low6wage members )such as ?oland, the Cech 4epublic and 4omania* were thus
targeted for new -!# by MNCs that wanted to reduce manufacturing costs. Lowever, there is a tradeoff K
thousands of (obs were lost in Western 2urope. The optimal method for a firm to penetrate a foreign
market is partially dependent on the characteristics of the market. !or example, if the consumers are used
to buying products from local firms, then licensing arrangements or (oint ventures may be more
appropriate. $efore investing in a foreign country, the potential benefits must be weighed against the
costs and risks associated with that specific country. #n particular, the MNC will want to review the
foreign country<s economic growth and other macroeconomic indicators, as well as the political structure
and policy issues. +s conditions change over time, some countries may become more attractive targets for
-!#, while other countries become less attractive. 2urope )especially 2astern 2urope*, 'atin +merica,
and +sia now receive a larger proportion of -!# than in the past.
The key to international diversification is to select foreign pro(ects whose performance levels are not
highly correlated over time. #n this way, the various international pro(ects are less likely to experience
poor performance simultaneously. #n terms of return, neither new pro(ect has an advantage. With regard
to risk, the new pro(ect is expected to exhibit slightly less variability in returns if it is located in the 5.".
Lowever, estimating the risk of the individual pro(ect without considering the overall firm would be a
mistake. "ome governments allow international ac,uisitions but impose special re,uirements on the
MNCs that desire to ac,uire a local firm. "uch conditions include environmental constraints, restrictions
on local sales, and employment re,uirements
M'$tinationa$ Ca5ita$ B'-"etin"
&Le%t're (. ) (5*
Learning Objectives
To co!pare the capital )ud"etin" anal$sis of an MNCs su)sidiar$ with that of its
parent/
To de!onstrate how !ultinational capital )ud"etin" can )e applied to deter!ine
whether an international pro3ect should )e i!ple!ented/ and
To explain how the risk of international pro3ects can )e assessed.
This chapter identifies additional considerations in multinational capital budgeting versus domestic
capital budgeting. "hould the capital budgeting for a multi6national pro(ect be conducted from the
viewpoint of the subsidiary that will administer the pro(ect, or the parent that will provide most of the
financingN The results may vary with the perspective taken because the net after6tax cash inflows to the
parent can differ substantially from those to the subsidiary.
"uch differences can be due to%
M Tax differentials
M What is the tax rate on remitted fundsN
M 4egulations that restrict remittances
M 2xcessive remittances
The parent may charge its subsidiary very high administrative fees. + parent<s perspective is appropriate
when evaluating a pro(ect, since any pro(ect that can create a positive net present value for the parent
should enhance the firm<s value. Lowever, one exception to this rule occurs when the foreign subsidiary
is not wholly owned by the parent.
The following forecasts are usually re,uired%
M #nitial investment
M Consumer demand over time
M ?roduct price over time
M Oariable cost over time
M !ixed cost over time
M ?ro(ect lifetime
M "alvage )li,uidation* value
When an MNC is unsure of the estimated cash flows of a proposed pro(ect, it needs to incorporate an
ad(ustment for this risk. @ne method is to use a risk6ad(usted discount rate. The greater the
uncertainty, the larger the discount rate that should be applied to the cash flows. +n MNC may also
perform sensitivity analysis or simulation using computer software packages to ad(ust its evaluation.
"ensitivity analysis involves considering alternative estimates for the input variables, while
simulation involves repeating the analysis many times using input values randomly drawn from their
respective probability distributions.
M'$tinationa$ Restr'%t'rin"
&Le%t're (1*
Learning Objectives
To introduce international ac0uisitions )$ MNCs as a for! of !ultinational
restructurin"/
To explain how MNCs conduct valuations of forei"n tar"et fir!s/
To explain wh$ the valuations of a tar"et fir! !a$ var$ a!on" MNCs/ and
To identif$ other !ethods of !ultinational restructurin".
