WELCOME TO

INTRODUCTION TO INTERNATIONAL FINANCE

Topic 1 :: Introduction
Dr. Md Mohan Uddin

Introduction to International Finance

u Finance in an international context…

u Why do we need to study international finance?
u We are living in a highly globalized and integrated
world economy
u Continued liberalization of international trade
further internationalizes the consumption pattern
u Globalized production: MNCs source inputs and locateate
productions anywhere in the world
u Integrated financial markets: internationally diversified
ified
d
investment, internationally tradable financial securities
urities

Dr. Md Mohan Uddin 2/24/2014 2

What makes international finance
special?
u Three major dimensions make international finance different from purely
domestic finance:
u Foreign exchange and political risks
u Market imperfections
u Expanded opportunity sets

Dr. Md Mohan Uddin 2/24/2014 3

What makes international finance special?

Foreign exchange and political risks

u Unexpected fluctuations of the exchange rates may adversely affect the MNCs
as well as individuals who are engaged in cross border transactions
u Exchange rate uncertainty may affect all the major economic functions
including consumption, production, and investment.
u Sovereign country can change the rules, e.g.,
u Tax rules
u Expropriation of assets
u In some countries, there is a lack of tradition of the rule of law.

Dr. Md Mohan Uddin 2/24/2014 4

What makes international finance special?
Market imperfections

u Market imperfections represent various frictions and impediments preventing

markets from functioning perfectly.
u Such frictions/ impediments/ barriers include
u Legal restrictions
u Excessive transportation and transaction costs
u Information asymmetry
u Discriminatory taxation

Dr. Md Mohan Uddin 2/24/2014 5

What makes international finance special?

Market imperfections

u Often, MNCs are motivated to locate production overseas due to such market
imperfections
u Imperfection in the international financial market often restrict the extent to
which investors can diversify their portfolios.

Dr. Md Mohan Uddin 2/24/2014 6

What makes international finance special?
Expanded opportunity set

u If firms venture into the arena of global markets, they can benefit from an
expanded opportunity set by:
u locating production in any country/region of the world to maximize performance
u raising fund in any capital market where the cost capital is the lowest.
u deploying assets on a global basis to gain from greater economies of scale.

Dr. Md Mohan Uddin 2/24/2014 7

What makes international finance

special?
u International finance is different from domestic finance and to be benefitted
from it,
u maximize the benefits from the global opportunity set
u control exchange rate and political risks
u manage various market imperfections

Dr. Md Mohan Uddin 2/24/2014 8

Effective international financial
management
u Effective financial management requires an underlying goal.
u Shareholder wealth maximization is considered as the fundamental goal of
sound financial management.
u Shareholder wealth maximization is long accepted as a goal in the Anglo-
Angl
Anglo
glo-
Saxon countries like Australia, Canada, UK, and USA.

Dr. Md Mohan Uddin 2/24/2014 9

Effective international financial

management
u In other countries like France or Germany, shareholders are viewed as merely
one among many “stakeholders” of the firm including:
u Employees
u Suppliers
u Customers
u In Japan, managers have typically sought to maximize the value of the
keiretsu—a family of firms to which the individual firms belongs.
belongs

Dr. Md Mohan Uddin 2/24/2014

2/24 10
Effective international financial
management
u As a result of recent liberalization and international integration of capital
markets even the managers in France, Germany, Japan, and other non-Anglo-
Saxon countries are beginning to pay serious attention to shareholder wealth
maximization.
u Shareholder wealth maximization does not imply that the firm would not
pursue other goals.
u Rather, shareholder wealth maximization also helps accomplishing other
legitimate goals.

Dr. Md Mohan Uddin 2/24/2014 11

Effective international financial

management
u As shown by a series of recent corporate scandals at companies like Enron,
WorldCom, and Global Crossing, managers may pursue their own private
interests at the expense of shareholders when they are not closely monitored.
u These calamities have painfully reinforced the importance of corporate
governance, i.e., the financial and legal framework for regulating the
ge
relationship between a firm’s management and its shareholders.

Dr. Md Mohan Uddin 2/24/2014

2/24 12
Effective international financial
management
u 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.

