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The International Financial Environment

Objectives:

INTERNATIONAL FINANCIAL MANAGEMENT

Understand why it is important to study international finance.

EUN / RESNICK

Distinguish international finance from domestic finance.

Second Edition

Lets say
Tata Motors, buoyed by its acquisition of JLR, is considering entering the international sports motorcycle market. In a bold move, it is contemplating acquiring KTM of Austria and plans to purchase controlling stake of 76% for 1.2 billion which will be paid out in quarterly installments over 2 years. The capital for acquisition is expected to be generated by Tatas local arm. From a finance perspective, what should senior managers of Tata Motors evaluate?

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Some factors to consider are:

Exchange rate (FXR) of INR to EUR Local interest rates for evaluating capital affordability Exchange rate risk/exposure over the transaction period Can the risks be managed (hedged)? Cost of managing risks? Strategic Likely FXR risks in KTMs key markets (e.g. AUD, GBP, GCC region) Strategic Synergy; cost of indenture; unforeseen liabilities etc.

How would the evaluation change if acquisition is to be financed by JLR operations?

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Overview
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Whats special about International Finance? Goals for International Financial Management Globalization of the World Economy Multinational Corporations
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Globalization of the World Economy: Recent Trends

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Emergence of Globalized Financial Markets Trade Liberalization and Economic Integration Privatization Rise of Private Equity; Hedge Funds; Structured Finance Rapidly growing inequality in the West
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International Finance deals with issues such as:

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Foreign Exchange Risk Political Risk Market Imperfections Expanded Opportunity Set
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Liberalization of Protectionist Legislation

Emergence of new trade agreements, Global Institutions & Trading Blocks.
For instance,
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The General Agreement on Tariffs and Trade (GATT) a multilateral agreement among member countries has reduced many barriers to trade. The World Trade Organization has the power to enforce the rules of international trade. North American Free Trade Agreement Gulf Cooperation Council European Economic Community and the Eurozone
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Privatization
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Selling off state-run enterprises to investors is also known as Denationalization. Often seen in socialist economies in transition to market economies. By most estimates this increases the efficiency of the enterprise. Often spurs a tremendous increase in crossborder investment.
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What is a Multinational Corporation?

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A firm that has incorporated in 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, produce goods with labor and capital equipment in a third country and sell their output in various other national markets.
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Theories of International Business

Why are firms motivated to expand their business internationally?
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Theory of Comparative Advantage

Country specific specialization can increase production efficiency. E.g.: Electronics manufacturing in Japan before, China today; BPO operations in India.

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Factor Endowment Theory (Hecksher-Ohlin Model)

Some factors are geographically distributed in which case firms are compelled to embark on international ventures. E.g.: Petroleum in the Middle-East (Saudi Aramco); Uranium in Australia; Gold & Diamonds in Southern Africa.

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Product Cycle Theory

As a firm matures in the domestic market, it may recognize new opportunities in new markets
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Modes of International Business

There are several methods by which firms can conduct international business.
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International Trade: The old school, conservative approach of exporting and/or importing items. Licensing: allows a firm to provide its technology in exchange for fees or some other benefits. Franchising: obligates a firm to provide a specialized sales or service strategy, support assistance, and possibly an initial investment in the franchise in exchange for periodic fees.

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Modes of International Business

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Firms may also penetrate foreign markets by engaging in a Joint Venture (joint ownership and operation) with firms that reside in those markets. Acquisitions of existing operations in foreign countries allow firms to quickly gain control over foreign operations as well as a share of the foreign market. Firms can also penetrate foreign markets by establishing new foreign subsidiaries. In general, any method of conducting business that requires a direct investment in foreign operations is referred to as a direct foreign investment (DFI).

The optimal international business method may depend on the characteristics of the MNC.
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The Organization of the Course

Macroeconomic Environment

The Financial Environment

Management of the Multinational Firm

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Evolution of the International Monetary System

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Bimetallism: Before 1870 (Gold and Silver coins)

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Worked far better for nations than managed fiduciary money No role for a central bank
Culminated in the creation of The Federal Reserve

(Classical) Gold Standard: 1870-1913 (Gold Oz. = Xs)

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Bretton Woods System: 1945-1972 (Gold = $s Xs) The Flexible Exchange Rate Regime: 1973-Present
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Every country for itself

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Bretton Woods System: 1945-1972

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Named for a 1944 meeting of 44 nations at Bretton Woods, New Hampshire, USA. The purpose was to design a postwar international monetary system. The goal was exchange rate stability without the gold standard. The result was the creation of the IMF and the World Bank. During this time the US takes centre stage as the first modern superpower
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Bretton Woods System: 1945-1972

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Under the Bretton Woods system, the U.S. dollar was pegged to gold at $35 per ounce and other currencies were pegged to the U.S. dollar. Each country was responsible for maintaining its exchange rate within 1% of the adopted par value by buying or selling foreign reserves as necessary. The Bretton Woods system was a dollar-based gold exchange standard.
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The Flexible Exchange Rate Regime: 1973-Present

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Flexible exchange rates (for developed countries) were declared acceptable to the IMF members. n Central banks were allowed to intervene in the exchange rate markets to iron out unwarranted volatilities. Gold was abandoned as an international reserve asset and for the most part USD was used. Non-oil-exporting countries and less-developed countries were given greater access to IMF funds.
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Current Exchange Rate Arrangements

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Free Float ( Yen)

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The largest number of countries, about 48, allow market forces to determine their currencys value. About 25 countries combine government intervention with market forces to set exchange rates. Such as the U.S. dollar or euro (through franc or mark). Some countries do not bother printing their own, they just use the U.S. dollar. For example, Ecuador has dollarized.
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Managed Float ( INR)

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Pegged to another currency ( GCC currencies)

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No national currency
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McGraw-Hill/Irwin
reserved.

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Copyright 2001 by The McGraw-Hill Companies, Inc. All rights

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McGraw-Hill/Irwin
reserved.

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Copyright 2001 by The McGraw-Hill Companies, Inc. All rights

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End of Session

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