$uilding a new subsidiary, ac,uiring a company, selling an existing subsidiary, downsiing operations,
and shifting production among subsidiaries, are all forms of multinational restructuring. MNCs
continually assess possible forms of multinational restructuring to capitalie on the changing economic,
political, and industrial conditions across countries. +n international ac,uisition enables a firm to
immediately expand its international business since the target is already in place. The firm also benefits
from the established customer relationships. Lowever, establishing a new subsidiary usually costs less,
and there will not be a need to integrate the parent<s management style with that of the target. The volume
of foreign ac,uisitions by 5.". firms has increased consistently since /==B. #n particular, 2uropean firms
have been attractive targets in view of the more uniform regulations across 2uropean 5nion member
countries, the momentum for free enterprise in 2astern 2urope, and the inception of the euro.
'ike any other long6term pro(ect, capital budgeting analysis can be used to determine whether a firm
should be ac,uired. Lence, the ac,uisition decision can be based on a comparison of the benefits and
costs as measured by the net present value )N?O*. +lthough the +sian crisis had devastating effects, it
created an opportunity for some MNCs to pursue new business in +sia. #n +sia, property values had
declined, the currencies were weakened, many firms were near bankruptcy, and the governments wanted
to resolve the crisis. Lowever, MNCs must also consider the lowered economic growth rates in +sia.
#n 2urope, many countries have adopted the euro as the local currency. This simplifies the analysis for an
MNC that is comparing possible target firms in the participating countries.
Tar"et7!5e%ifi% Fa%tors
M Target<s previous cash flows K These may serve as an initial base from which future cash flows
can be estimated.
M Managerial talent of the target K The ac,uiring firm may allow the ac,uired firm to be managed
as it was before the ac,uisition, downsie the firm, or restructure its operations.
Co'ntr#7!5e%ifi% Fa%tors
M Target<s local economic conditions K -emand is likely to be higher when the economic
conditions are strong.
M Target<s local political conditions K Cash flow shocks are less likely when the political conditions
are favorable.
M +n MNC should periodically reassess its -!#s to determine whether to retain them or to sell
)divest* them.
M The MNC can compare the present value of the cash flows from the pro(ect if it is continued, to
the proceeds that would be received )after taxes* if it is divested.
M'$tinationa$ Cost of Ca5ita$ an- Ca5ita$
!tr'%t're &Le%t're (2 ) (8*
Learning Objectives
To explain how corporate and countr$ characteristics influence an MNCs cost of
capital/
To explain wh$ there are differences in the costs of capital across countries/ and
To explain wh$ there are differences in the costs of capital across countries/ and
To explain how corporate and countr$ characteristics are considered )$ an MNC when it
esta)lishes its capital structure.
+ firm<s capital consists of e,uity )retained earnings and funds obtained by issuing stock* and debt
)borrowed funds*. The cost of e,uity reflects an opportunity cost, while the cost of debt is reflected
in the interest expenses. !irms want a capital structure that will minimie their cost of capital, and
hence the re,uired rate of return on pro(ects. The capital asset pricing model )C+?M* can be used to
assess how the re,uired rates of return of MNCs differ from those of purely domestic firms.
C+?M% ke F 4f G b )4m K 4f *
Where,
ke F the re,uired return on a stock
4f F risk6free rate of return
4m F market return
b F the beta of the stock
+ stock<s beta represents the sensitivity of the stock<s returns to market returns, (ust as a pro(ect<s
beta represents the sensitivity of the pro(ect<s cash flows to market conditions. The lower a pro(ect<s
beta, the lower its systematic risk, and the lower its re,uired rate of return, if its unsystematic risk can
be diversified away. +n MNC that increases its foreign sales may be able to reduce its stock<s beta,
and hence reduce the re,uired return. Lowever, some MNCs consider unsystematic pro(ect risk to be
important in determining a pro(ect<s re,uired return. Lence, we cannot say whether an MNC will
have a lower cost of capital than a purely domestic firm in the same industry.
