International

FINANCIAL MANAGEMENT

TRINH QUOC DAT

Main Reference: Multinational Business Finance, 15th edition by
Eitemen et al., 2019.
Supportive Reference: International Financial Management, 13th
edition by Jeff Madura - Thomson, 2017.
LEARNING OBJECTIVES

 Differentiate between International finance and purely domestic

finance.
 Classify function and structure of foreign exchange market.
 Analyse factors affecting country’s balance of payment.
 Analyse and manage foreign exchange rate risks
 Master the way a multinational companies runs their business:
raise funds, operating management, financing, risk management
and so forth.
Course Accessment.

 Participation & Quiz: 15%

 Project and Presentation: 15%
 Mid-term exam: 30%
 Final Exam: 40%

 A group of 4-6 students

 Students can take leave up to 20% of the course hours.
 What is IFM?
 International financial Management is the branch of economics that studies the dynamics of
exchange rates, foreign investment, global financial system, and how these affect international
trade. It also studies international projects, international investments and capital flows, and trade
deficits. It includes the study of futures, options and currency swaps.

 Important theories in international finance include the Mundell-Fleming model, the optimum
currency area (OCA) theory, as well as the purchasing power parity (PPP) theory. Whereas
international trade theory makes use of mostly microeconomic methods and theories, international
finance theory makes use of predominantly macroeconomic methods and concepts.
 Benefits of studying IF
 Among the events that affect the firm and that must be managed are
changes in exchange rates, inflation rates, and asset values (and these
events are often themselves related).

 Because of the integration of financial markets, events in distant lands

have effects that reverberate in other regions of the world (domino
effects, contagion, systemic risk).

 Even companies with a domestic focus are affected by the global

financial environment as they compete with firms that are
internationally active.

 Inflation, jobs, economic growth rates, bonds and stock prices, oil and
food prices, government revenues and other important financial
variables are all tied to exchange rates and other developments in the
increasingly integrated financial market.
 Growing importance of IF
 Over the last decades international financial flows have grown much faster
than world GDP or world trade. This trend is in large parte a reflection of
international trade and the process of globalization. International financial
flows have grown much faster than the real economy.

 While IF contributes to world prosperity through the efficient allocation of

capital worldwide, it is also a source of concern for the challenges that it
poses for financial stability as shown by the recent financial crises.

 Financial flows are extremely volatile. Between 2002 and 2007 (before the
start of the current crisis international financial flows (gross) have grown
from 5% to 17% of world GDP. After the Lehman default (gross)
international financial flows plummeted to 1% of GDP in 2008!!
Factors behind the growth of IF
 Growth of International Trade (finance associated to commercial trade –
export and import)

 Growth of Multinational Corporations (finance associated to FDIs and M&A

activity) and Multinational Banking

 Growth of the eurodollar market (refers to U.S. dollar-denominated deposits

at foreign banks or foreign branches of American banks; by being located
outside of the United States).

 Growth of International Finance per se (finance associated to the growth of

global saving and the need to improve risk-return trade-offs)
Ratio of world merchandise trade volume growth to
world real GDP growth, 1981-2016.
% change and ratio

Sources: WTO Secretariat for trade, consensus

estimates for GDP
Main components of global finance

 Currencies
 Market and policy variables (exchange rates, interest rates, risk,
ratings)
 Assets/financial instruments (cash and deposits, bonds, stock,
loans,
 derivatives, insurance contracts, etc.)
 Players (international organizations, central banks, supervisory
authorities, accounting standard setting bodies, rating agencies,
commercial and investment banks, institutional investors,
sovereign funds, MCEs, financial lobbies, etc.)
 Markets: the (physical or virtual) places or ‘centres’ where
financial transactions take place
Introduction to MNCs and Foreign
Exchange market

 MNC – Multinational Corporations

 Foreign Exchange Market
The International Financial Environment

Multinational Corporation (MNC)

Foreign Exchange Markets

Dividend
Remittance
Exporting & Financing Investing
& Importing & Financing

Product Markets Subsidiaries International

Financial
Markets
 Chapter
1
Multinational Financial Management:
An Overview

South-Western/Thomson Learning © 2003

Chapter Objectives

 To identify the main goal of the multinational corporation (MNC)

and conflicts with that goal;
 To describe the key theories that justify international business;
and
 To explain the common methods used to conduct international
business.
 MNC concepts
 Nowadays, connectivity and integration of countries and
corporations and the people within them in terms of their
economic, political, and social activities are increasing –
Globalization.
 Therefore, multinational corporations dominate the corporate
landscape.
 Multinational corporations (MNCs) are defined as firms that
engage in some form of international business (produce and
sell products and services in more than on nation).
Goal of the MNC

