IFM Merged Slides Learning

International Capital Flows
• Capital flows usually represent portfolio investment or direct foreign

investment.
• The Direct Foreign Investment (DFI) positions inside and outside the
Ghana have risen substantially over time, indicating increasing
globalization.
• In particular, both DFI positions increased during periods of strong
economic growth.
Factors Affecting DFI
• Changes in Restrictions
• New opportunities may arise from the removal of government barriers.
• Privatization
• DFI has also been stimulated by the selling of government operations.
• Potential Economic Growth
• Countries with higher potential economic growth are more likely to attract
DFI.
Factors Affecting DFI
• Tax Rates
• Countries that impose relatively low tax rates on corporate earnings are more
likely to attract DFI.
• Exchange Rates
• Firms will typically prefer to invest their funds in a country when that
country’s currency is expected to strengthen.
Factors Affecting International Portfolio Investment
• Tax Rates on Interest or Dividends

• Investors will normally prefer countries where the tax rates are relatively low.
• Interest Rates
• Money tends to flow to countries with high interest rates.
• Exchange Rates
• Foreign investors may be attracted if the local currency is expected to
strengthen.
Agencies that Facilitate International Flows
International Monetary Fund (IMF)
• The IMF is an organization of 183 member countries. Established in
1946, it aims
• to promote international monetary cooperation and exchange stability;
• to foster economic growth and high levels of employment; and
• to provide temporary financial assistance to help ease imbalances of
payments.
Agencies that Facilitate International Flows
International Monetary Fund (IMF)
• Its operations involve surveillance, and
financial and technical assistance.
• In particular, its compensatory financing facility
attempts to reduce the impact of export instability on
country economies.
• The IMF uses a quota system, and its unit of account is
the SDR (special drawing right).
Agencies that Facilitate International
Flows
World Bank Group
• Established in 1944, the Group assists development with the primary
focus of helping the poorest people and the poorest countries.
• It has 183 member countries, and is composed of five organizations -
IBRD, IDA, IFC, MIGA and ICSID.
Agencies that Facilitate
International Flows
IBRD: International Bank for Reconstruction and Development
• Better known as the World Bank, the IBRD provides loans and
development assistance to middle-income countries and
creditworthy poorer countries.
• In particular, its structural adjustment loans are intended to enhance
a country’s long-term economic growth.
International Flows
IBRD: International Bank for Reconstruction
and Development
• The IBRD is not a profit-maximizing
organization. Nevertheless, it has earned a net
income every year since 1948.
• It may spread its funds by entering into cofinancing
agreements with official aid agencies, export credit
agencies, as well as commercial banks.
International Flows
IDA: International Development Association
• IDA was set up in 1960 as an agency that lends to the very poor
developing nations on highly concessional terms.
• IDA lends only to those countries that lack the financial ability to
borrow from IBRD.
• IBRD and IDA are run on the same lines, sharing the same staff,
headquarters and project evaluation standards.
International Flows
IFC: International Finance Corporation
• The IFC was set up in 1956 to promote sustainable private sector
investment in developing countries, by
• financing private sector projects;
• helping to mobilize financing in the international financial markets; and
• providing advice and technical assistance to businesses and governments.
International Flows
MIGA: Multilateral Investment Guarantee Agency
• The MIGA was created in 1988 to promote FDI in emerging
economies, by
• offering political risk insurance to investors and lenders; and
• helping developing countries attract and retain private investment.
International Flows
ICSID: International Centre for Settlement of Investment Disputes
• The ICSID was created in 1966 to facilitate the settlement of
investment disputes between governments and foreign investors,
thereby helping to promote increased flows of international
investment.
International Flows
World Trade Organization (WTO)
• Created in 1995, the WTO is the successor to the General Agreement
on Tariffs and Trade (GATT).
• It deals with the global rules of trade between nations to ensure that
trade flows smoothly, predictably and freely.
• At the heart of the WTO's multilateral trading system are its trade
agreements.
Agencies that Facilitate International
Flows
World Trade Organization (WTO)
• Its functions include:
• administering WTO trade agreements;
• serving as a forum for trade negotiations;
• handling trade disputes;
• monitoring national trading policies;
• providing technical assistance and training for developing countries;
and
• cooperating with other international groups.
International Flows
Bank for International Settlements (BIS)
• Set up in 1930, the BIS is an international organization that fosters
cooperation among central banks and other agencies in pursuit of
monetary and financial stability.
• It is the “central banks’ central bank” and “lender of last resort.”
International Flows
Bank for International Settlements (BIS)
• The BIS functions as:
• a forum for international monetary and financial
cooperation;
• a bank for central banks;
• a center for monetary and economic research; and
• an agent or trustee in connection with international
financial operations.
International Flows
Regional Development Agencies
• Agencies with more regional objectives relating to economic
development include
• the Inter-American Development Bank;
• the Asian Development Bank;
• the African Development Bank; and
• the European Bank for Reconstruction and Development.
Impact of International Trade on an MNC’s Value
National Income in Foreign Countries Inflation in Foreign Countries
Trade Agreements Exchange Rate Movements
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the U.S. parent at the end of period t
E (ERj,t ) = expected exchange rate at which currency j can be
converted to dollars at the end of period t
k = weighted average cost of capital of the parent
6
Government Influence On Exchange Rates
1
Chapter Objectives
• To describe the exchange rate systems used by various governments;
• To explain how governments can use direct and indirect intervention
to influence exchange rates; and
• To explain how government intervention in the foreign exchange
market can affect economic conditions.
2
Exchange Rate Systems
• Exchange rate systems can be classified according to the degree to
which the rates are controlled by the government.
• Exchange rate systems normally fall into one of the following
categories:
• fixed
• freely floating
• managed float
• pegged
3
Fixed Exchange Rate System
• In a fixed exchange rate system, exchange rates are

either held constant or allowed to fluctuate only
within very narrow bands.
• The Bretton Woods era (1944-1971) fixed each
currency’s value in terms of gold.
• The 1971 Smithsonian Agreement which followed
merely adjusted the exchange rates and expanded
the fluctuation boundaries. The system was still
fixed.
4
Online Application
• Find out more about the Bretton Woods conference and the
Smithsonian Agreement at:
• http://www.imfsite.org/origins/confer.html
• http://www.mises.org/money.asp
5
Fixed Exchange Rate System
• Pros: Work becomes easier for the MNCs.
• Cons: Governments may revalue their currencies. In fact, the dollar
was devalued more than once after the U.S. experienced balance of
trade deficits.
• Cons: Each country may become more vulnerable to the economic
conditions in other countries.
6
Freely Floating Exchange Rate System
• In a freely floating exchange rate system, exchange rates are determined
solely by market forces demand and supply.
• Pros: Each country may become more insulated against the economic
problems in other countries.
• Pros: Central bank interventions that may affect the economy unfavorably
are no longer needed.
• Pros: Governments are not restricted by exchange rate boundaries when
setting new policies.
• Pros: Less capital flow restrictions are needed, thus enhancing the
efficiency of the financial market.
7
Freely Floating Exchange Rate System
• Cons: MNCs may need to devote substantial resources to managing
their exposure to exchange rate fluctuations.
• Cons: The country that initially experienced economic problems (such
as high inflation, increasing unemployment rate) may have its
problems compounded.
8
Managed Float Exchange Rate System
• In a managed (or “dirty”) float exchange rate system, exchange rates are
allowed to move freely on a daily basis and no official boundaries exist.
However, governments may intervene to prevent the rates from moving
too much in a certain direction.
• Cons: A government may manipulate its exchange rates such that its own
country benefits at the expense of others.
9
Pegged Exchange Rate System
• In a pegged exchange rate system, the home currency’s value is
pegged to a foreign currency or to some unit of account, and moves
in line with that currency or unit against other currencies.
• The European Economic Community’s snake arrangement (1972-
1979) pegged the currencies of member countries within established
limits of each other.
10
• The European Monetary System which followed in