The cost of capital can vary across countries, such that%
M MNCs based in some countries have a competitive advantage over othersC
M MNCs may be able to ad(ust their international operations and sources of funds to capitalie on
the differencesC and
M MNCs based in some countries tend to use a debt6intensive capital structure.
+ firm<s cost of debt is determined by%
M the prevailing risk6free interest rate of the borrowed currency, and
M the risk premium re,uired by creditors.
M The risk6free rate is determined by the interaction of the supply of and demand for funds. #t is
thus influenced by tax laws, demographics, monetary policies, economic conditions, etc.
M The risk premium compensates creditors for the risk that the borrower may default on its
payments.
M The risk premium is influenced by economic conditions, the relationships between corporations
and creditors, government intervention, the degree of financial leverage, etc.
M + firm<s return on e,uity can be measured by the risk6free interest rate plus a premium that
reflects the risk of the firm. The cost of e,uity represents an opportunity cost, and is thus also
based on the available investment opportunities. #t can be estimated by applying a price6earnings
multiple to a stream of earnings. Ligh ?2 multiple low cost of e,uity.
When the risk level of a foreign pro(ect is different from that of the MNC, the MNC<s weighted
average cost of capital )W+CC* may not be the appropriate re,uired rate of return for the pro(ect.
There are various ways to account for this risk differential in the capital budgeting process. The
overall capital structure of an MNC is essentially a combination of the capital structures of the
parent body and its subsidiaries. The capital structure decision involves the choice of debt versus
e,uity financing, and is influenced by both corporate and country characteristics. +s economic
and political conditions and the MNC<s business change, the costs and benefits of each
component cost of capital will change too. +n MNC may revise its capital structure in response
to the changing conditions. !or example, some MNCs have revised their capital structures to
reduce their withholding taxes on remitted earnings. + larger amount of internal funds may be
available to the parent. The need for debt financing by the parent may be reduced.
The revised composition of debt financing may affect the interest charged on debt as well as the
MNC<s overall exposure to exchange rate risk. + smaller amount of internal funds may be
available to the parent. The need for debt financing by the parent may be increased. The revised
composition of debt financing may affect the interest charged on debt as well as the MNC<s
overall exposure to exchange rate risk. +n MNC may deviate from its :local; target capital
structure when local conditions and pro(ect characteristics are taken into consideration. #f the
proportions of debt and e,uity financing in the parent or some other subsidiaries can be ad(usted
accordingly, the MNC may still achieve its :global; target capital structure.
Co'ntr# Ris/ Ana$#sis
&Le%t're (4 )26*
Learning Objectives
To identif$ the co!!on factors used )$ MNCs to !easure a countr$s political risk and
financial risk/
To explain the techni0ues used to !easure countr$ risk/ and
To explain how MNCs use the assess!ent of countr$ risk when !akin" financial
decisions.
This chapter attempts to ac,uaint the student with various forms of risk that must be considered by a
multinational corporation. Methods used to assess country risk are defined. #t should be emphasied
that country risk is often difficult to assess. !urthermore, it may change over time. + firm should
incorporate the country risk assessment in its decision of whether to begin )or continue* business in a
particular country. #f it decides to conduct business there, it should continue to assess country risk as
it decides whether to expand in that country.
Co'ntr# ris/ represents the potentially adverse impact of a country<s environment on an MNC<s
cash flows. Country risk analysis can be used%
M to monitor countries where the MNC is currently doing businessC
M as a screening device to avoid conducting business in countries with excessive riskC and
M to revise its investment or financing decisions in light of recent events.
Po$iti%a$ Ris/ Fa%tors
M +ttitude of consumers in the host country, some consumers are very loyal to locally manufactured
products.
M +ctions of host government, the host government may impose special re,uirements or taxes,
restrict fund transfers, and subsidie local firms. MNCs can also be hurt by a lack of restrictions,
such as failure to enforce copyright laws.