 The commonly accepted goal of an MNC is to maximize

shareholder wealth like any other corporations.
 Therefore, main target is increasing efficiency, reduce costs,
improve business sales and performance.
 Conflicts Against the MNC Goal

 For corporations with shareholders who differ from their managers (separate
between ownership and managent), a conflict of goals can exist - the agency
problem.
 An agency cost is an economic concept concerning the fee to a "principal" (an
organization, person or group of persons), when the principal chooses or hires
an "agent" to act on its behalf.
Question

Between purely domestic corporation/firm and MNCs, which one

have bigger agency costs? Explain.
Agency costs
MNCs vs purely domestic firms
 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.
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.
20 A. Managing the MNC

Common Methods to Improve Control

• Establishing a centralized database of information
• Ensuring that all data are reported consistently among subsidiaries
• Implementing a system that automatically checks data for unusual
discrepancies
• Speeding the process by which all departments and subsidiaries
have access to data needed
• Making executives more accountable for financial statements by
personally verifying accuracy
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
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
Question

 What is the advantages and

disadvantages of these two ways of
management?
Decentralized Management

 this style gives more control to those managers who are closer to
the subsidiary’s operations and environment.
 This style is more likely to result in higher agency costs because
subsidiary managers may make decisions that do not focus on
maximizing the value of the entire MNC
 Centralized Management

• Reduce agency costs because it allows managers of the parent to control

foreign subsidiaries and therefore reduces the power of subsidiary managers.
• the parent’s managers may make poor decisions for the subsidiary if they are
not as informed as subsidiary managers about fi nancial characteristics of the
subsidiary.
Balance Management Control

 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.
Impact of Management Control

 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.
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.
 Monitoring and intervention by large shareholders.
Noted: A hostile takeover is the acquisition of one company (called the target
company) by another (called the acquirer) that is accomplished by going
directly to the company's shareholders or fighting to replace management
to get the acquisition approved. A hostile takeover can be accomplished
through either a tender offer or a proxy fight.
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.
 Theories of International Business

Why are firms motivated to expand their

business internationally?
 Theory of Comparative Advantage
• Specialization by countries can increase production efficiency. That means some
countries are more beneficial at some producing specific goods while other are
beneficial at other goods.
• Examples: Developing countries have cheap labor-cost advantages while developed
countries have technology and capital advantages.
• When a country specializes in some products, it may not produce other products, so
trade between countries is essential.
 Theories of International Business

Why are firms motivated to expand their

business internationally?
 Imperfect Markets Theory
 The markets for the various resources used in production are “imperfect.” That
means products might be immobile and costly to produce.
 There are costs and often restrictions related to the transfer of labor and other
resources used for production. There may also be restrictions on transferring funds
and other resources among countries
 Theories of International Business
Why are firms motivated to expand their
business internationally?

 Product Cycle Theory

• firms become established in the home market as a result of some
perceived advantage over existing competitors. Because
information about markets and competition is more readily
available at home, so, a firm is likely to establish itself first in its
home country.
• Foreign demand for the firm’s product will initially be
accommodated by exporting.
• However, As a firm matures, it may recognize additional
opportunities outside its home country (internationally)
The International Product Life Cycle

 Firm creates  Firm exports product

product to to accommodate foreign  Firm
accommodate local demand. establishes
demand. foreign
subsidiary to
establish
presence in
foreign country
and possibly to
a. Firm or reduce costs.
differentiates
product from b. Firm’s foreign
competitors business declines as its
and/or expands competitive
product line in advantages are
foreign country. eliminated.
 International
Business Methods
How firms create their international Business?
 International trade
 Licensing
 Franchising
 Joint ventures
 Acquisitions of existing operations
 Establishing new foreign subsidiaries
 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.
 Firms can also use their websites to accept orders online. Some products such as
software can be delivered directly to the importer over the Internet in the form of a
file that lands in the importer’s computer.
International
Business Methods
• Licensing is a way that a company sells licenses to other (typically
smaller) companies to use its intellectual property (IP), brand, design
or business programs.
• Licensing allows firms to use their technology in foreign markets without
a major investment in foreign countries and without the transportation
costs that result from exporting.
• However, it is difficult for the firm providing the technology to ensure
quality control in the foreign production process
• Franchising: the franchisee uses another firm's successful business
model and brand name to operate what is effectively an independent
branch of the company.
• It 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.
Licensing vs Franchising
Franchising Licensing
Governed by Securities law Contract law