1979 held the exchange rates of member countries
together within specified limits and also pegged
them to a European Currency Unit (ECU) through
the exchange rate mechanism (ERM).
• The ERM experienced severe problems in 1992, as
economic conditions and goals varied among member
countries.
11
• In 1994, Mexico’s central bank pegged the peso to

the U.S. dollar, but allowed a band within which the
peso’s value could fluctuate against the dollar.
• By the end of the year, there was substantial downward
pressure on the peso, and the central bank allowed the
peso to float freely. The Mexican peso crisis had just
began ...
12
Currency Boards
• A currency board is a system for maintaining the value of the local currency
with respect to some other specified currency.
• The currency board is a variant of the Pegged Exchange rate system
• Under a currency board, the management of the exchange rate and money
supply are given to a monetary authority that makes decisions about the
valuation of a nation's currency.
• A currency board maintains absolute, unlimited convertibility between its

notes and coins and the currency against which they are pegged (the anchor
currency), at a fixed rate of exchange, with no restrictions on current-account
or capital-account transactions.
• For example, Hong Kong tied the value of the Hong Kong dollar to the U.S.
dollar (HK$7.8 = $1) since 1983, while Argentina has tied the value of its peso
to the U.S. dollar (1 peso = $1) since 1991.
13
Currency Boards
• For a currency board to be successful, it must have

credibility in its promise to maintain the exchange
rate.
• It has to intervene to defend its position against the
pressures exerted by economic conditions, as well
as by speculators who are betting that the board
will not be able to support the specified exchange
rate.
14
Exposure of a Pegged Currency to Interest
Rate Movements
• A country that uses a currency board does not have complete
control over its local interest rates, as the rates must be
aligned with the interest rates of the currency to which the
local currency is tied.
• Note that the two interest rates may not be exactly the same
because of different risks.
• A currency that is pegged to another currency will have to
move in tandem with that currency against all other
currencies.
• So, the value of a pegged currency does not necessarily reflect
the demand and supply conditions in the foreign exchange
market, and may result in uneven trade or capital flows.
15
Dollarization
• Dollarization refers to the replacement of a local

currency with U.S. dollars.
• Dollarization goes beyond a currency board, as the
country no longer has a local currency.
• For example, Ecuador implemented dollarization in
2000.
16
A Single European Currency €
• In 1991, the Maastricht treaty called for a single European currency.
On Jan 1, 1999, the euro was adopted by Austria, Belgium, Finland,
France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal,
and Spain. Greece joined the system in 2001.
• By 2002, the national currencies of the 12 participating countries will
be withdrawn and completely replaced with the euro.
17
• Within the euro-zone, cross-border trade and capital flows will occur
without the need to convert to another currency.
• European monetary policy is also consolidated because of the single
money supply. The Frankfurt-based European Central Bank (ECB) is
responsible for setting the common monetary policy.
18
• The ECB aims to control inflation in the participating countries and to
stabilize the euro within reasonable boundaries.
• The common monetary policy may eventually lead to more political
harmony.
• Note that each participating country may have to rely on its own
fiscal policy (tax and government expenditure decisions) to help solve
local economic problems.
19
• As currency movements among the European countries will be
eliminated, there should be an increase in all types of business
arrangements, more comparable product pricing, and more trade
flows.
• It will also be easier to compare and conduct valuations of firms
across the participating European countries.
20
• Stock and bond prices will also be more comparable and there should
be more cross-border investing. However, non-European investors
may not achieve as much diversification as in the past.
• Exchange rate risk and foreign exchange transaction costs within the
euro-zone will be eliminated, while interest rates will have to be
similar.
21
• Since its introduction in 1999, the euro has declined against many
currencies.
• This weakness was partially attributed to capital outflows from
Europe, which was in turn partially attributed to a lack of confidence
in the euro.
• Some countries had ignored restraint in favor of resolving domestic
problems, resulting in a lack of solidarity.
22
Government Intervention
• Each country has a government agency (called the central

bank) that may intervene in the foreign exchange market to
control the value of the country’s currency.
• In the United States, the Federal Reserve System (Fed) is the
central bank.
• In Ghana the Central Bank is the Bank of Ghana
• www.bog.gov.gh
23
• Central banks manage exchange rates

• to smooth exchange rate movements,
• to establish implicit exchange rate boundaries, and/or
• to respond to temporary disturbances.
• Often, intervention is overwhelmed by market forces. However,
currency movements may be even more volatile in the absence of
intervention.
• Direct intervention refers to the exchange of currencies that the central
bank holds as reserves for other currencies in the foreign exchange
market.
• Direct intervention is usually most effective when there is a
coordinated effort among central banks.
24
• When a central bank intervenes in the foreign

exchange market without adjusting for the change
in money supply, it is said to engaged in
nonsterilized intervention.
• In a sterilized intervention, Treasury securities are

purchased or sold at the same time to maintain the
money supply.
25
Nonsterilized Intervention
Bank of Ghana
To $ GHC
Strengthen
the GHC: Banks participating
in the foreign
exchange market
Bank of Ghana
To Weaken $ GHC
the GHC:
Banks participating
in the foreign
exchange market 26
Sterilized Intervention
Bank of Ghana T- securities

To $ GHC Financial
Strengthen GHC institutions
the GHC: Banks participating that invest
in the foreign in Treasury
exchange market securities
GHC
Bank of Ghana
To Weaken $ GHC Financial
T- securities
the GHC: institutions
Banks participating that invest
in the foreign in Treasury
exchange market securities
27
• Some speculators attempt to determine when the

central bank is intervening, and the extent of the
intervention, in order to capitalize on the
anticipated results of the intervention effort.
28
• Central banks can also engage in indirect

intervention by influencing the factors that
determine the value of a currency.
• For example, the Bank of Ghana may attempt to
increase interest rates (and hence boost the cedi’s
value) by reducing the Ghana money supply.
• Note that high interest rates adversely affects local
borrowers.
29
• Governments may also use foreign exchange controls (such as
restrictions on currency exchange) as a form of indirect intervention.
30
Online Application
• During the 1997-98 Asian financial crisis, some governments
intervened in an attempt to control their exchange rates. Find out
more about the crisis (and the consequences of the intervention
efforts) at http://www.stern.nyu.edu/globalmacro/.
31
Exchange Rate Target Zones
• Many economists have criticized the present exchange rate
system because of the wide swings in the exchange rates of
major currencies.
• Some have suggested that target zones be used, whereby an
initial exchange rate will be established with specific
boundaries (that are wider than the bands used in fixed
exchange rate systems).
• The ideal target zone should allow rates to adjust to
economic factors without causing wide swings in
international trade and fear in the financial markets.
• However, the actual result may be a system no different
from what exists today.
32
Intervention as a Policy Tool
• Like tax laws and money supply, the exchange rate
is a tool which a government can use to achieve its
desired economic objectives.
• A weak home currency can stimulate foreign
demand for products, and hence local jobs.
However, it may also lead to higher inflation.
• A strong currency may cure high inflation, since the
intensified foreign competition (import increase)
should cause domestic producers to refrain from
increasing prices. However, it may also lead to
higher unemployment
33
Impact of Government Actions on Exchange Rates
Government
Monetary
and Fiscal Policies
Relative Interest Relative Inflation Relative National