M $lockage of fund transfers, if fund transfers are blocked, subsidiaries will have to undertake
pro(ects that may not be optimal for the MNC.
M Currency inconvertibility, the MNC parent may need to exchange earnings for goods if the
foreign currency cannot be changed into other currencies.
M War, internal and external battles, or even the threat of war, can have devastating effects.
M $ureaucracy, bureaucracy can complicate businesses.
M Corruption, corruption can increase the cost of conducting business or reduce revenue.
#ndicators of economic growth, the current and potential state of a country<s economy is important
since a recession can severely reduce demand. + country<s economic growth is dependent on several
financial factors 6 interest rates, exchange rates, inflation, etc. + macroassessment of country risk is
an overall risk assessment of a country without considering the MNC<s business. + microassessment
of country risk is the risk assessment of a country with respect to the MNC<s type of business. The
overall assessment thus consists of macropolitical risk, macrofinancial risk, micropolitical risk, and
microfinancial risk. Note that there is clearly a degree of sub(ectivity in%
M identifying the relevant political and financial factors,
M determining the relative importance of each factor, and
M predicting the values of factors that cannot be measured ob(ectively.
The checklist approach involves rating and weighting all the macro and micro political and financial
factors to derive an overall assessment of country risk. The -elphi techni,ue involves collecting
various independent opinions and then averaging and measuring the dispersion of those opinions.
Puantitative analysis techni,ues like regression analysis can be applied to historical data to assess the
sensitivity of the business to various risk factors. #nspection visits involve traveling to a country and
meeting with government officials, firm executives, and consumers to clarify uncertainties. The
procedures for ,uantifying country risk will vary with the assessor, the country being assessed, as
well as the type of operations being planned. !irms use country risk ratings when screening potential
pro(ects, and when monitoring existing pro(ects. @ne approach to comparing political and financial
ratings among countries is the foreign investment risk matrix )!#4M *. The matrix displays financial
)or economic* and political risk by intervals ranging from :poor; to :good.; 2ach country can be
positioned on the matrix based on its political and financial ratings.
Lon"7Term Finan%in"
&Le%t're 2( )22*
Learning Objectives
To explain wh$ MNCs consider lon"4ter! financin" in forei"n currencies/
To explain how the feasi)ilit$ of lon"4ter! financin" in forei"n currencies can )e
assessed.
To explain how the assess!ent of lon"4ter! financin" in forei"n currencies can )e
ad3usted for )onds with floatin" interest rates.
"ince MNCs commonly invest in long6term pro(ects, they rely heavily on long6term financing. @nce
the capital structure decision has been made, the MNC must consider the possible sources of e,uity or
debt, and the costs and risks associated with each source. Many MNCs obtain e,uity funding in their
home country, and engage in debt financing in foreign countries. The cost of debt financing depends
on the ,uoted interest rate and the changes in the exchange rate of the borrowed currency over the life
of the loan. To estimate the cost, an MNC needs to%
M determine the amount of funds needed,
M forecast the issue price of the bond, and
M forecast the exchange rates for the times when it has to pay the bondholders.
#f the borrowed currency appreciates over time, an M NC will need more funds to cover the coupon
or principal payments. The potential savings from issuing lower6yield bonds denominated in a foreign
currency should be weighed against the potential risk of incurring high costs if the borrowed currency
appreciates over time. When issuing bonds in a foreign currency, the exchange rate is very important.
Lowever, a point estimate does not account for forecast uncertainty.
Lence, a probability distribution of the exchange rate should be developed and used to compute the
expected financing cost and its probability distribution. The exchange rate probability distribution can
also be fed into a computer simulation program to generate the probability distribution of the
financing cost. The exchange rate risk from financing with bonds in foreign currencies can be reduced
in various ways.
M @ffsetting cash inflows
M !oreign currency receipts can help offset bond payments in the same currency.
