01 Introduction to International Finance 2010

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Harris Turino K.Prasetiya Mulya Business School

Introduction toInternational Finance

Jakarta 2010


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INTERNATIONAL FINANCE

VSCORPORATE FINANCE

FOREX RISK & POLITICAL RISK

MARKET IMPERFECTION

Trade Barrier

Tariff and Non Tariff Barrier

EXPAND OPPORTUNITY SET

Low labor cost

Possible Financing Market


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Multinational Corporation (MNC)

Foreign Exchange Markets

Product Markets Subsidiaries InternationalFinancial

Markets

DividendRemittance& FinancingExporting

& Importing

Investing& Financing

Part IThe International Financial Environment


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Chapter Objectives

To identify the main goal of themultinational corporation (MNC) and

conflicts with that goal; To describe the key theories that justify

international business; and

To explain the common methods usedto conduct international business.


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Goal of the MNC

The commonly accepted goal of anMNC is to maximize shareholder

wealth. We will focus on MNCs that are based

in the United States and that wholly own

their foreign subsidiaries.


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Conflicts Against the MNC

Goal For corporations with shareholders who

differ from their managers, a conflict of

goals can exist - the agency problem. 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.


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Impact of Management

Control The magnitude of agency costs can

vary with the management style of the

MNC. A centralizedmanagement style

reduces agency costs. However, a

decentralizedstyle gives more control tothose managers who are closer to thesubsidiarys operations and

environment.


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Centralized Multinational Financial Management

for an MNC with two subsidiaries, A and B

FinancialManagersof Parent

Capital Expendituresat A

Inventory andAccountsReceivable

Management at A

CashManagement

at A

Financing at A

Capital Expendituresat B


Management at B

CashManagement

at B

Financing at B


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Decentralized Multinational Financial Management

for an MNC with two subsidiaries, A and B

FinancialManagers

of A

Capital Expendituresat A


Management at A

CashManagement

at A

Financing at A

Capital Expendituresat B


Management at B

CashManagement

at B

Financing at B

FinancialManagers

of B


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Control Some MNCs attempt to strike a balance

- they allow subsidiary managers to

make the key decisions for theirrespective operations, but the decisionsare monitored by the parents

management.


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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 documentscan be sent electronically too.


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Why are firms motivated to expandtheir business internationally?

Theories of International

Business

Theory of Comparative Advantage

Specialization by countries can increaseproduction efficiency.

Imperfect Markets Theory

The markets for the various resources used inproduction are imperfect.

Product Cycle Theory

As a firm matures, it may recognize additional

opportunities outside its home country.


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Foreign Market Competition Framework

Global Market

FOREIGN MARKET

International Market

Entry Strategy

Export Licensing Franchising

Multi-country Global Strategic Alliance

ScanningBehavior


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Foreign Markets

Company operates in a select fewforeign countries, with modest

ambitions to expand further

Company markets products in 50 to 100countries and is expanding operations

into additional country markets annually

WHY? STRATEGIC ISSUE

Gain access to new customers

Achieve lower costsandenhance firms competitiveness

Capitalize on its core

competencies

Spread business riskacross awider market base

Products (customize or standardize)

Basic competitive strategy (sameor modify it)

Location of activities (where is

the best locational advantage)

Capabilities and resources strength(how to transfer efficiently)

International Market Global Market

Obtain access to valuablenatural resources


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Type of Competition in Foreign Market

Competition in one country notclosely connected to competitionin other countries.

Industry conditions and

competitive forces in each nationalmarket differ in important respects.

Buyers in different countries are

attracted to different productattributes.

Sellers vary from country tocountry.

Competitive conditions acrosscountry are strongly linked: Same rivals in many countriesA true international market

exists. A firms competitive position in one

country is affected by its position inother countries.

CAis based on a firms world-wide

operations and overall globalstanding.

Rival firms vie for

worldwide leadership!Rival firms battle for

national championships

Multi-country Competition Global Competition


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InstitutionsOrganization

Strategy

Industry condition(Porter, 1980)

Firm-specific resources(Barney, 1991)

Formal andinformalconstraints

(Scott, 1995;Oliver, 1997)

Dynamic

Interactions

Scanning Behavior

Government regulation Law enforcement Economic contracts

Norms of behavior Lifestyle and taste Culture and ideology

Formal Institution:

Informal Institution:

Complex Dynamics Hostile

(Peng, 2002)

Institutions are the rules of the game in a society thatconstrain and shape human interactions formally andinformally (Peng, 2002).