Rates Rates Income Levels
International International
Exchange Rates
Capital Flows Trade
Government
Purchases & Sales
of Currencies
Tax Laws, in Quotas,
etc. Foreign Exchange Market Tariffs, etc. 34
Impact of Central Bank Intervention
on an MNC’s Value
Direct Intervention
Indirect Intervention
m 
n 
E CFj , t  E ER j , t 
 j 1 
Value =   
t =1  1  k  t

 
E (CFj,t ) = expected cash flows in currency j to be received
by the U.S. parent at the end of period t
E (ERj,t ) = expected exchange rate at which currency j can
be converted to dollars at the end of period t
k = weighted average cost of capital of the parent 35
Chapter Review
• Exchange Rate Systems
• Fixed Exchange Rate System
• Freely Floating Exchange Rate System
• Managed Float Exchange Rate System
• Pegged Exchange Rate System
• Currency Boards
• Exposure of a Pegged Currency to Interest Rate and Exchange Rate
Movements
• Dollarization
36
Chapter Review
• A Single European Currency

• Membership
• Euro Transactions
• Impact on European Monetary Policy
• Impact on Business Within Europe
• Impact on the Valuation of Businesses in Europe
• Impact on Financial Flows
• Impact on Exchange Rate Risk
• Status Report on the Euro
37
Chapter Review
• Government Intervention
• Reasons for Government Intervention
• Direct Intervention
• Indirect Intervention
• Exchange Rate Target Zones
38
Chapter Review
• Intervention as a Policy Tool

• Influence of a Weak Home Currency on the Economy
• Influence of a Strong Home Currency on the Economy
• How Central Bank Intervention Can Affect an MNC’s Value
39
International Financial Markets
1
Objectives
• To describe the background and corporate use of the following

international financial markets:
• foreign exchange market,
• Eurocurrency market,
• Eurocredit market,
• Eurobond market, and
• international stock markets.
2
Motives for Using
• The markets for real or financial assets are prevented from complete
integration by barriers such as tax differentials, tariffs, quotas, labor
immobility, communication costs, cultural differences, and financial
reporting differences.
• Yet, these barriers can also create unique opportunities for specific
geographic markets that will attract foreign investors.
3
Motives for Using
• Investors invest in foreign markets:
• to take advantage of favorable economic conditions;
• when they expect foreign currencies to appreciate against their own; and
• to reap the benefits of international diversification.
4
Motives for Using
• Creditors provide credit in foreign markets:
• to capitalize on higher foreign interest rates;
• when they expect foreign currencies to appreciate against their own; and
• to reap the benefits of international diversification.
5
Motives for Using
• Borrowers borrow in foreign markets:
• to capitalize on lower foreign interest rates; and
• when they expect foreign currencies to depreciate against their own.
6
Foreign Exchange Market
• The foreign exchange market allows currencies to be exchanged in order to
facilitate international trade or financial transactions. This market allows currencies
to be exchanged in order to facilitate international trade or financial transactions
Balance of Payment, (BoP).
• A 24-hour market where currencies are traded to facilitate BoP adjustments
• A $5 trillion/day market: most widely traded currencies include $, €, ¥, and £
• Major FX centers: London, New York, Tokyo, Hong Kong, Singapore, and Dubai
• Other FX centers are located in the commercial cities of countries
7
Key Players in FX Markets
• Currency traders and FX brokers
• Major commercial banks
• Speculators
• Central Banks of countries
• Each of the above players has its own objective for participating in the
FX market.
8
• The system for establishing exchange rates has evolved over time.
• From 1876 to 1913, each currency was convertible into gold at a specified rate, as
dictated by the gold standard.
• This was followed by a period of instability, as World War I began and the Great
Depression followed.
• The 1944 Bretton Woods Agreement called for fixed currency exchange rates.
• By 1971, the U.S. dollar appeared to be overvalued. The Smithsonian Agreement
devalued the U.S. dollar and widened the boundaries for exchange rate
fluctuations from ±1% to ±2%.
9
• Even then, governments still had difficulties maintaining exchange rates within
the stated boundaries.
• In 1973, the official boundaries for the more widely traded currencies were
eliminated and the floating exchange rate system came into effect.
10
Foreign Exchange Transactions
• There is no specific building or location where traders exchange currencies.
Trading also occurs around the clock.
• The market for immediate exchange is known as the spot market. Cash
delivery for spot currency transactions is usually the standard settlement
date of two business days after the transaction date (T+2).
• Currency trading between banks occurs in the interbank market. Within

this market, forex brokers sometimes act as intermediaries.
• The exchange rate quoted in newspapers are for large transactions of over
$1 million
11
• The forward market enables an MNC to lock in the exchange rate at which
it will buy or sell a certain quantity of currency on a specified future date
e.g., 30, 60, 90 or 180 days from today.
• Hundreds of banks facilitate foreign exchange transactions, though the top
20 handle about 50% of the transactions. Citi, Société Générale, Crown
Agents Bank, UBS, ANZ, NatWest Markets among others
• At any point in time, arbitrage ensures that exchange rates are similar
across banks.
12
• The following attributes of banks are important to foreign exchange
customers:
• competitiveness of quote
• special relationship between the bank and its customer
• speed of execution
• advice about current market conditions
• forecasting advice
13
• Banks provide foreign exchange services for a fee: the bank’s bid (buy)
quote for a foreign currency will be less than its ask (sell) quote. This
is the bid/ask spread.
• bid/ask % spread = ask rate – bid rate
ask rate
• Example: Suppose bid price for £ = $1.52, ask price = $1.60.
bid/ask % spread = (1.60–1.52)/1.60 = 5%
14
• The bid/ask spread is normally larger for those currencies that are less frequently
traded.
• The spread is also larger for “retail” transactions than for “wholesale”
transactions between banks or large corporations.
• The spread on currency quotations is positively influenced by
• order costs,
• inventory costs, and
• currency risk, and negatively influenced by
• competition, and
• volume.
• The spread for heavily traded currencies like the $, €, £, and ¥ are low because
of their liquidity.
15
Interpreting Foreign Exchange Quotations
• Exchange rate quotations for widely traded currencies are frequently