#n particular, an MNC can aggregate its cash inflows from all euro6one countries to cover the
payments for its euro6denominated bonds. + firm may hedge its exchange rate risk through the
forward market. Lowever, the firm may not be able to save costs due to interest rate parity.
+ currency swap enables firms to exchange currencies at periodic intervals. #t can be a useful
alternative to forward or futures contracts. #n a parallel )or back6to6back* loan, two parties
simultaneously provide loans to each other )or to a subsidiary of the other party* with an agreement to
repay at a specified point in the future. + firm may issue bonds in several foreign currencies for
diversity. To avoid the higher transaction costs associated with multiple bond issues, the firm may
develop a currency cocktail bond.
@ne popular currency cocktail is the "pecial -rawing 4ight )"-4*. $efore making the debt maturity
decision, MNCs may want to assess the yield curves of the countries in which they need funds. +
yield curve is shaped by the demand for and supply of funds at various maturity levels in a country<s
debt market. +n upward6sloping yield curve means that the annualied yields are lower for short6term
debt than for long6term debt.
Continuing financial innovation has resulted in a number of variations%
M +ccretion swap K increasing notional value.
M +mortiing swap K decreasing notional value
M $asis )floating6for6floating* swap
M Callable swap
M !orward swap K swap begins at a future date
M ?utable swap
M Qero6coupon swap
M "waption K swap option
!+ort7Term Finan%in"
&Le%t're 2, ) 2.*
Learning Objectives
To explain wh$ MNCs consider forei"n financin"/
To explain how MNCs deter!ine whether to use forei"n financin"/ and
To illustrate the possi)le )enefits of financin" with a portfolio of currencies.
This chapter explains short6term liability management of MNCs, a part of multinational management that
is often neglected in other textbooks. !rom this chapter, students should learn that correct financing
decisions can reduce the firm<s costs. While foreign financing costs cannot usually be perfectly fore6
casted, firms should evaluate the probability of reducing costs through foreign financing.
2uronotes are unsecured debt securities with typical maturities of /, B or R months. They are underwritten
by commercial banks. MNCs may also issue 2uro6commercial papers to obtain short6term financing.
MNCs utilie direct 2urobank loans to maintain a relationship with 2urobanks too. $efore an MNC<s
parent or subsidiary searches for outside funding, it should determine if any internal funds are available.
?arents of MNCs may also raise funds by increasing their markups on the supplies that they send to their
subsidiaries. +n MNC may finance in a foreign currency to offset a net receivables position in that
foreign currency. +n MNC may also consider borrowing foreign currencies when the interest rates on
such currencies are attractive, so as to reduce financing costs.
The actual cost of financing depends on
M the interest rate on the loan, and
M the movement in the value of the borrowed currency over the life of the loan.
The effective financing rate, rf , can be written as%
rf F )/ G if *)/ G ef * K /
where,
if F the foreign currency interest rate
ef F the E in the foreign currency<s spot rate F "tG/ K "
There are various criteria an MNC must consider in its financing decision, including
M interest rate parity,
M the forward rate as a forecast, and
M exchange rate forecasts.
M #nterest 4ate ?arity )#4?*
#f #4? holds, foreign financing with a simultaneous hedge of that position in the forward market will
result in financing costs that are similar to those for domestic financing. #f the forward rate is an
unbiased predictor of the future spot rate, then the effective financing rate of a foreign loan will on
average be e,ual to the domestic financing rate. !irms may use exchange rate forecasts to forecast the
effective financing rate of a foreign currency, or they may compute the break6even exchange rate that
will e,uate the domestic and foreign financing rates. "ometimes, it may be useful to develop
probability distributions, instead of relying on single point estimates.
Finan%in" Internationa$ Tra-e
&Le%t're 25 )21*
Learning Objectives
To descri)e the !ethods of pa$!ent for international trade/
To explain co!!on trade finance !ethods
To descri)e the !a3or a"enc$ that facilitates international trade with export insurance
and5or loan pro"ra!s.
