Finance

Chapter 19Multinational financial management

International operations

A multinational (MNC), or global corporation, is a firm that operates in an integrated fashion in a number of countries.

Companies “go global” for 6 primary reasons:

1. Expand markets (Coca Cola, Sony)

2. Obtain raw materials (Exxon Oil)

3. Seek new technology (Xerox, P&G)

4. Lower production costs (GE)

5. Avoid trade barriers (Honda, Toyota in the U.S.)

6. Diversify (cushion impact of adverse economic conditions in one country, GM)

Implications of globalization

Corporations use their economic power to exert substantial economic and political influence over host governments

The traditional American policy & doctrine of independence and self-reliance is now in question

To whom is the corporation loyal?

MNC vs. domestic financial management

Different currency denominations-exchange rate considerations

Economic & legal issues Different tax laws Common law (UK) French Civil Law

Language

Culture

Role of government Are all market places competitive?

Political risk Nationalizing firms (Venezuela) Kidnappings

Exchange rates

Exchange rate – the number of units of a given currency that can be purchased for one unit of another currency

Direct quote – the number of domestic currency units required to purchase one unit of a foreign currency ¥6.574 = $1.00

Indirect quote – the number of units of foreign currency that can be purchased for one unit of domestic currency $0.152 = ¥1.00

Exchange rates

Exchange rate fluctuations make it difficult to estimate the dollars that a U.S. overseas operation will produce

Floating exchange rate system – the U.S. and other major trading nations (except China) operate under a floating exchange rate system Currency rates float with market conditions largely

unrestricted by government intervention Central banks operate in the foreign exchange

market to smooth out exchange rate fluctuations Recent G7 actions to weaken the Japanese yen

See WSJ article Pages 731-732

Exchange rates

Pegged exchange rates – occur when a country establishes a fixed exchange rate with a major currency. Consequently, the values of pegged currencies move together over time.

Convertible currency – a currency that may be readily exchanged for other currencies (pg. 732)

Spot rates

Spot rates – the rates paid for delivery of currency “on the spot”

Forward currency exchange – the rate paid for delivery at some agreed-upon future date (30, 90, 180 days)

Forward rate can be at either a premium or discount to the spot rate

Parity & risk

Interest rate parity – holds that investors should expect to earn the same return in all countries after adjusting for risk

Purchasing power parity – aka law of one price, implies the level of exchange rates adjusts so that identical goods cost the same in different countries

Political risk – a foreign government may take some action that will decrease the value of the investment

Exchange rate risk – risk of losses due to fluctuations in the value of domestic currency relative to the values of foreign currencies (e.g., dollars vs. yen)

Cash flows

The relevant cash flows in international capital budgeting are the (domestic currency) dollars that can be repatriated to the parent company

Eurodollars are U.S. dollars deposited in banks outside the U.S. Interest rates tied to LIBOR (London Interbank

Offer Rate)

International capital markets

U.S. firms often raise long-term capital at a lower cost outside the U.S. by selling bonds in the international capital markets

International bonds Foreign bonds – like domestic bonds except the

issuer is a foreign company Eurobonds – bonds sold in a foreign country but

denominated in the currency of the issuing company’s home country