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International Finance PPT 1 (Intro)
International Finance PPT 1 (Intro)
Dr. Amrieta
International Finance
A corporation is a company engaged in producing and
selling goods or services in more than one country.
Usually, it consists of a parent company located in the
home country and several foreign subsidiaries.
A multinational is characterized more by attitude than the
physical reality of an integrated system of marketing and
production activities worldwide.
“Where in the world should we build our plants, sell our
products, raise capital, and hire personnel?” i.e. a global
perspective, rather than the perspective of the home
country, where the parent is located.
Dr. Amrieta
International Finance
Many of the problems of multinational firms are due to
the use of different currencies used in different
countries and the consequent need to exchange them.
There are political divisions as well as currency divisions
between countries.
A financial manager has to decide how international
events will affect a firm and what steps can be taken to
exploit positive developments and insulate the firm from
harmful ones.
Dr. Amrieta
International Finance
variables are changes in exchange rates, interest rates,
inflation rates and asset values.
However, these variables are interconnected.
Hence foreign exchange risk is not simply added to
other business risks. The amount of risk depends
crucially on the way exchange rates and other
financial prices are connected.
Dr. Amrieta
International Finance
Even companies that operate only domestically but
compete with firms producing abroad and selling in
their local market are affected by international
developments.
Thus, US appliance manufacturers with no overseas
sales will find US sales and profit margins affected by
exchange rates which influence the dollar prices of
imported appliances.
Dr. Amrieta
Outline
Basis for international trade
We will look at why there is international trade and on
what basis trade occurs, i.e. who exports what to whom.
How multinationals fit into the traditional theory
What is the role of multinationals in international trade
Dr. Amrieta
Absolute Advantage theories
Number of units of factors of production required per unit
of final product
Coal Wheat
US 2 units/ton 1 unit/ton
Germany 1 unit/ton 4 units/ton
Dr. Amrieta
Specialized Factors of Production
If some factors are specialized, i.e. relatively more efficient in
the production of one commodity rather than the other, the
prices of the factors that specialize in the commodity that is
exported will gain because of greater demand, once trade
begins.
This is because demand for a factor is a derived demand and is
based on demand for the goods that the factors produce.
US producers of coal that cannot switch to wheat production
will be hurt, since the demand for their product will drop.
The greater the gains from trade for a country overall, the
greater the cost of trade to those factors of production that
specialize in producing the commodity, now imported.
Dr. Amrieta
Monetary Prices and Exchange
Rates
Suppose before the start of trade, each production unit costs
$30 in the US and £10 in the UK. Then the prices of wheat and
coal in the two countries will be:
Coal Wheat
US $60/ton $30/ton
UK £30/ton £40/ton
After trade begins, terms of trade will equalize between countries; we
can have any rate of exchange between 1 wheat: 0.5 coal or 1:1.33.
Suppose the terms of trade are 1:1. This is consistent with the within-
country prices given below.
Coal Wheat
US $30/ton $30/ton
UK £30/ton £30/ton
Dr. Amrieta
Monetary Prices and Exchange
Rates
What about the exchange rate? Suppose the exchange rate
were $3 = £1, then the dollar-equivalent prices would be:
Coal Wheat
US $30/ton $30/ton
UK $90/ton $90/ton
Dr. Amrieta
Exchange Rate Equilibrium
British products will become more attractive to
Americans and American products will become
less attractive to the British.
This process will continue until both countries
find their comparative advantage and the terms of
trade between coal and wheat are equal in both
countries. The exchange rate will also have to
adjust so that dollar costs of production are
equalized across countries.
Dr. Amrieta
Factor Price Equalization
The shift in the demand for factors of production in
the two countries should cause factor prices to
equalize.
However, this will happen only if free trade is not
impeded.
If trade is not free, i.e. goods and services cannot
move across borders, factors of production may move,
if permitted.
Dr. Amrieta
Multinational Firm - I
Does the Multinational Corporation represent
movement of capital?
The theory of comparative advantage rests on factor
differences across countries. However, when
countries become increasingly homogenous, other
factors might determine trade.
Dr. Amrieta
Multinational
Firm - II
Economies of scale might require a transnational
entity.
Improved communications permit intermediate
commodities to be traded – the example of the Barbie
doll.
Cultural predilections, historical accidents and
government policies, differences in attitudes to
labor/unions.
Development of International Finance – raising capital
abroad, sharing risk across borders, tax arbitrage, need
for diversification.
Dr. Amrieta
Financial Issues for the
Multinational Firm
foreign exchange risk management
managing working capital and the internal financial
system
financing foreign units
capital budgeting
evaluation and control
Dr. Amrieta