Multinational Finance Exam 1

1. Multinational Corporation: firms that engage in some form of international

business
2. Risk involved with international business (2): -Political Risk
-Economic/ Financial
3. Why international business? (3 main theories):
3 Main Theories
-Theory of Comparative Advantage
-Imperfect Markets Theory
-Product Cycle Theory
4. Theory of Comparative Advantage: countries should specialize in the goods for
which they have a comparative advantage and trade for other goods. Should
improve world welfare.
5. Absolute Advantage: the ability to produce a good using fewer inputs than
another producer. If each country has an absolute advantage in one good and
specializes in that good, then both countries can gain from trade. (Adam Smith) 6.
Comparative Advantage: the ability to produce a good at a lower opportunity
cost than another producer. Trade should be based on comparative advantage.
Countries should specialize in producing the good for which they have the
comparative advantage. (David Ricardo)
7. Imperfect Markets Theory: Factors of production are not completely mobile,
particularly labor.
(seek out lower labor costs)
8. International Trade: Use of Exports and Imports More conservative approach
exchange rate risk
9. Licensing: An arrangement whereby one firm provides its technology (copyright
trade mark etc) in exchange for fees and other considerations
Pro: not a major investment
Con: hard to maintain quality control
10. Franchising: An arrangement whereby one firm provides a specialized sales or
service strategy, support assistance, and possibly an initial investment in the
franchise in exchange for periodic fees
11. Joint Ventures: a venture that is jointly owned and operated by two or more
firms.
(Toyota and Mazda in US)
12. Acquisition of Foreign operations: Allow firms to gain full control over a
foreign business (High Risk)
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13. Establishing new subsidiaries: New operations, very very high risk and large
investment
14 Motives for FDI (5):
-Attract new sources of demand
-Enter markets where superior profits are possible
-Exploit monopolistic advantages
-React to trade restrictions
-Diversify internationally
15. Expected return of a portfolio: 5_ _5]=5d_5e 5_ _5e+5d_5f 5_ _5f
16. Standard deviation of returns: 5 _5]= (5d_5e^2 5 _5e^2+5d_5f^2 5 _5f^2+25d_
17. Cost related motives for FDI (5):
-Economies of scale
- use foreign factors of production (cheap labor and land)
-use of foreign raw materials
-use of foreign technology
-react to exchange rate movements
18. Gov typically support FDI that decreases unemployment and
introduces new technology (5): Gov incentives are
-tax breaks
-discounted or rent free land and buildings
-low interest loans
-subsidized energy
-reduced environmental regulation
19. Gov typically oppose FDI that erodes market share of domestic
companies: Barriers include legal impediments to mergers or acquisitions -red
tape
- other regulations
20. Constellation Brands: a "leading international producer and marketer of beer,
wine and spirits with operations in the U.S., Canada, Mexico, New Zealand and
Italy."
Original joint venture then bought US company
21. Political Risk: Expropriation is the most serious risk
22. Preventing Expropriation (6): Use a short-term horizon
Rely on unique supplies or technology