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Strategic Choice

Strategic to Enter Foreign Market

Export Licensing Franchising

Home countryplants

Foreign countryplants

Product

PatentedCompetitiveStrategy

LocationCapabilities &

ResourceStrength

STRATEGIC ISSUE

Multicountry Global Joint Venture

Six generic strategic commonly used to enter FM

Firms can use combination of them or separately


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Exporting Licensing Franchising

o Economic trade-offhave not met yeto No international capabilities to enter FM

+ Minimize risk, capital, anddirect investment

+ Export: conservative way totest foreign market

Risk of reproducing good or service Risk of cross-country quality control Export: risk of currency fluctuation Export: additional cost of shipping,

tax, etc.

Exporting

Product

Excellent initialstrategy topursueinternationalsales

Licensing

Patented

product ortechnologyknow-how

Manufacturingfirms

Franchising

Patented

product ortechnologyknow-how

Trading &service firms


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o Customize competitive strategy

o Different product &different brandin different countries

o Scatter plants across many hostcountries, each producing productversion for local markets.

o Preferably use local supplier

oAdapt marketing and distributionto local customs and culture ofeach country

o Transfer competencies andcapabilities from country tocountry where feasible

o Give country managers fairly widestrategy-making latitude and

autonomy over local operation

o Pursue same basic competitivestrategy

o Same products under same brandname worldwide

o Locational maximum advantage,usually in countries whereproduction costs are lowest

o Use best suppliers form anywhere

o Coordinate marketing anddistribution worldwide (minor

adaptation in local when needed)

o Compete on basis ofsametechnologies, competencies, andcapabilities

o Coordinate major strategic

decisions worldwide

Multicountry Strategy Global Strategy

Multicountry and Global Strategy


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Think and Act: Local vs. Global

Loca

l

Global

ACT

Local Global THINK

Local strategy for eachcountry

Same strategy worldwide(Global Strategy)

Combination Global-LocalStrategy

Delegate strategy making

Fit competitive strategy orproducts to local marketcondition

Same basic competitivestrategy or products

Coordinate strategic actionsfrom central headquarter

Same basic competitivestrategy

Create or adopt products to fitthe local market


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Multicountry Strategies at Coca-Cola

Coca-Cola strive to meet the demand oflocaltastes and culture, offering 300 brands insome countries.

Its network of bottlers and distributors is distinctly local, and

the companys products and brands are formulated to cater tolocal tastes.

The ways in which Coca-Colas local operating units bringproducts to market, the packaging that is used, and the

companys advertising message are all intended to match thelocal culture and fit in with local business practices.

Many of the ingredients and supplies for Coca-Colas productsare sourced locally.


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Exposure to International Risk

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.

International business usually increases anMNCs exposure to:


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Managing for Value

Like domestic projects, foreign projectsinvolve an investment decision and a

financing decision. When managers make multinational

finance decisions that maximize the

overall present value of future cashflows, they maximize the firms value,

and hence shareholder wealth.


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n

ttt

k1=

$,

1CFE=Value

E (CF$,t) = expected cash flows to be received at the end ofperiod t

n = the number of periods into the future in whichcash flows are received

k = the required rate of return by investors

Valuation Model for an MNC

Domestic Model


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n

tt

m

j

tjtj

k1=

1

,,

1

ERECFE

=Value

E (CFj,t) = expected cash flows denominated in currencyjto be

received by the U.S. parent at the end of period tE (ERj,t) = expected exchange rate at which currencyjcan be

converted to dollars at the end of period tk = the weighted average cost of capital of the U.S.

parent company


Valuing International Cash Flows


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Impact of New International Opportunitieson an MNCsValue

Exchange Rate Risk

n

t t

m

j

tjtj

k1=

1

,,

1

ERECFE

=Value

Political Risk

Exposure toForeign Economies

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01 Introduction to International Finance 2010

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