This chapter first suggests why international trade can be difficult. Then, it explains the various ways in
which banking institutions can facilitate international trade by resolving problems faced by the exporter
and importer. #n any international trade transaction, credit is provided by either
M the supplier )exporter*,
M the buyer )importer*,
M one or more financial institutions, or
M any combination of the above.
M The form of credit whereby the supplier funds the entire trade cycle is known as supplier credit.
?repayments
M The goods will not be shipped until the buyer has paid the seller.
M Time of payment % $efore shipment
M .oods available to buyers % +fter payment
M 4isk to exporter % None
M 4isk to importer % 4elies completely on exporter to ship goods as ordered
Letters of %re-it &L8C*
M These are issued by a bank on behalf of the importer promising to pay the exporter upon
presentation of the shipping documents.
M Time of payment % When shipment is made
M .oods available to buyers % +fter payment
M 4isk to exporter % Oery little or none
M 4isk to importer % 4elies on exporter to ship goods as described in documents
Drafts &Bi$$s of E3%+an"e*
M Time of payment % @n maturity of draft
M .oods available to buyers % $efore payment
M 4isk to exporter % 4elies on buyer to pay
M 4isk to importer % 4elies on exporter to ship goods as described in documents
Consi"nments
M The exporter retains actual title to the goods that are shipped to the importer.
M Time of payment % +t time of sale by buyer to third party
M .oods available to buyers % $efore payment
M 4isk to exporter % +llows importer to sell inventory before paying exporter
M 4isk to importer % None
O5en A%%o'nts
M The exporter ships the merchandise and expects the buyer to remit payment according to the
agreed6upon terms.
M Time of payment % +s agreed upon
M .oods available to buyers % $efore payment
M 4isk to exporter % 4elies completely on buyer to pay account as agreed upon
M 4isk to importer % None
Internationa$ Cas+ Mana"ement
&Le%t're 22 )28*
Learning Objectives
To explain the difference in anal$6in" cash flows fro! a su)sidiar$ perspective versus a
parent perspective/
To explain the various techni0ues used to opti!i6e cash flows/
To explain co!!on co!plications in opti!i6in" cash flows/ and
To explain the potential )enefits and risks of forei"n invest!ents.
This chapter emphasies the decisions involved in the management of cash by an MNC. The
additional opportunities and risks of cash management for an MNC versus a domestic firm should be
stressed. There are actually three key components of the chapter. The first is distinguishing between
subsidiary control over excess cash versus centralied control. +n argument is made in favor of
centralied control. The second component is optimiing cash flow. "everal techni,ues are
recommended to optimie cash flow. !inally, the decision of where to invest excess cash should be
discussed with consideration of all factors that need to be incorporated for this decision.
The management of working capital has a direct influence on the amount and timing of cash flow.
M !'9si-iar# e35enses K #t is difficult to forecast the payments for international purchases of raw
materials or supplies because of exchange rate fluctuations, ,uotas, sales volume volatility, etc.
M !'9si-iar# re0en'e K #nternational sales may be more volatile than domestic sales because of
exchange rate fluctuations, business cycles, etc.
M !'9si-iar# -i0i-en- 5a#ments K #f the payments and fees )royalties, overhead charges* for the
parent are known and denominated in the subsidiary<s currency, forecasting cash flows will be
easier.
+fter accounting for all cash outflows and inflows, the subsidiary must either invest its excess cash or
borrow to cover its cash deficiencies. #f the subsidiary has access to lines of credit and overdraft
facilities, it may maintain ade,uate li,uidity without substantial cash balances. The centralied cash
management division of an MNC cannot always accurately forecast the events that affect parent6
subsidiary or intersubsidiary cash flows. #t should, however, be ready to react to any event by
considering any potential adverse impact on cash flows, and how to avoid such adverse impacts. The
more ,uickly the cash inflows are received, the more ,uickly they can be invested or used for other
purposes.