listed in the news media on a daily basis.
• Forward rates may be quoted too.
• The quotations normally reflect the ask prices for large transactions.
16
• Direct quotations represent the value of a foreign currency in dollars for example $1:
Ghc8.2000 or
• indirect quotations represent the number of units of a foreign currency per dollar. Indirect
quotation = 1/direct quotation. Ghc1:$0.1220.
• The exchange rate has two components-the base currency and the counter currency. In
a direct quotation, the foreign currency is the base currency and the domestic currency is
the counter currency
• Note that exchange rate quotations sometimes include IMF’s special drawing rights (SDRs).
• Special Drawing Rights (SDRs) The SDR is an international reserve asset created by the IMF to
supplement the official reserves of its member countries. The SDR is not a currency. It is a
potential claim on the freely usable currencies of IMF members.
• The same currency may also be used by more than one country.
17
• A cross exchange rate reflects the amount of one foreign currency per
unit of another foreign currency.
• Value of 1 unit of currency A in units of currency B
Cross Rate= value of currency A in $
value of currency B in $
18
• A cross exchange rate reflects the amount of one foreign currency per unit of another foreign currency.
• Example Direct quote: $1.50/£, $.009/¥, what is the exchange rate between the ¥/£ that is value of £ in
¥.
• Two ways
• First use indirect quote ie reciprocal to get a common base currency, then work out the cross rates
Indirect quote: .67£/$, 111.11¥/$
The cross rate = 111.11/0.67= 165.67¥/£
• Value of £ in ¥ = value of £ in $
value of ¥ in $
• = $1.50/£
$.009/¥
= 166.67¥/£
19
Currency Futures and Options Market
• A currency futures contract specifies a standard volume of a particular
currency to be exchanged on a specific settlement date. Unlike
forward contracts however, futures contracts are sold on exchanges.
• Currency options contracts give the right to buy or sell a specific
currency at a specific price within a specific period of time. They are
sold on exchanges too.
20
Eurocurrency Market $
• U.S. dollar deposits placed in banks in Europe and other continents are
called Eurodollars.
• In the 1960s and 70s, the Eurodollar market, or what is now referred to
as the Eurocurrency market, grew to accommodate increasing
international business and to bypass stricter U.S. regulations on banks
in the U.S.
21
• The Eurocurrency market is made up of several large banks called
Eurobanks that accept deposits and provide loans in various
currencies.
• For example, the Eurocurrency market has historically recycled the oil
revenues (petrodollars) from oil-exporting (OPEC) countries to other
countries.
22
• Although the Eurocurrency market focuses on large-volume
transactions, there are times when no single bank is willing to lend
the needed amount.
• A syndicate of Eurobanks may then be composed to underwrite the
loans. Front-end management and commitment fees are usually
charged for such syndicated Eurocurrency loans.
23
• The recent standardization of regulations around the world has promoted
the globalization of the banking industry.
• The Single European Act opened up the European banking industry and
increased its efficiency.
• The 1988 Basel Accord signed by G-10 central banks outlined common
capital standards, such as the structure of risk weights, for their banking
industries.
• The Basel Accord outlined risk-weighted capital adequacy requirements for
banks.
• The Basel II & III Accord attempts to account for operational risk and bank
capital adequacy.
24
• The Eurocurrency market in Asia is sometimes referred to separately
as the Asian dollar market.
• The primary function of banks in the Asian dollar market is to channel
funds from depositors to borrowers.
• Another function is interbank lending and borrowing.
25
LOANS
Eurocredit Market
• Loans of one year or longer are extended by Eurobanks to MNCs or
government agencies in the Eurocredit market. These loans are
known as Eurocredit loans.
• Floating rates are commonly used, since the banks’ asset and liability
maturities may not match - Eurobanks accept short-term deposits but
sometimes provide longer term loans.
26
Syndicated Loans
• Sometimes a single bank is unwilling or unable to lend the amount
needed by a particular MNC or government agency.
• A lead bank may then organize a syndicate of banks to underwrite the
loan.
• Borrowers that receive a syndicated loan typically incur front-end
management and commitment fees, in addition to the floating rate
interest on the loan.
27
BONDS
Eurobond Market
There are two types of international bonds.
Bonds denominated in the currency of the country where they are
placed but issued by borrowers foreign to the country are called
foreign bonds or parallel bonds.
Bonds that are sold in countries other than the country represented
by the currency denominating them are called Eurobonds.
28
BONDS
Eurobond Market
• The emergence of the Eurobond market is partially due to the 1963
Interest Equalization Tax imposed in the U.S.
• The tax discouraged U.S. investors from investing in foreign
securities, so non-U.S. borrowers looked elsewhere for funds.
• Then in 1984, U.S. corporations were allowed to issue bearer bonds
directly to non-U.S. investors, and the withholding tax on bond
purchases was abolished.
29
BONDS
Eurobond Market
• Eurobonds are underwritten by a multi-national syndicate of
investment banks and simultaneously placed in many countries
through second-stage, and in many cases, third-stage, underwriters.
• Eurobonds are usually issued in bearer form, pay annual coupons,

may be convertible, may have variable rates, and typically have few
protective covenants.
30
BONDS
Eurobond Market
• Interest rates for each currency and credit conditions in the Eurobond
market change constantly, causing the popularity of the market to vary
among currencies.
• About 70% of the Eurobonds are denominated in the U.S. dollar.
• In the secondary market, the market makers are often the same
underwriters who sell the primary issues.
31
Comparing Interest Rates Among Currencies
• Interest rates vary substantially for different countries, ranging from
about 0.5% sometimes (-ve) in Japan to about 60% in Russia.
• Interest rates are crucial because they affect the MNC’s cost of
financing.
• The interest rate for a specific currency is determined by the demand
for and supply of funds in that currency.
32
Why U.S. Dollar Interest Rates Differ from Brazilian Real
Interest Rates
Interest Interest S
Rate Rate
for $ S for Real
D
D
Quantity of $ Quantity of Real
• The curves are further to the right for the dollar because the U.S. economy is
larger.
• The curves are higher for the Brazilian Real because of the higher inflation in
Brazil.
33
Comparing Interest Rates Among Currencies
• As the demand and supply schedules change over time for a specific
currency, the equilibrium interest rate for that currency will also
change.
• Note that the freedom to transfer funds across countries causes the
demand and supply conditions for funds to be somewhat integrated,
such that interest rate movements become integrated too.
34
International Stock Markets
• In addition to issuing stock locally, MNCs can also obtain funds by
issuing stock in international markets.
• This will enhance the firm’s image and name recognition, and
diversify the shareholder base. The stocks may also be more easily
diversted.
• Note that market competition should increase the efficiency of new
issues.
35
• Stock issued in the U.S. by non-U.S. firms or governments are called
Yankee stock offerings. Many of such recent stock offerings resulted
from privatization programs in Latin America and Europe.
• Non-U.S. firms may also issue American depository receipts (ADRs),
which are certificates representing bundles of stock. ADRs are less
strictly regulated.
36
• The locations of the MNC’s operations can influence the decision
about where to place stock, in view of the cash flows needed to cover
dividend payments.
• Market characteristics are important too. Stock markets may differ in
size, trading activity level, regulatory requirements, taxation rate, and
proportion of individual versus institutional share ownership.
37
• Electronic communications networks (ECNs) have been created to
match orders between buyers and sellers in recent years.
• As ECNs become more popular over time, they may ultimately be
merged with one another or with other exchanges to create a single
global stock exchange.
38
Comparison of International Financial Markets
• The foreign cash flow movements of a typical MNC can be classified
into four corporate functions, all of which generally require the use of
the foreign exchange markets.
Foreign trade. Exports generate foreign cash inflows while imports
require cash outflows.
39
Comparison of International Financial Markets
Direct foreign investment (DFI). Cash outflows to acquire foreign
assets generate future inflows.
Short-term investment or financing in foreign securities, usually in
the Eurocurrency market.
Longer-term financing in the Eurocredit, Eurobond, or international
stock markets.
40
MNC Use of International Money and Capital Markets
• The foreign cash flow movements of a typical MNC can be classified

into:
• Foreign trade flows – exports and imports
• Direct foreign investment (DFI) activity – acquisition of foreign real
assets
• Short-term investment or working capital needs
• Longer-term financing in the international bond or stock markets
41
Foreign Cash Flow Chart of an MNC
Foreign
MNC Parent Exchange
Transactions
Export/Import Dividend
Remittance Foreign
& Financing Exchange
Foreign
Medium- & Markets
Business Long-Term
Short-Term
Clients Financing
Investment Long-Term
Export/Import & Financing Financing
Eurocurrency Eurocredit &

Market Eurobond International
Short-Term Markets Stock Markets
Foreign
Investment & Financing
Subsidiaries
Medium- & Long-Term Financing
Long-Term Financing 42
Impact of Global Financial Markets on an MNC’s Value
Improved global image from Cost of borrowing funds

issuing stock in global markets in global markets
m 
n 
E CFj , t  E ER j , t 
 j 1 
Value =   
t =1  1  k  t

