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Theories of FDI
One set of theories seeks to explain why a firm will favor direct investment as a means of entering a foreign market when two other alternatives, exporting and licensing are open to it. Another set of theories seeks to explain why firms in the same industry often undertake FDI at the same time and why they favor certain locations over others as targets for FDI and a third theory attempts to combine the two as the electric paradigm.
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2. 3.
The viability of an exporting strategy is often constrained by transportation costs and trade barriers. By limiting import quotas, government increase attractiveness of FDI. Licensing may result in a firms giving away valuable technological knowhow to a potential foreign competitor.
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i.
ii. iii. iv.
Host country benefits: Resource transfer effects (+) Employment effects (+) Balance of payments effects (+) Competition and economic growth effects (+)
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iii.
Perceived loss of national sovereignty and autonomy (foreign parent may interfere in key decisions
of host country)
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2.
3. 4. 5.
Attract new source s of demand by establishing a subsidiary. Enter markets in which superior profits are possible. Fully benefit from economies of scale. Use foreign factors of production. Use foreign raw materials.
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Problem # 1
Expected rate of return from investment in home country is 15% with 4.5% level of risk and from foreign country is 18% with 3.5% level of risk. Fund allocated in home country is 45% and rest in foreign country. Correlation coefficient between returns of two countries is 0.75. What is the portfolio return and risk for the MNC?
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Problem # 2
Citi N.A. operates its banking services in Bangladesh, Pakistan and England. It will be in operation for next 3 years in these countries. The cost of capital of Citi N.A. is 10.50%, Calculate the value of the MNC based on the expected annual earnings and expected exchange rate for the next 3 years are given in the following table (amount in million):
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Problem #2
Country Year 1 Year 2 Year 3
E(CF)
BD Pakistan England
Tk.200 Rs.350 215
E(ER)
$1=58.50 $1=50.00 $1=0.68
E(CF)
Tk.250 Rs.450 220
E(ER)
$1=59.50 $1=51.50 $1=0.69
E(CF)
Tk.195 Rs.500 240
E(ER)
$1=59.75 $1=52.25 $1=0.65
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Problem # 3
An US MNC has already invested its 65% fund in home country for earning 14% rate of return with 5% level of risk. Remaining 35% fund can be invested either in US or in UK. If investment is made in US then possible rates of return are 16% with 25% probability, 19% with 55% probability and 12% with 20%v probability. If investment is made in UK then possible rates of return are 10% with 45% probability, 18% with 15% probability and 22% with 40%v probability. The correlation coefficient between rates of return between investments in US is 0.65 and between US & UK is 0.75. In which country, should new investment be made?