Dr. Md Mohan Uddin 2/24/2014 13

Globalization of the World Economy:

Major Trends and Developments
u Key trends and developments include:
u Emergence of Globalized Financial Markets
u Emergence of the Euro as a Global Currency
u Europe’s Sovereign Debt Crisis of 2010
u Trade Liberalization and Economic Integration
u Privatization
u Global Financial Crisis of 2008-2009

Dr. Md Mohan Uddin 2/24/2014 14

Globalization of the World Economy:
Emergence of globalized financial markets

u Deregulation of Financial Markets

u Advances in Technology
u have greatly reduced information and transaction costs,, which has led to:
u Financial Innovations, such as
u Currency futures and options
u Multi-currency bonds
u Cross-border stock listings
u International mutual funds

Dr. Md Mohan Uddin 2/24/2014 15

Globalization of the World Economy:

Emergence of the euro as a global currency

u The advent of the euro in 1999 represents a momentous event in the history
of world financial system
u More than 300 million Europeans are using the common
currency
u Many new members of the EU would like to adopt the euro
u The transaction domain of the euro may become larger
than the USD in near future

Dr. Md Mohan Uddin 2/24/2014 16

Globalization of the World Economy:
Europe’s sovereign-debt crisis of 2010
u All EU member states are automatically members of both the Economic and
Monetary Union (EMU) and the Stability and Growth Pact (SGP)
u SGP is an agreement, among the member states of the European Union, to
facilitate and maintain the stability of the EMU
u The SGP requires each Member State to implement a fiscal policy aiming for
the country to stay within the limits on government deficit (3% of GDP)

Dr. Md Mohan Uddin 2/24/2014 17

Globalization of the World Economy:

Europe’s sovereign-debt crisis of 2010
u In December 2009, the new Greek government revealed that the actual
budget deficit was 12.7 percent compared to the previously forecasted 3.7
percent based on falsified national account data
u Therefore, Greece actually was in a serious violation of the SGP.
u This situation was a result of excessive borrowing and spending, with wages
and prices rising faster than productivity

Dr. Md Mohan Uddin 2/24/2014 18

Globalization of the World Economy:
Europe’s sovereign-debt crisis of 2010
u Greece could not use the traditional means of depreciating national currency
as the country had adopted the euro.
u Investors became worried about sovereign default
u They started to sell off Greek government bonds
u The panic spread to other weak European countries, especially Ireland,
Portugal, and Spain

Dr. Md Mohan Uddin 2/24/2014 19

Globalization of the World Economy:

Europe’s sovereign-debt crisis of 2010
u In 2010, credit rating agencies downgraded the government bonds of the
affected countries
u Borrowing and refinancing became more costly
u Although the debt crisis in Greece accounted for only about 2.5% of Eurozone
GDP, it quickly escalated to a Europe-wide debt crisis

Dr. Md Mohan Uddin 2/24/2014 20

Globalization of the World Economy:
Europe’s sovereign-debt crisis of 2010

Dr. Md Mohan Uddin 2/24/2014 21

Globalization of the World Economy:

Europe’s sovereign-debt crisis of 2010
u On May 9, 2010, EU countries led by France and Germany, jointly with IMF, put
together a massive Euro 750 billion package to bail out Greece and other
weak countries.
u The agreement on the bailout plan was slow and thus became expensive due
to
u Europe’s lack of political union
u Fragmented decision making structure

Dr. Md Mohan Uddin 2/24/2014 22

Globalization of the World Economy:
Trade liberalization and economic integration
u Over the past 50 years, international trade increased about twice as fast as
world GDP.
u There has been a change in the attitudes of many of the world’s governments,
who have abandoned mercantilist views and embraced free trade as the
surest route to prosperity for their citizenry.

Dr. Md Mohan Uddin 2/24/2014 23

Globalization of the World Economy:

Trade liberalization and economic integration
u The General Agreement on Tariffs and Trade (GATT) is a multilateral
agreement among member countries that has reduced many barriers to trade.
u The World Trade Organization (WTO) has the power to enforce the rules of
international trade.

Dr. Md Mohan Uddin 2/24/2014 24

Globalization of the World Economy:
Trade liberalization and economic integration
u The European Union (EU) was established to foster economic integration
among the countries of Western Europe.
u The North American Free Trade Agreement (NAFTA) calls for phasing out
impediments to trade between Canada, Mexico, and the United States over a
15-year period beginning in 1994.

Dr. Md Mohan Uddin 2/24/2014 25

Globalization of the World Economy:

Privatization
u The selling of state-run enterprises to investors is also known as
“denationalization.”
u Privatization is often seen as socialist economies in transition to market
economies.
u By most estimates, this increases the efficiency of the enterprise.
u It also often spurs a tremendous increase in cross-border investment.

Dr. Md Mohan Uddin 2/24/2014 26

Globalization of the World Economy:
Global financial crisis of 2008—2009
u The “Great Recession” was the most serious, synchronized economic
downturn since the Great Depression of the 1930s.
u Factors included:
u Households and financial institutions borrowed too much and took too much risk.
u This risk was repackaged with securitization.

Dr. Md Mohan Uddin 2/24/2014 27

Multinational Corporations

u A multinational corporation (MNC) is a

firm that has been incorporated in one
country and has production and sales
operations in other countries.
u There are about 60,000 MNCs in the
world.
u 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.

Dr. Md Mohan Uddin 2/24/2014 28

Dr. Md Mohan Uddin 2/24/2014 29