 
Cost of parent’s equity Cost of parent’s funds
in global markets borrowed in global markets
E (CFj,t ) = expected cash flows in currency j to be received

by the U.S. parent at the end of period t
E (ERj,t ) = expected exchange rate at which currency j can
be converted to dollars at the end of period t
43
How Financial Markets Affect an MNC’s Value
• Since interest rates commonly vary among countries, an MNC may
use the international financial markets to reduce its cost of capital,
thereby achieving a higher valuation.
44
Exchange Rate Determination
Objectives
• To explain how exchange rate movements are measured;

• To explain how the equilibrium exchange rate is determined;
and
• To examine the factors that affect the equilibrium exchange
rate.
Measuring Exchange Rate Movements
• An exchange rate measures the value of one currency in units of
another currency.
• When a currency declines in value, it is said to depreciate. When it
increases in value, it is said to appreciate.
• On the days when some currencies appreciate while others
depreciate against the dollar, the dollar is said to be “mixed in
trading.”
Measuring Exchange Rate Movements
• The percentage change (% D) in the value of a foreign
currency is computed as
St – St-1
St-1
where St denotes the spot rate at time t.
• A positive % D represents appreciation of the

foreign currency, while a negative % D represents
depreciation.
Exchange Rate Equilibrium
• An exchange rate represents the price of a currency, which is
determined by the demand for that currency relative to the
supply for that currency.
Value of £
S: Supply of £
$1.60
equilibrium exchange
$1.55
rate
$1.50
D: Demand for £
Quantity of £
Factors that Influence Exchange Rates
Assumption: Two Countries U.S. and Britain
Relative Inflation Rates
$/£ U.S. inflation 

S1
  U.S. demand for
S0
r1 British goods, and
r0 hence £.
D1
  British desire for U.S. goods,
D0
and hence the supply of £.
Quantity of £
 End result, demand for $ ,£,
Assumption: Two Countries U.S. and Britain
Relative Interest Rates
$/£ U.S. interest rates 

S0
  U.S. demand for
S1
r0 British bank deposits,
r1 and hence £.
D0
  British desire for U.S. bank
D1
deposits, and hence the supply
Quantity of £ of £.
 End result, demand for $,  £,
• A relatively high interest rate may actually reflect
expectations of relatively high inflation, which
discourages foreign investment.
• It is thus useful to consider real interest rates,

which adjust the nominal interest rates for
inflation.

• real nominal
interest  interest – inflation rate
rate rate
• This relationship is sometimes called the
Fisher effect.
Relative Income Levels
$/£ U.S. income level 

  U.S. demand for
S0 ,S1
British goods, and
r1
r0 hence £.
D1
 No expected change for the
D0
supply of £.
Quantity of £
 End result, demand for $,£,
Government Controls
• Governments may influence the equilibrium exchange rate by:
• imposing foreign exchange barriers,
• imposing foreign trade barriers,
• intervening in the foreign exchange market, and
• affecting macro variables such as inflation, interest rates, and income levels.
Expectations
• Foreign exchange markets react to any news that may have a future
effect.
• Institutional investors often take currency positions based on
anticipated interest rate movements in various countries.
• Because of speculative transactions, foreign exchange rates can be
very volatile.
Expectations
Signal Impact on GHC
Poor Ghana economic indicators Weakened
BoG governor suggests MPC is Strengthened
unlikely to cut Ghana interest rates
A possible decline in German Strengthened
interest rates
Central banks expected to Weakened
intervene to boost the euro
Interaction of Factors
• Trade-related factors and financial factors sometimes interact.
Exchange rate movements may be simultaneously affected by these
factors.
• For example, an increase in the level of income sometimes causes
expectations of higher interest rates.
Interaction of Factors
• Over a particular period, different factors may place
opposing pressures on the value of a foreign
currency.
• The sensitivity of the exchange rate to these factors is
dependent on the volume of international
transactions between the two countries.
How Factors Can Affect Exchange Rates
Trade-Related
Factors
1. Inflation Ghana demand for foreign goods, i.e.
Differential demand for foreign currency
2. Income
Differential Foreign demand for Ghana goods, i.e.
3. Gov’t Trade supply of foreign currency
Restrictions
Exchange rate
between foreign
currency and the
Ghana cedi
Financial Ghana demand for foreign securities,

Factors i.e. demand for foreign currency
1. Interest Rate
Differential Foreign demand for Ghana securities,
i.e. supply of foreign currency
2. Capital Flow
Restrictions
Speculating on Anticipated Exchange Rates
Chicago Bank expects the exchange rate of the New Zealand dollar to appreciate from its present
level of $0.50 to $0.52 in 30 days. Say $ 20 million available. How can Chicago Bank make profit,
US rate is 7.20% and New Zealand Rate is 6.48% for 30 days
Borrows at 7.20% for 30 days
1. Borrows $20 4. Holds $20,912,320

million
Returns $20,120,000
Profit of $792,320
Exchange at Exchange at
$0.50/NZ$ $0.52/NZ$
Lends at 6.48% for 30

days
2. Holds NZ$40 3. Receives
million NZ$40,216,000
Speculating on Anticipated Exchange Rates
Chicago Bank expects the exchange rate of the New Zealand dollar to depreciate
from its present level of $0.50 to $0.48 in 30 days. Say NZ$40 million available.
Rate in NZ is 6.96% and rate in US is 6.72%
Borrows at 6.96% for 30 days
1. Borrows NZ$40 4. Holds

million NZ$41,900,000
Returns NZ$40,232,000
Profit of NZ$1,668,000
or $800,640
Exchange at Exchange at
$0.50/NZ$ $0.48/NZ$
Lends at 6.72% for 30

days
2. Holds $20 3. Receives $20,112,000
million
Impact of Exchange Rates on an MNC’s Value
Inflation Rates, Interest Rates,

Income Levels, Government Controls,
Expectations
m 
n 
E CFj , t ) E ER j , t )
 j 1 
Value =   
t =1  1  k ) t

 
E (CFj,t ) = expected cash flows in currency j to be received by
E (ERj,t ) = expected exchange rate at which currency j can be
converted to dollars at the end of period t
Practice Questions
1) Assume that a bank’s bid price for Canadian dollars is $.7938, while
its ask price is $.81. What is the bid/ask percentage spread?
2) Compute the forward discount or premium for the Mexican peso
whose 90-day forward rate is $0.102 and spot rate is $0.10. Sate
whether your answer is a discount or premium.
3) If a dollar is worth 1.7 Singapore dollars, what is the U.S dollar
value of a Singapore dollar?
4) Assume Poland’s currency (the zloty ) is worth $.17 and a Japanese
yen is worth $0.008. What is the cross rate of the zloty with respect
to yen? That is, how many yen equal a zloty?
Balance of Payment
International Flow of Funds

Objectives
• To explain the key components of the balance of payments;

and
• To explain how the international flow of funds is influenced
by economic factors and other factors.
Balance of Payments
• The balance of payments is a measurement of all economic transactions
between domestic and foreign residents over a specified period of time.
• Each transaction is recorded as both a credit and a debit, i.e. double-

entry bookkeeping.
• The transactions are presented in three groups – a current account, a
capital account, and a financial account.
The Balance of Payments- Importance for MNC
• BOP data is important for business managers, investors, consumers,
government policymakers and MNC as it is a gauge of a nations
competitiveness or health (domestic and/or foreign)
• For a MNC both home and host country BOP data is important as:
• An indication of pressure on a country’s foreign exchange rate
• A signal of the imposition or removal of controls in various sorts of
payments (dividends, interest, license fees, royalties and other cash
disbursements)
• A forecast of a country’s market potential (especially in the short run)
4-24
Typical BOP Transactions
• Each of the following represents an international economic transaction that is
counted in and captured in BOP for Ghana:
• A Ghanaian subsidiary of a Japanese automobile manufacturer acts as a
distributor for the Japanese made automobiles in the Ghanaian market
• A Ghanaian-based firm manages the construction of a major water treatment
facility in an overseas country
• The Ghanaian subsidiary of a foreign firm pays profits (dividends) back to its
parent firm
• Overseas firms purchase raw materials in Ghana
• A Ghanaian tourist purchases souvenirs in an overseas country
• An overseas investor purchases a Ghanaian debt security through an investment
broker outside Ghana. Eurobond
IMF Balance of Payment Manual
• https://www.imf.org/en/Publications/Manuals-
Guides/Issues/2016/12/31/Balance-of-Payments-Manual-Sixth-
Edition-22588
• Section 152
Fundamentals of BOP Accounting
• The BOP must balance