Registration Required Not required

Territorial rights Offered to franchisee Not offered; licensee can sell similar licenses and products in
same area

Support and training Provided by franchiser Not provided

Royalty payments Yes Yes

Use of trademark/logo Logo and trademark retained by franchiser and used by Can be licensed
franchisee

Examples McDonalds, Subway, 7-11, Dunkin Donuts Microsoft Office

control Franchiser exercise control over franchisee. licensor does not have control over licensee
International
Business Methods

 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.
 International
Business Methods
Firms may also penetrate foreign markets by
engaging in a joint venture

• A joint venture is a venture that is jointly owned and operated by two or more
firms (in ownership and operation).
• allow two firms to apply their respective comparative advantages in a given
project.
• A joint venture can help your business grow faster, increase productivity and
generate greater profits. A successful joint venture can offer: access to new
markets and distribution networks, increased capacity, sharing of risks and costs
with a partner, access to greater resources, including specialised staff, technology
and finance
• However, the partners have different objectives for the joint venture; the partners
bring in different levels of expertise, investment or assets into the venture;
different cultures and management styles result in poor integration and co-
operation; the partners don't provide sufficient leadership and support in the early
stages
 International
Business Methods
Firms may also penetrate foreign markets by
engaging in a acquisition of an existing
business
 Acquisitions allow firms to have full control over their foreign
businesses and to quickly obtain a large portion of foreign market
share.
 However, because of the large investment required, normally, an
acquisition of an existing corporation is subject to the risk of large
losses.
 International
Business Methods
 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). Foreign direct investment (FDI) occurs when a company from one
country makes a significant investment that leads to at least a 10% ownership
interest in a firm in another country.
 Foreign direct investments can be made in a variety of ways, including the
opening of a subsidiary or associate company in a foreign country, acquiring a
controlling interest in an existing foreign company, or by means of a merger or
joint venture with a foreign company
 The optimal international business method may depend on the characteristics
of the MNC.
 42 International Business Models

Summary of Methods by Risk

Franchising New FDI

and Foreign Foreign
Joint Ventures Acquisitions Subsidiaries

LEAST MOST
RISK RISK

Degrees of Risk to MNC

Foreign direct investment
(Vietnam 2017 - 2018)
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.
 International Opportunities
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
International Opportunities

• 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.
International Opportunities

 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.
Online Application

 For more information on the Asian crisis, check out the following
sites:
 http://www.stern.nyu.edu/~nroubini/asia/AsiaHomepage.html
 http://www.asienhaus.org/navigat/english/asienhau.htm
 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.
Online Application

• Visit FRED®, Fed's economic time-series database, at

http://www.stls.frb.org/fred for numerous economic and financial
time series, e.g., balance of payment statistics, interest rates,
foreign exchange rates.
• Visit http://www.ita.doc.gov/td/industry/otea (Office of Trade
and Economic Analysis) for an outlook of international trade
conditions for each of several industries.
 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

 Overview of an MNC’s Cash Flows

Profile B: MNCs focused on International Trade

and International Arrangements

Payments for products U.S. Customers

Payments for supplies U.S. Businesses

U.S.-
based
Payments for exports Foreign Importers
MNC
Payments for imports Foreign Exporters

Fees for services

Foreign Firms
Costs of services
Overview of an MNC’s Cash Flows
Profile C: MNCs focused on International Trade, International
Arrangements, and Direct Foreign Investment

Payments for products U.S. Customers

Payments for supplies U.S. Businesses

U.S.- Payments for exports Foreign Importers

based
MNC Payments for imports Foreign Exporters

Fees for services

Foreign Firms
Costs of services
Funds remitted
Foreign Subsidiaries
Funds invested
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.
 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
Valuation Model for an MNC
 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 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 = the weighted average cost of capital of the
Valuation Model for an MNC

 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.
 Valuation Model for an MNC
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
Chapter Review

• 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
Chapter Review

 International Business Methods

 International Trade
 Licensing
 Franchising
 Joint Ventures
 Acquisitions of Existing Operations
 Establishing New Foreign Subsidiaries
Chapter Review

 International Opportunities
 Investment Opportunities
 Financing Opportunities
 Opportunities in Europe
 Opportunities in Latin America
 Opportunities in Asia
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
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