Common methods include the establishment of lockboxes around the world )to reduce mail float* and
preauthoried payments )charging a customer<s bank account directly*.
Mana"in" 9$o%/e- f'n-s% + government may re,uire that funds remain within the country in order
to create (obs and reduce unemployment. +n MNC can shift cost6incurring activities )like 4S-* to
the host country, ad(ust the transfer pricing policy )such that higher fees have to be paid to the
parent*, borrow locally rather than from the parent, etc. Managing intersubsidiary cash transfers. +
subsidiary with excess funds can provide financing by paying for its supplies earlier than is necessary.
This techni,ue is called $ea-in". +lternatively, a subsidiary in need of funds can be allowed to lag its
payments. This techni,ue is called $a""in".
When a subsidiary delays its payments to the other subsidiaries, the other subsidiaries may be forced
to borrow until the payments arrive. "ome governments may prohibit the use of a netting system, or
periodically prevent cash from leaving the country.
The abilities of banks to facilitate cash transfers for MNCs may vary among countries. The banking
systems in different countries usually differ too. 2xcess funds can be invested in domestic or foreign
short6term securities, such as 2urocurrency deposits, Treasury bills, and commercial papers.
"ometimes, foreign short6term securities have higher interest rates. Lowever, firms must also account
for the possible exchange rate movements. Centralied cash management allows for more efficient
usage of funds and possibly higher returns. When multiple currencies are involved, a separate pool
may be formed for each currency. !unds can also be invested in securities that are denominated in the
currencies needed in the future.
#f an MNC is not sure of how exchange rates will change over time, it may prefer to diversify its cash
among securities that are denominated in different currencies. The degree to which such a portfolio
will reduce risk depends on the correlations among the currencies. -ynamic hedging refers to the
strategy of hedging when the currencies held are expected to depreciate, and not hedging when they
are expected to appreciate. The overall performance is dependent on the firm<s ability to accurately
forecast the direction of exchange rate movements.
Deri0ati0es Usa"e in Ris/ Mana"ement 9# Non7
Finan%ia$ Firms: E0i-en%e from Gree%e
&Le%t're 24 ),6*
Learning Objectives
M To explain the key findings and important implications with respect to the usage of derivatives in
.reece.
M The results of the survey indicate that the use of derivatives in risk management is not
wide spread among domestic firms.
M #t is observed that large firms are more likely to use derivatives contrary to the small sie ones.
M !irms use derivatives mainly to manage their interest rate risk and secondary their foreign
exchange risk.
M The main purpose of the hedging policy of domestic firms is to reduce the volatility in cash
flows.
M !irms appear to use sophisticated risk assessment methods, such as value at risk )Oa4*.
M The use of options by firms is limited and the more common excuse for this behavior is their high
cost.
M Oery interesting is the conclusion that most firms develop an internal risk management
department.
M !inally firms using derivatives state that their hedging policy is not influenced by any domestic
macroeconomic factor.
M $usiness environment of the country not to be favorable of derivatives use.
M #n conclusion, the approach of the domestic non6financial firms that use derivatives is in
line with the international hedging practices.
M This convergence is verified by the comparative evidence of different surveys that is presented.
M The repetition of this survey in the near future is expected to lead to valuable conclusions
as to the evolution of risk management by .reek non6financial firms through time, both in
,uantitative and ,ualitative terms.
Internationa$ E;'it# Mar/ets
&Le%t're ,(*
Learning Objectives
& %tatistical (erspective
Market %tructure- Tradin" (ractices- and Costs
International E0uit$ Market Bench!arks
7orld E0uit$ Market Bench!ark %hares
Tradin" in International E0uities
Factors &ffectin" International E0uit$ Returns
+lmost =IE of the total market capitaliation of the world<s e,uity markets is accounted for by the
market capitaliation of the developed world. The other /IE is accounted for by the market capitaliation
of developing countries in :emerging markets;.