• It cannot be in disequilibrium unless something has not been
counted or has been counted improperly
• Therefore it is incorrect to state that the BOP is in
disequilibrium
4-27
Fundamentals of BOP Accounting
• There are three main elements of the actual process of measuring
international economic activity:
1. Identifying what is and is not an international economic
transaction
2. Understanding how the flow of goods, services, assets, and
money create debits and credits to the overall BOP
3. Understanding the bookkeeping procedures for BOP accounting
• It is a daunting task to measure all international transactions that take
place in and out of a country over a year
4-28
The BOP as a Cash Flow Statement
• The BOP is often misunderstood as many people infer from its
name that it is a balance sheet, whereas in fact it is a cash flow
statement
• By recording all international transactions over a period of time
such as a year, it tracks the continuing flows of purchases and
payments between a country and all other countries
• It does not add up the value of all assets and liabilities of a
country on a specific date (as an individual firm’s balance sheet
would do)
4-29
The BOP as a Flow Statement
• Two types of business transactions dominate the balance of payments:
• Exchange of Real Assets (tangible assets, plant and Machinery)
• Exchange of Financial Assets ( financial securities, bonds etc)
• Although assets can be identified as belonging to distinct groups, it is
easier to think of all assets simply as goods that can be bought or sold (a
clock versus a bond)
4-30
The Accounts of the BOP
• The BOP is composed of two primary sub accounts, the
• Current Account and
• the Capital/Financial Account
• In addition, the Official Reserves account tracks government
currency transactions
• A fourth account, the Net Errors and Omissions account is produced
to preserve the balance of the BOP
4-31
Balance of Payments
• The current account summarizes the flow of funds between one
specified country and all other countries due to the purchases
of goods or services, the provision of income on financial
assets, or unilateral current transfers (e.g. government grants
and pensions, private remittances).
• A current account deficit suggests a greater outflow of funds

from the specified country for its current transactions.
The Current Account
• The Current Account includes all international economic transactions with income or
payment flows occurring within one year, the current period. It consists of the following
four subcategories:
• Goods trade and import of goods-Movable goods include general merchandise, goods used for
processing other goods, and non-monetary gold. An export is marked as a credit (money coming in),
and an import is noted as a debit (money going out).
• Services trade-These transactions result from an intangible action, such as transportation, business
services, tourism, royalties, or licensing. If money is being paid for a service, it is recorded as an import
(a debit). If money is received, it is recorded as an export (credit).
• Income- money going in (credit) or out (debit) of a country from salaries, portfolio investments
• Current transfers unilateral transfers such as aids, remittances, among others
• The Current Account is typically dominated by the first component which is known as the
Balance of Trade (BOT) even though it excludes service trade
4-33
Balance of Payments
• The current account is commonly used to assess the balance of trade,
which is simply the difference between merchandise exports ( value of
goods provided to the rest of the world) and merchandise imports ( value
of goods received from the rest of the world).
Balance of Payments
• The new capital account includes unilateral current transfers ( one way
transfer of money) that are really shifts in assets, not current income. E.g.
debt forgiveness, transfers by immigrants, the sale or purchase of rights to
natural resources or patents.
• This account measures all international economic transactions of financial
assets. It is divided into two major components:
• The Capital Account
• The Financial Account
• The Capital Account is minor (in magnitude), while the Financial Account is
significant
Balance of Payments
• The financial account (which was called the capital account previously)
summarizes the flow of funds resulting from the sale of assets between
one specified country and all other countries.
• Assets include official reserves, other government assets, direct foreign
investments, investments in securities, etc.
• Financial assets can be classified in a number of different ways including
the length of the life of the asset (maturity) and the nature of the
ownership (public or private)
The Financial Account
• The Financial Account consists of three components;
• Direct Investment – in which the investor exerts some explicit
degree of control over the assets
• Portfolio Investment – in which the investor has no control over
the assets financial instruments
• Other Investment – consists of various short-term and long-term
trade credits, cross-border loans, currency deposits, bank deposits
and other Account receivable and Account payable related to
cross-border trade
4-37
Direct Investment
• This is the net balance of capital dispersed from and into Ghana for the purpose of
exerting control over assets.
• Foreign direct investment arises from 10% ownership of voting shares in a domestic
firm by foreign investors. The Ghana Investment Promotion Center (GIPC) has the
guidelines. Visit their website https://gipc.gov.gh/ for details and also GIPC Act, 2013
(Act 865).
• The source of concern over foreign investment in any country focuses on two topics:
control and profit.
• Some countries possess restrictions on what foreigners may own in their country.
• The general rule or premise is that domestic land, assets and industry should be
owned by residents of the country.
• Concerns over profit stem from the same argument.
4-38
Portfolio Investment
• The purchase of debt securities across borders is classified as
portfolio investment because debt securities by definition do not
provide the buyer with ownership or control.
• Portfolio investment is motivated by a search for returns rather than

to control or manage the investment.
4-39
Net Errors & Omissions / Official Reserves
Accounts
• The Net Errors and Omissions account ensures that the BOP actually balances.
• The Official Reserves Account is the total reserves held by official monetary
authorities within the country.
• These reserves are normally composed of the major currencies used in
international trade and financial transactions (hard currencies).
• The significance of official reserves depends generally on whether the country is
operating under a fixed exchange rate regime or a floating exchange rate system.
4-40
The BOP in Total
• A surplus in the BOP implies that the demand for the country’s
currency exceeded the supply and that the government should allow
the currency value to increase -in value - or intervene and accumulate
additional foreign currency reserves in the Official Reserves Account.
• A deficit in the BOP implies an excess supply of the country’s currency

on world markets, and the government should then either devalue
the currency or expend its official reserves to support its value.
4-41
Year Variables ;Ghana Balance of Payment , source Bank of Ghana
2018 A. Current Account (US$'M) -2,043.90
2018 Merchandise Trade Balance (US$'M) 1,808.65
2018 Exports (f.o.b) (US$'M) 14,942.72
2018 Cocoa beans & Products (US$'M) 2,179.99
2018 Gold (US$'M) 5,435.71
2018 Timber & Timber Products (US$'M) 221.47
2018 Crude Oil (US$'M) 4,573.41
2018 Other Exports (US$'M) 2,532.14
2018 Imports (f.o.b) (US$'M) -13,134.07
2018 Non-oil (US$'M) -10,553.17
2018 Oil & Gas (US$'M) -2,580.90
2018 B. Balance on Services, Income and Transfers (US$'M) -3,852.55
2018 Services (net) (US$'M) -2,513.78
2018 Credit (US$'M) 7,571.99
2018 Debit (US$'M) -10,085.77
2018 Income (net) (US$'M) -3,921.81
2018 Credit (US$'M) 598.27
2018 Debit (US$'M) -4,520.09
2018 Transfers (net) (US$'M) 2,583.05
2018 Private (net) (US$'M) 2,564.34
2018 Official (net) (US$'M) 18.70
2018 C. Financial and Capital Account (US$'M) 1,500.42
2018 Capital (net) (US$'M) 257.76
2018 Direct investments (US$'M) 2,908.18
2018 Other investments (US$'M) -1,665.52
The BOP Interaction with Key Macroeconomic Variables
• A nation’s balance of payments interacts with nearly all of its key

