Introduction to international finance

Topic 1 :: Introduction Dr. Md Mohan Uddin

Introduction to International Finance

Finance in an international context…

Why do we need to study international finance?

We are living in a highly globalized and integrated

world economy

Continued liberalization of international trade

further internationalizes the consumption pattern

Globalized production: MNCs source inputs and locate

productions anywhere in the world

Integrated financial markets: internationally diversified

investment, internationally tradable financial securities

2/24/2014 Dr. Md Mohan Uddin 2

What makes international finance

special?

Three major dimensions make international finance different from purely

domestic finance:

Foreign exchange and political risks

Market imperfections

Expanded opportunity sets


What makes international finance special?

Foreign exchange and political risks

Unexpected fluctuations of the exchange rates may adversely affect the MNCs

as well as individuals who are engaged in cross border transactions

Exchange rate uncertainty may affect all the major economic functions

including consumption, production, and investment.

Sovereign country can change the rules, e.g.,

Tax rules

Expropriation of assets

In some countries, there is a lack of tradition of the rule of law.




Market imperfections represent various frictions and impediments preventing

markets from functioning perfectly.

Such frictions/ impediments/ barriers include

Legal restrictions

Excessive transportation and transaction costs

Information asymmetry

Discriminatory taxation




Often, MNCs are motivated to locate production overseas due to such market

imperfections

Imperfection in the international financial market often restrict the extent to

which investors can diversify their portfolios.



Expanded opportunity set

If firms venture into the arena of global markets, they can benefit from an

expanded opportunity set by:

locating production in any country/region of the world to maximize performance

raising fund in any capital market where the cost capital is the lowest.

deploying assets on a global basis to gain from greater economies of scale.


What makes international finance

special?

International finance is different from domestic finance and to be benefitted

from it,

maximize the benefits from the global opportunity set

control exchange rate and political risks

manage various market imperfections


Effective international financial

management

Effective financial management requires an underlying goal.

Shareholder wealth maximization is considered as the fundamental goal of

sound financial management.

Shareholder wealth maximization is long accepted as a goal in the Anglo-

Saxon countries like Australia, Canada, UK, and USA.



management

In other countries like France or Germany, shareholders are viewed as merely

one among many “stakeholders” of the firm including:

Employees

Suppliers

Customers

In Japan, managers have typically sought to maximize the value of the

keiretsu—a family of firms to which the individual firms belongs.



management

As a result of recent liberalization and international integration of capital

markets even the managers in France, Germany, Japan, and other non-Anglo-

Saxon countries are beginning to pay serious attention to shareholder wealth

maximization.

Shareholder wealth maximization does not imply that the firm would not

pursue other goals.

Rather, shareholder wealth maximization also helps accomplishing other

legitimate goals.



management

As shown by a series of recent corporate scandals at companies like Enron,

WorldCom, and Global Crossing, managers may pursue their own private

interests at the expense of shareholders when they are not closely monitored.

These calamities have painfully reinforced the importance of corporate

governance, i.e., the financial and legal framework for regulating the

relationship between a firm’s management and its shareholders.



management

These types of issues can be much more serious in many other parts of the

world, especially emerging and transitional economies, such as Indonesia,

Korea, and Russia, where legal protection of shareholders is weak or virtually

non-existing.


Globalization of the World Economy:

Major Trends and Developments

Key trends and developments include:

Emergence of Globalized Financial Markets

Emergence of the Euro as a Global Currency

Europe’s Sovereign Debt Crisis of 2010

Trade Liberalization and Economic Integration

Privatization

Global Financial Crisis of 2008-2009



Emergence of globalized financial markets

Deregulation of Financial Markets

Advances in Technology

have greatly reduced information and transaction costs, which has led to:

Financial Innovations, such as

Currency futures and options

Multi-currency bonds

Cross-border stock listings

International mutual funds



Emergence of the euro as a global currency

The advent of the euro in 1999 represents a momentous event in the history

of world financial system

More than 300 million Europeans are using the common

currency

Many new members of the EU would like to adopt the euro

The transaction domain of the euro may become larger

than the USD in near future



Europe’s sovereign-debt crisis of 2010

All EU member states are automatically members of both the Economic and

Monetary Union (EMU) and the Stability and Growth Pact (SGP)

SGP is an agreement, among the member states of the European Union, to

facilitate and maintain the stability of the EMU

The SGP requires each Member State to implement a fiscal policy aiming for

the country to stay within the limits on government deficit (3% of GDP)




In December 2009, the new Greek government revealed that the actual

budget deficit was 12.7 percent compared to the previously forecasted 3.7

percent based on falsified national account data

Therefore, Greece actually was in a serious violation of the SGP.

This situation was a result of excessive borrowing and spending, with wages

and prices rising faster than productivity




Greece could not use the traditional means of depreciating national currency

as the country had adopted the euro.

Investors became worried about sovereign default

They started to sell off Greek government bonds

The panic spread to other weak European countries, especially Ireland,

Portugal, and Spain




In 2010, credit rating agencies downgraded the government bonds of the

affected countries

Borrowing and refinancing became more costly

Although the debt crisis in Greece accounted for only about 2.5% of Eurozone

GDP, it quickly escalated to a Europe-wide debt crisis







On May 9, 2010, EU countries led by France and Germany, jointly with IMF, put

together a massive Euro 750 billion package to bail out Greece and other

weak countries.

The agreement on the bailout plan was slow and thus became expensive due

to

Europe’s lack of political union

Fragmented decision making structure



Trade liberalization and economic integration

Over the past 50 years, international trade increased about twice as fast as

world GDP.

There has been a change in the attitudes of many of the world’s governments,

who have abandoned mercantilist views and embraced free trade as the

surest route to prosperity for their citizenry.




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

agreement among member countries that has reduced many barriers to trade.

The World Trade Organization (WTO) has the power to enforce the rules of

international trade.




The European Union (EU) was established to foster economic integration

among the countries of Western Europe.

The North American Free Trade Agreement (NAFTA) calls for phasing out

impediments to trade between Canada, Mexico, and the United States over a

15-year period beginning in 1994.



Privatization

The selling of state-run enterprises to investors is also known as

“denationalization.”

Privatization is often seen as socialist economies in transition to market

economies.

By most estimates, this increases the efficiency of the enterprise.

It also often spurs a tremendous increase in cross-border investment.



Global financial crisis of 2008—2009

The “Great Recession” was the most serious, synchronized economic

downturn since the Great Depression of the 1930s.

Factors included:

Households and financial institutions borrowed too much and took too much risk.

This risk was repackaged with securitization.


Multinational Corporations

A multinational corporation (MNC) is a firm that has been incorporated in one country and has production and sales operations in other countries.

There are about 60,000 MNCs in the world.

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.



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Introduction to international finance

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