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INTERNATIONAL

FINANCIALMANAGEMENT

EUN / RESNICK

Fourth Edition

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Chapter Objectives:

Understand why it is important to study

international finance.

Distinguish international finance from domestic

finance.

1Chapter OneGlobalization & theMultinational Firm

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Whats Special about International Finance?

Goals for International Financial Management

Globalization of theWorld Economy

Multinational Corporations

Organization of the Text

Summary

Chapter One Outline

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Whats Special about

International Finance? Foreign Exchange Risk

Political Risk

Market Imperfections

Expanded Opportunity Set

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Whats Special about

International Finance? Foreign Exchange Risk

The risk that foreign currency profits may evaporate in

dollar terms due to unanticipated unfavorable exchangerate movements.

Suppose $1 = 100 and you buy 10 shares of Toyota at

10,000 per share.

One year later the investment is worth ten percent morein yen: 110,000

But, if the yen has depreciated to $1 = 120, your

investment has actually lostmoney in dollar terms.

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Whats Special about

International Finance? Political Risk

Sovereign governments have the right to regulate the

movement of goods, capital, and people across theirborders. These laws sometimes change in unexpected

ways.

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Market Imperfections

Legal restrictions on movement of goods,

people, and money Transactions costs

Shipping costs

Tax arbitrage

Whats Special about

International Finance?

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The Example of Nestls Market

Imperfection Nestl used to issue two different classes of

common stock bearer shares and registered shares.

Foreigners were only allowed to buy bearer shares. Swiss citizens could buy registered shares.

The bearer stock was more expensive.

On November 18, 1988, Nestl lifted restrictionsimposed on foreigners, allowing them to hold

registered shares as well as bearer shares.

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Nestls Foreign Ownership Restrictions

12,000

10,000

8,000

6,000

4,000

2,000

0

11 20 31 9 18 24

Source: Financial Times, November 26, 1988 p.1. Adapted with permission.

SF

Bearer share

Registered share

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The Example of Nestls Market

Imperfection Following this, the price spread between the two

types of shares narrowed dramatically.

This implies that there was a major transfer of wealthfrom foreign shareholders to Swiss shareholders.

Foreigners holding Nestl bearer shares wereexposed to political risk in a country that is widely

viewed as a haven from such risk. The Nestl episode illustrates both the importance

of considering market imperfections and the perilof political risk.

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Expanded Opportunity Set

It doesnt make sense to play in only one corner

of the sandbox. True for corporations as well as individual

investors.

Whats Special about

International Finance?

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The focus of the text is to equip the reader with

the intellectual toolbox of an effective global

managerbut what goal should this effectiveglobal manager be working toward?

Maximization of shareholder wealth?

or Other Goals?

Goals for International Financial

Management

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Maximize ShareholderWealth

Long accepted as a goal in the Anglo-Saxon

countries, but complications arise.

Who are and where are the shareholders?

In what currency should we maximize their

wealth?

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Other Goals

In other countries shareholders are viewed as merely one

among many stakeholders of the firm including:

Employees Suppliers

Customers

In Japan, managers have typically sought to maximize the

value of the keiretsua family of firms to which theindividual firms belongs.

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Other Goals

As shown by a series of recent corporate scandalsat companies like Enron,WorldCom, and GlobalCrossing, managers may pursue their own privateinterests at the expense of shareholders when theyare not closely monitored.

These calamities have painfully reinforced the

importance ofcorporate governancei.e. thefinancial and legal framework for regulating therelationship between a firms management and itsshareholders.

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Other Goals

These types of issues can be much more serious in

many other parts of the world, especially emerging

and transitional economies, such as Indonesia,Korea, and Russia, where legal protection of

shareholders is weak or virtually non-existing.

No matter what the other goals, they cannot beachieved in the long term if the maximization of

shareholder wealth is not given due consideration.

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Globalization of theWorld Economy:

Major Trends Emergence of Globalized Financial Markets

Emergence of the Euro as a Global Currency

Trade Liberalization and Economic Integration

Privatization

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Deregulation of Financial Markets

coupled with

Advances in Technologyhave greatly reduced information and

transactions costs, which has led to:

Financial Innovations, such as

Currency futures and options Multi-currency bonds

Cross-border stock listings

International mutual funds

Emergence of Globalized

Financial Markets

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Emergence of the Euro as a Global Currency

A momentous event in the history of world

financial systems.

Currently more than 300 million Europeans in 22countries are using the common currency on a

daily basis.

In May 2004, 10 more countries joined theEuropean Union and adopt the euro.

The transaction domain of the euro may become

larger than the U.S. dollars in the near future.

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Euro Area

Austria

Belgium

Cyprus Czech Republic

Estonia

Finland

France Germany

Greece

Hungary

Ireland

22 Countries participatingintheeuro: Italy

Latvia

Lithuania Luxembourg

Malta

Poland

Portugal Slovak Republic

Slovenia

Spain

The Netherlands

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Value of the Euro in U.S. Dollars

January 1999 to Dec 2004

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Economic Integration

Over the past 50 years, international trade

increased about twice as fast as world GDP.

There has been a sea change in the attitudes ofmany of the worlds governments who have

abandoned mercantilist views and embraced free

trade as the surest route to prosperity for their

citizenry.

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Liberalization of

Protectionist Legislation The General Agreement on Tariffs and Trade

(GATT) a multilateral agreement among member

countries has reduced many barriers to trade. TheWorld Trade Organization has the power to

enforce the rules of international trade.

On January 1, 2005 the end of the era of quotason imported textiles ended.

This is an event of historic proportions.

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NAFTA

The North American Free Trade Agreement(NAFTA) calls for phasing out impediments totrade between Canada, Mexico and the UnitedStates over a 15-year period.

For Mexico, the ratio of export to GDP hasincreased dramatically from 2.2% in 1973 to

28.7% in 2001. The increased trade will result in increased

numbers of jobs and a higher standard of livingfor all member nations.

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Privatization

The selling off state-run enterprises to investors is

also known as Denationalization.

Often seen in socialist economies in transition tomarket economies.

By most estimates this increases the efficiency of

the enterprise. Often spurs a tremendous increase in cross-border

investment.

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Multinational Corporations

A firm that has incorporated on one country and

has production and sales operations in other

countries. There are about 60,000 MNCs in the world.

Many MNCs obtain raw materials from one

nation, financial capital from another, producegoods with labor and capital equipment in a third

country and sell their output in various other

national markets.

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Top 10 MNCs

1 General Electric United States

2 Vodafone Group PLC United Kingdom

3 Ford Motor Company United States

4 British Petroleum Co. PLC United Kingdom

5 General Motors United States

6 Royal Dutch/Shell Group UK/Netherlands

7 Toyota Motor Corporation Japan8 Total Fina Elf France

9 France Telecom France

10 ExxonMobile Corporation United States

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End Chapter One