macroeconomic variables
• Interacts means that the BOP affects and is affected by such key
macroeconomic factors as:
• Gross Domestic Product (GDP)
• The exchange rate
• Interest rates
• Inflation rates
4-43
Factors Affecting-International Trade Flows
• Inflation
• A relative increase in a country’s inflation rate will decrease its
current account, as imports increase and exports decrease.
• National Income
• A relative increase in a country’s income level will decrease its
current account, as imports increase.
Factors Affecting International Trade Flows
• Government Restrictions
• A government may reduce its country’s imports by imposing tariffs on imported
goods, or by enforcing a quota. Note that other countries may retaliate by
imposing their own trade restrictions.
• Sometimes though, trade restrictions may be imposed on certain products for
health and safety reasons.
Factors Affecting International Trade Flows
• Exchange Rates
• If a country’s currency begins to rise in value, its current account balance will
decrease as imports increase and exports decrease.
• Note that the factors are interactive, such that their simultaneous
influence on the balance of trade is a complex one.
Correcting A Balance of Trade Deficit
• By reconsidering the factors that affect the balance of trade, some
common correction methods can be developed.
• For example, a floating exchange rate system may correct a trade
imbalance automatically since the trade imbalance will affect the
demand and supply of the currencies involved.
Correcting A Balance of Trade Deficit
• However, a weak home currency may not necessarily improve a trade
deficit.
• Foreign companies may lower their prices to maintain their competitiveness.
• Some other currencies may weaken too.
• Many trade transactions are prearranged and cannot be adjusted
immediately. This is known as the J-curve effect.
• The impact of exchange rate movements on intracompany trade is limited.
Trade Balance Adjustment to Exchange Rate Changes: The J-Curve
4-49
Multinational Financial Management:
An Overview
Objectives
• Identify the main goal of the multinational corporation (MNC) and conflicts
with that goal;
• Describe the key theories that justify international business; and
• Explain the common methods used to conduct international business.
1
The Multinational Company (MNC)- Introduction
• A multinational company (MNC) or Multinational Enterprise (MNE) is one
that owns or controls production or service facilities outside the country
in which it is based.
• MNC/MNE can also be defined as one that has operating subsidiaries,
branches or affiliates located in foreign countries.
• The ownership of some MNCs is so dispersed internationally that they are
known as transnational corporations.
• The transnationals are usually managed from a global perspective rather
than from the perspective of any single country.
1-2
MNC- Introduction
• The US, Europe and Japan are the major sources of Foreign Direct
Investment (FDI)
• Main recipients of FDI are in South East Asia, South America, Canada,
and Europe.
• More globalisation has been facilitated by deregulation, free movement
of capital, and telecommunications.
Multinationals benefit in various ways, including:
• economies of scale
• access to specialist labour
• access to cheaper labour and other resources
• closer to customers
• closer to suppliers
• access to grants / tax breaks
3
Goal of the MNC
• The commonly accepted goal of an MNC is to maximize shareholder
wealth.
4
Conflicts Against the MNC Goal
• For corporations with shareholders who differ from their managers, a
conflict of goals can exist - the agency problem. Managers pursuing their
interest and not that of Shareholders.
• Agency costs are normally larger for MNCs than for purely domestic
firms.
• The sheer size of the MNC.
• The scattering of distant subsidiaries.
• The culture of foreign managers.
• Subsidiary value versus overall MNC value.
5
Impact of Management Control
• The magnitude of agency costs can vary with the management style
of the MNC.
• A centralized management style reduces agency costs. However, a
decentralized style gives more control to those managers who are
closer to the subsidiary’s operations and environment.
6
Centralized Multinational Financial Management
for an MNC with two subsidiaries, A and B
Cash Financial Cash

Management Managers Management
at A of Parent at B
Inventory and Inventory and

Accounts Accounts
Receivable Receivable
Management at A Management at B
Financing at A Financing at B
Capital Expenditures Capital Expenditures

at A at B
7
Decentralized Multinational Financial Management
for an MNC with two subsidiaries, A and B
Cash Financial Financial Cash

Management Managers Managers Management
at A of A of B at B
Inventory and Inventory and

Accounts Accounts
Receivable Receivable
Management at A Management at B
Financing at A Financing at B
Capital Expenditures Capital Expenditures

at A at B
8
Which is Better, Centralized or Decentralized?
• Discuss
• Discuss five reasons why domestic Ghanaian firms worry about

Multinatioinal Company activities in Ghana?
• Import & export of products, components and services

• Licensing of foreign firms to conduct their foreign business
• Exposure to foreign competition in the domestic market
• Indirect exposure to international risks through relationships with customers and suppliers
9
• Some MNCs attempt to strike a balance - they allow subsidiary
managers to make the key decisions for their respective operations,
but the decisions are monitored by the parent’s management.
10
• Electronic networks make it easier for the parent to monitor the

actions and performance of foreign subsidiaries.
• For example, corporate intranet or internet email facilitates
communication. Financial reports and other documents can be sent
electronically too.
11
Impact of Corporate Control
• Various forms of corporate control can reduce agency costs.

• Stock compensation for board members and executives.
• The threat of a hostile takeover.
• Threat of firing
• Monitoring and intervention by large shareholders.
12
Constraints Interfering with the MNC’s Goal
• As MNC managers attempt to maximize their firm’s value, they may
be confronted with various constraints.
• Environmental constraints.
• Regulatory constraints.
• Ethical constraints.
13
Theories of International Business
Why are firms motivated to expand their business

internationally?
Theory of Comparative Advantage
• Ricardo’s theory of comparative advantage - a country should specialize in the
production of those goods that it produces most efficiently and buy the goods
that it produces less efficiently from other countries.
• even if this means buying goods from other countries that it could produce more efficiently
itself
• Specialization by countries can increase production efficiency.
Imperfect Markets Theory
• The markets for the various resources used in production are “imperfect.”
14
Theories of International Business - Market Imperfections:
• MNCs strive to take advantage of imperfections in national markets for

products, factors of production, and financial assets.
• Imperfections in the market for products translate into market opportunities
for MNCs.
• Large international firms are better able to exploit such competitive factors as
economies of scale, managerial and technological expertise, product
differentiation, and financial strength than are their local competitors.
1-15
Theories of International Business - Market Imperfections
• Strategic motives drive the decision to invest abroad and become a MNC
and can be summarized under the following categories:
• Market seekers
• Raw material seekers
• Production efficiency seekers
• Knowledge seekers
• Political safety seekers
• These categories are not mutually exclusive.
1-16
Theories of International Business
Why are firms motivated to expand their business

internationally?
Product Cycle Theory
Vernon (mid-1960s ) proposed the product life-cycle theory - as products
mature both the location of sales and the optimal production location will
change affecting the flow and direction of trade
• As a firm matures, it may recognize additional opportunities outside its home

country.
17
The International Product Life Cycle
 Firm creates product  Firm exports product to