M 'atin +merica
M +sia
M 2astern 2urope
M Mideast&+frica
4ecently the growth rates in these emerging markets have been strong, but with more volatility than we
have here at home. The e,uity markets of the developed world tend to be much more li,uid than
emerging markets. 'i,uidity refers to how ,uickly an asset can be sold without a ma(or price concession.
"o, while investments in emerging markets may be profitable, the focus should be on the long term.
The e,uity markets of the developed world tend to be much more li,uid than emerging markets. 'i,uidity
refers to how ,uickly an asset can be sold without a ma(or price concession.
"o, while investments in emerging markets may be profitable, the focus should be on the long term.
2merging Markets tend to be much more concentrated than our markets. Concentrated in relatively few
companies. That is, a few issues account for a much larger percentage of the overall market capitaliation
in emerging markets than in the e,uity markets of the developed world.
M ?rimary Markets% shares offered for sale directly from the issuing company.
M "econdary Markets% provide market participants with marketability and share valuation.
M -ealer Market% the stock is sold by dealers, who stand ready to buy and sell the security for their
own account. #n the 5."., the @TC market is a dealer market.
M +uction Market% @rganied exchanges have specialists who match buy and sell orders. $uy and
sell orders may get matched without the specialist buying and selling as a dealer.
M +utomated 2xchanges% Computers match buy and sell orders
Internationa$ Ban/in" an- Mone# Mar/et
&Le%t're ,2*
Learning Objectives
International Bankin" %ervices
Reasons for International Bankin"
T$pes of International Bankin" Offices
Capital &de0uac$ %tandards
International Mone$ Market
International *e)t Crisis
#nternational $anks do everything domestic banks do and%
M +rrange trade financing.
M +rrange foreign exchange.
M @ffer hedging services for foreign currency receivables and payables through forward and option
contracts.
M @ffer investment banking services )where allowed*.
T#5es of Internationa$ Ban/in" Offi%es
M Correspondent $ank
M 4epresentative @ffices
M !oreign $ranches
M "ubsidiary and +ffiliate $anks
M 2dge +ct $anks
M @ffshore $anking Centers
M #nternational $anking !acilities
+ correspondent banking relationship exists when two banks maintain deposits with each other.
Correspondent banking allows a bank<s MNC client to conduct business worldwide through his local
bank or its correspondents. + representative office is a small service facility staffed by parent bank
personnel that is designed to assist MNC clients of the parent bank in dealings with the bank<s
correspondents. 4epresentative offices also assist with information about local business customs, and
credit evaluation of the MNC<s local customers. + foreign branch bank operates like a local bank, but is
legally part of the the parent. #t is sub(ect to both the banking regulations of home country and foreign
country. #t can provide a much fuller range of services than a representative office. $ranch $anks are the
most popular way for 5.". banks to expand overseas.
+ subsidiary bank is a locally incorporated bank wholly or partly owned by a foreign parent. +n affiliate
bank is one that is partly owned but not controlled by the parent. 5.". parent banks like foreign
subsidiaries because they allow 5.". banks to underwrite securities. 2dge +ct banks are federally
chartered subsidiaries of 5.". banks that are physically located in the 5.". that are allowed to engage in a
full range of international banking activities. The 2dge +ct was a /=/= amendment to "ection 09 of the
/=/> !ederal 4eserve +ct.
+n international banking facility is a separate set of accounts that are segregated on the parents books. +n
international banking facility is not a uni,ue physical or legal identity. +ny 5.". bank can have one.
#nternational banking facilities have captured a lot of the 2urodollar business that was previously handled
offshore. $ank capital ade,uacy refers to the amount of e,uity capital and other securities a bank holds as
reserves. There are various standards and international agreements regarding how much bank capital is
:enough; while traditional bank capital standards may be enough to protect depositors from traditional
credit risk, they may not be sufficient protection from derivative risk. !or example, $arings $ank, which
collapsed in /==9 from derivative losses, looked good on paper relative to capital ade,uacy standards e
nsure the safety and soundness of the banking system.