International finance 2

– Foreign Exchange Exposure– Financial Management for a Multinational Firm... • The Market for Foreign Exchange• International Parity Relationships... Comparative advantage• If countrie

International Finance

Lecture 1

– Foreign Exchange Exposure

– Financial Management for a

Multinational Firm

• The Market for Foreign Exchange

• International Parity Relationships

Globalization and the Multinational Firm

Additional Risks

price of your product changes for foreign customers as FX changes

• Political Risk: Macro, Micro

• Additional risks increase cost of capital of

rate of return by investors and third parties.

Additional Opportunities

• opportunities

• costs for resources

• New product

Managerial objectives

• Consensus in North America

– Long-run wealth maximization

– Who are the owners? Are home country owners’

interests superior to those of foreign country

owners?

Managerial objectives

wealth maximization.

companies follow wealth

maximization rule.

major shareholders, also generally

companies are private .

objective should be to maximize

consolidated after tax .

Recent Trends in the World Economy

• Globalization

• Introduction of

• Trade liberalization

•

Multinational Enterprise

• MNE: Multinational firm is a company that has operating branches, subsidiaries and affiliates located in countries.

• It has both domestic and foreign

• Go to World Investment Report and look for the list of largest transnational

corporations (Largest TNCs).

• Multinationals face two of

risks in addition to normal risks faced by domestic companies (Fx and political)

Why do firms become

produce (efficiently as compared with the other countries), sell their products, and buy

what they need but do not produce

– According to the theory of comparative advantage, in Situation 2 all participating countries are _

than in Situation 1, under a set of assumptions

Comparative advantage

No trade exists

Terms of trade

Comparative advantage

Comparative advantage

Comparative advantage

• If countries specialize in producing certain goods

because they can do it more _ than the others, they use their comparative advantage over the other countries

• In general, countries that specialize and trade are _ than those that do not

– This effect is _ automatic, all depends on the terms of trade (open the spreadsheet and

see if dashed lines are always _ the solid lines for each country)

• A constant need for international transactions =

constant need for / interest in international finance

• The Market for Foreign Exchange

• International Parity Relationships

International Monetary System

• … is the institutional within which international payments are made, movements of are

accommodated and exchange rates

among currencies are determined

International Monetary System

• History of the international

monetary system

• Current currency

• Major events

History of the International Monetary System

• Bimetalism: Before

• The Gold Standard,

• The Interwar Years and World War II,

• Bretton Woods and the International Monetary Fund,

• Fixed Exchange Rates, 1945-1973

• 1973- Present

Current Currency Regimes

• Exchange Arrangements with no

separate legal tender

• Currency Board Arrangements

Fixed versus Flexible Exchange

Rate

• Fixed exchange rate brings foreign exchange, trade, and investment , may be very expensive to implement, creates currency

arbitrage

• Flexible exchange rate allows to conduct

monetary policy, is cheaper for the government to implement, eliminates

arbitrage opportunities, but introduces

that may adversely affect trade and investment.

Major Events after 1973

The Economics and Currencies

of Asia, July–Nov 1997

Daily Exchange Rates:

Russian Rubles per U.S Dollar

The European Union, 1999

Financial Markets in the Brazilian Crisis, January 11–15, 1999

Daily Exchange Rates:

Brazilian Real per U.S Dollar