11.Overview of International Financial Environment & Intl Monetary System

7/30/2019 11.Overview of International Financial Environment & Intl Monetary System

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INTERNATIONAL

FINANCIAL

MANAGEMENT

EUN / RESNICKSecond Edition

The International

Financial

Environment

Objectives:

Understand why it is important to study internationalfinance.

Distinguish international finance from domestic finance.

Lets say

Tata Motors, buoyed by its acquisition of JLR, is consideringentering the international sports motorcycle market. In a boldmove, it is contemplating acquiring KTM of Austria and plans topurchase controlling stake of 76% for 1.2 billion which will bepaid out in quarterly installments over 2 years. The capital foracquisition is expected to be generated by Tatas local arm.

From a finance perspective, what should senior managers of Tata

Motors evaluate?

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Some factors to consider are: Exchange rate (FXR) of INR to EUR

Local interest rates for evaluating capital affordability

Exchange rate risk/exposure over the transaction period

Can the risks be managed (hedged)? Cost of managing risks?

Strategic Likely FXR risks in KTMs key markets (e.g. AUD, GBP, GCCregion)

Strategic Synergy; cost of indenture; unforeseen liabilities etc.

How would the evaluation change if acquisition is to

be financed by JLR operations?1-2

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l Whats special about International Finance?

l Goals for International Financial Management

l Globalization of the World Economy

l Multinational Corporations

Overview


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Globalization of the World Economy:

Recent Trendsl Emergence of Globalized Financial Markets

l Trade Liberalization and Economic Integration

l Privatization

l Rise of Private Equity; Hedge Funds; Structured Finance

l Rapidly growing inequality in the West

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International Finance deals with

issues such as:

l Foreign Exchange Risk

l

Political Risk

l Market Imperfections

l Expanded Opportunity Set


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Liberalization of

Protectionist Legislation

Emergence of new trade agreements, Global

Institutions & Trading Blocks.

For instance,

l The General Agreement on Tariffs and Trade (GATT) a multilateral

agreement among member countries has reduced many barriers to

trade.

l The World Trade Organization has the power to enforce the rules of

international trade.

l North American Free Trade Agreement

l Gulf Cooperation Council

l European Economic Community and the Eurozone

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Privatization

l Selling off state-run enterprises to investors is

also known as Denationalization.

l Often seen in socialist economies in transition to

market economies.

l By most estimates this increases the efficiency of

the enterprise.

l Often spurs a tremendous increase in cross-

border investment.


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What is a Multinational Corporation?

l A firm that has incorporated in one country and has

production and sales operations in other countries.

l There are about 60,000 MNCs in the world.

l Many MNCs obtain raw materials from one nation,

financial capital from another, produce goods with labor

and capital equipment in a third country and sell their

output in various other national markets.

Theories of International Business

Why are firms motivated to expand their business internationally?

1. Theory of Comparative Advantage

n Country specific specialization can increase production efficiency. E.g.:

Electronics manufacturing in Japan before, China today; BPO operations in India.

2. Factor Endowment Theory (Hecksher-Ohlin Model)

n Some factors are geographically distributed in which case firms are compelled

to embark on international ventures. E.g.: Petroleum in the Middle-East (Saudi

Aramco); Uranium in Australia; Gold & Diamonds in Southern Africa.

3. Product Cycle Theory

n As a firm matures in the domestic market, it may recognize new opportunities in

new markets

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Modes of International BusinessThere are several methods by which firms can conduct international

business.

l International Trade: The old school, conservative approach of exportingand/or importing items.

l Licensing: allows a firm to provide its technology in exchange for fees orsome other benefits.

l 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.

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Modes of International Business

l Firms may also penetrate foreign markets by engaging in aJoint Venture

(joint ownership and operation) with firms that reside in those markets.

l Acquisitions of existing operations in foreign countries allow firms to quicklygain control over foreign operations as well as a share of the foreign market.

l Firms can also penetrate foreign markets by establishing new foreign

subsidiaries.

l 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.1-11


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The Organization of the Course

Macroeconomic

Environment

The Financial

Environment

Management of

the Multinational

Firm

No. of Sessions

9

No. of Sessions

5

No. of Sessions

6

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Evolution of the

International Monetary System

l Bimetallism: Before 1870 (Gold and Silver coins)n Worked far better for nations than managed fiduciary money

n No role for a central bank

l

(Classical) Gold Standard: 1870-1913 (Gold Oz. = Xs)n Culminated in the creation of The Federal Reserve

l Bretton Woods System: 1945-1972 (Gold =$sXs)

l The Flexible Exchange Rate Regime: 1973-Presentn Every country for itself


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Bretton Woods System:

1945-1972l Named for a 1944 meeting of 44 nations at Bretton

Woods, New Hampshire, USA.

l The purpose was to design a postwar international

monetary system.

l The goal was exchange rate stability without the gold

standard.

l The result was the creation of the IMF and the World

Bank.

l During this time the US takes centre stage as the first

modern superpower

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Bretton Woods System:

1945-1972

l Under the Bretton Woods system, the U.S. dollar

was pegged to gold at $35 per ounce and other

currencies were pegged to the U.S. dollar.

l Each country was responsible for maintaining its

exchange rate within 1% of the adopted par

value by buying or selling foreign reserves as

necessary.

l The Bretton Woods system was a dollar-based

gold exchange standard.


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The Flexible Exchange Rate Regime:

1973-Presentl Flexible exchange rates (for developed countries) were

declared acceptable to the IMF members.

n Central banks were allowed to intervene in the

exchange rate markets to iron out unwarranted

volatilities.

l Gold was abandoned as an international reserve asset

and for the most part USD was used.

l Non-oil-exporting countries and less-developed countries

were given greater access to IMF funds.

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Current Exchange Rate Arrangements

l Free Float ( Yen)n The largest number of countries, about 48, allow market forces

to determine their currencys value.

l Managed Float ( INR)n About 25 countries combine government intervention with

market forces to set exchange rates.

l Pegged to another currency ( GCC currencies)n Such as the U.S. dollar or euro (through franc or mark).

l No national currencyn Some countries do not bother printing their own, they just use

the U.S. dollar. For example, Ecuador has dollarized.


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McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hil l Companies, I nc. All rights1-18

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McGraw-Hill/Irwin Copyright 2001 by The McGraw-Hil l Companies, I nc. All rights1-21


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End of Session

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Documents

11.Overview of International Financial Environment & Intl Monetary System