to accommodate local accommodate foreign  Firm
demand. demand. establishes
foreign subsidiary
to establish
presence in
foreign country
and possibly to
a. Firm differentiates reduce costs.
or
product from competitors
and/or expands product b. Firm’s foreign
line in foreign country. business declines as its
competitive advantages
are eliminated.
18
International Business Methods
There are several methods by which firms can conduct
international business.
• International trade is a relatively conservative approach involving
exporting and/or importing.
• The internet facilitates international trade by enabling firms to advertise and
manage orders through their websites.
19
• Licensing allows a firm to provide its technology in exchange for fees or
some other benefits. Licensing applies to the registered trademarks.
• 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. Franchise is about the entire
brand and operations.
• Example acting as an agent for a company’s product.
20
• 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.
21
• 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.
22
International Opportunities
• Investment opportunities - The marginal return on projects for an
MNC is above that of a purely domestic firm because of the
expanded opportunity set of possible projects from which to select.
• Financing opportunities - An MNC is also able to obtain capital

funding at a lower cost due to its larger opportunity set of funding
sources around the world.
23
Cost-benefit Evaluation for Purely Domestic Firms versus MNCs
Purely
Investment
Domestic
Opportunities MNC
Marginal Firm
Return on
Projects MNC
Purely
Marginal Domestic
Cost of Firm
Capital
Financing Appropriate Size
Opportunities for Purely Appropriate Size
Domestic Firm for MNC
X Y Asset Level
of Firm 24
• Opportunities in Europe
• The Single European Act of 1987.
• The removal of the Berlin Wall in 1989.
• The inception of the euro in 1999.
• Opportunities in Latin America
• The North American Free Trade Agreement (NAFTA) of 1993.
• The General Agreement on Tariffs and Trade (GATT) accord.
25
• Opportunities in Asia
• The reduction of investment restrictions by many Asian countries during the
1990s.
• China’s potential for growth.
• The Asian economic crisis in 1997-1998.
Opportunities in Africa
• AU
• Ecowas
• AfCFTA
26
Exposure to International Risk
International business usually increases an MNC’s exposure to:
exchange rate movements

• Exchange rate fluctuations affect cash flows and foreign demand.
foreign economies
• Economic conditions affect demand.
political risk
• Political actions affect cash flows.
27
Overview of an MNC’s Cash Flows
Profile A: MNCs focused on International Trade
Payments for products U.S. Customers
U.S.- Payments for supplies U.S. Businesses

based
MNC
Payments for exports Foreign Importers
Payments for imports Foreign Exporters
28
Profile B: MNCs focused on International Trade and
International Arrangements
Payments for supplies U.S. Businesses

U.S.-based
MNC
Payments for exports Foreign Importers
Fees for services

Foreign Firms
Costs of services
29
Profile C: MNCs focused on International Trade, International Arrangements, and Direct Foreign
Investment

Payments for supplies U.S. Businesses
U.S.-based Payments for exports Foreign Importers

MNC
Fees for services

Foreign Firms
Costs of services
Funds remitted
Foreign Subsidiaries
Funds invested
30
Managing for Value
• Like domestic projects, foreign projects involve an investment
decision and a financing decision.
• When managers make multinational finance decisions that maximize
the overall present value of future cash flows, they maximize the
firm’s value, and hence shareholder wealth.
31
Valuation Model for an MNC
• Domestic Model
n
E CF$, t 
Value = 
t =1 1  k 
t
E (CF$,t ) = expected cash flows to be received at the end of period t

n = the number of periods into the future in which cash flows
are received
k = the required rate of return by investors
32
• Valuing International Cash Flows
 m 
n 
E CFj , t  E ER j , t 
 j 1 
Value =   
t =1  1  k  t


 

E (CFj,t ) = expected cash flows denominated in currency j to be received by
E (ERj,t ) = expected exchange rate at which currency j can be converted to
dollars at the end of period t
k = the weighted average cost of capital of the U.S. parent company
33
• An MNC’s financial decisions include how much business to conduct

in each country and how much financing to obtain in each currency.
• Its financial decisions determine its exposure to the international
environment.
34
Impact of New International Opportunities
on an MNC’s Value
Exposure to
Foreign Economies Exchange Rate Risk
 m 
n 
E CFj , t  E ER j , t 
 j 1 
Value =   
t =1  1  k  t


 

Political Risk
35
• Goal of the MNC
• Conflicts Against the MNC Goal
• Impact of Management Control
• Impact of Corporate Control
• Constraints Interfering with the MNC’s Goal
• Theories of International Business
• Theory of Comparative Advantage
• Imperfect Markets Theory
• Product Cycle Theory
36
Chapter Review
• International Business Methods
• International Trade
• Licensing
• Franchising
• Joint Ventures
• Acquisitions of Existing Operations
• Establishing New Foreign Subsidiaries
37
Chapter Review
• International Opportunities
• Investment Opportunities
• Financing Opportunities
• Opportunities in Europe
• Opportunities in Latin America
• Opportunities in Asia
38
Chapter Review
• Exposure to International Risk
• Exposure to Exchange Rate Movements
• Exposure to Foreign Economies
• Exposure to Political Risk
• Overview of an MNC’s Cash Flows
• Managing for Value
39
Chapter Review
• Valuation Model for an MNC
• Domestic Model
• Valuing International Cash Flows
• Impact of Financial Management and International Conditions on Value
• How Chapters Relate to Valuation
40

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International Capital Flows

• Capital flows usually represent portfolio investment or direct foreign

• Tax Rates on Interest or Dividends

National Income in Foreign Countries Inflation in Foreign Countries

Trade Agreements Exchange Rate Movements

• In a fixed exchange rate system, exchange rates are

• The European Monetary System which followed in

• In 1994, Mexico’s central bank pegged the peso to

• A currency board maintains absolute, unlimited convertibility between its

• For a currency board to be successful, it must have

• Dollarization refers to the replacement of a local

• Each country has a government agency (called the central

• Central banks manage exchange rates

• When a central bank intervenes in the foreign

• In a sterilized intervention, Treasury securities are

Bank of Ghana T- securities

• Some speculators attempt to determine when the

• Central banks can also engage in indirect

Relative Interest Relative Inflation Relative National

• A Single European Currency

• Intervention as a Policy Tool

• To describe the background and corporate use of the following

• to take advantage of favorable economic conditions;

• to reap the benefits of international diversification.

• to capitalize on higher foreign interest rates;

• to reap the benefits of international diversification.

• to capitalize on lower foreign interest rates; and

• when they expect foreign currencies to depreciate against their own.

• A 24-hour market where currencies are traded to facilitate BoP adjustments

• A $5 trillion/day market: most widely traded currencies include $, €, ¥, and £

• Other FX centers are located in the commercial cities of countries

• Currency trading between banks occurs in the interbank market. Within

• Exchange rate quotations for widely traded currencies are frequently

• Eurobonds are usually issued in bearer form, pay annual coupons,

• The foreign cash flow movements of a typical MNC can be classified

Eurocurrency Eurocredit &

Improved global image from Cost of borrowing funds

E (CFj,t ) = expected cash flows in currency j to be received

• To explain how exchange rate movements are measured;

• A positive % D represents appreciation of the

$/£ U.S. inflation 

$/£ U.S. interest rates 

• It is thus useful to consider real interest rates,

Relative Interest Rates

$/£ U.S. income level 

Financial Ghana demand for foreign securities,

Borrows at 7.20% for 30 days

1. Borrows $20 4. Holds $20,912,320

Lends at 6.48% for 30

Borrows at 6.96% for 30 days

1. Borrows NZ$40 4. Holds

Lends at 6.72% for 30

Inflation Rates, Interest Rates,

International Flow of Funds

• To explain the key components of the balance of payments;

• Each transaction is recorded as both a credit and a debit, i.e. double-

• The BOP must balance

• A current account deficit suggests a greater outflow of funds

• Portfolio investment is motivated by a search for returns rather than

• A deficit in the BOP implies an excess supply of the country’s currency

• A nation’s balance of payments interacts with nearly all of its key

Cash Financial Cash

Inventory and Inventory and

Capital Expenditures Capital Expenditures