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Hire local labor
Borrow local funds
Purchase insurance
Use project finance
23. Macro assessment of risk: overall risk assessment of a country and involves
consideration of all variables that affect country risk except those that are unique
to a particular firm or industry
24. Micro assessment of risk: involves the assessment of a country as it relates to
the MNC's type of business.
25 Economic Growth: 5:575C=56+5<+5:+5A5K
26. Expansionary Monetary policy: increases the money supply and lowers interest
rates
27. Contractionary monetary policy: decreases the money supply and increases
interest rates
28. Inflation: occurs when the overall level of prices is rising
- too much is bad moderate is good
29. Exchange rates: price of one currency in terms of another currency
- a strong currency typically leads to higher imports and lower exports , strong dollar
makes foreign goods cheaper but US goods more expensive
30. Present value: PV= FV/ (1+I)^N
31. Eurocurrency: time deposit of money in an international bank different from the
country that issued the currency (Eurodollars are dollars in banks outside US)
32. Eurocredit loans:: short to medium term loans of one year or longer extended
by banks to MNCs or gov agencies, typically 5 years
33. Syndicated loans: Sometimes a single bank is unwilling or unable to lend the
amount needed by the borrower. In such a case, a syndicate of banks can
participate in the lending. Spreads the risk of default across all banks and creates
an incentive for borrower to repay the loan.
34. Foreign bond: issued by a borrower foreign to the country where the bond is
placed (german company issuing bond but using dollars)
35. Eurobond: bonds sold in countries other than the country of the currency
dominating the bond (german company issuing USD bond in japan)
36. Firms seek to list their stock in foreign exchanges to (6): - tap new sources
of capital
-increase the liquidity of their stock
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-increase the shareholder base
-increase the global visibility of the firm
-lower their cost of capital
-bond to a stricter regulatory environment
37. Yankee stock offerings: direct listing of the foreign stock mostly canadian firms
38. American depository receipts: certificates that trade in the US in dollars but
represent ownership of foreign equity
39. Level 1 american depository receipt: trade over the counter no registration with
SEC required
40. Level 2 american depository receipt: trade in organized exchanges require
SEC registration and reconciliation of financial statements to GAAP or IFRS
41. Level 3 american depository receipt: same as level 2 but represents
new shares
42 Private placements for american depository receipts: special placements with
qualified institutional buyers no SEC required not for bonding
43. Foreign Exchange Market: allow for the exchange of one currency for another
44. Before 1875: Bimetallism: both gold and silver were used as international
means of payment and the exchange rates among currencies were determined by
either their gold or silver contents
45. 1875-1914: Classical Gold Standard: 1. gold alone is assured of unrestricted
coinage 2. there is two way convertibility between gold and national currencies
as a stable ratio and 3. gold may be freely exported or imported
46. 1915-1944: Interwar period: characterized by economic nationalism and weak
(and futile) attempts to restore gold standard
47. 1945-1972: Bretton woods system: countries were pegged to the dollar with was
pegged to gold. Also established the world bank and the international monetary
fund (IMF)
48. 1973- present:: the flexible/ floating exchange rate regime: the Jamaica
agreement in 1976 declared flexible exchange rate regimes as acceptable and
it allowed central banks to intervene in currency markets to manage
unwarranted volatilities
49. Over the counter market: with no physical location: trading does not take place
in central marketplace; instead market is a world wide linkage of market participants
through a telecommunications network
Two tier: wholesale (interbank) and retail (clients)

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50. Foreign exchange dealers: intermediaries in the forex market that exchange
the currencies desired by companies/individuals
51. Spot market: involves the immediate purchase/ sale of foreign exchange (cash
settlement is typically made 1-2 business days after a transaction). 52. Spot rate:
exchange rate in the spot market is known as the spot rate
53. Direct quote: expresses the domestic currency as the price currency and the
foreign currency as the base currency - s(domestic/foreign)
54. Indirect quote: expresses the foreign currency as the price currency and the
domestic currency as the base currency - s(foreign/domestic)
55. Hierarchy of Quotes: -If EURO is involved it is the base currency
-GBP involved it is the base currency (except with the euro)
- USD involved it is base currency (except with euro and gbp
-Exceptions: AUD and NZD base when quoted against USD
56. Cross Exchange Rate: an exchange rate between a currency pair where
neither currency is the U.S. dollar
57. If exchange rate increases..: the "price" of the BASE currency is rising. In
other words, the base currency is appreciating/strengthening/ gaining value relative
to the price currency.
58 If the exchange rate decreases...: the "price" of the BASE currency is falling.
In other words, the BASE currency is depreciating/ weakening/ losing value relative
to price currency.
59. Advantages of a strong dollar: -lower import prices
-US products lower prices to keep up with import prices which causes less inflation -
Cost of foreign investment is low
-foreign capital attracted to strong currency leads to lower interest rates
60. Disadvantages of strong dollar: -Exports become less competitive
-more competition for domestic firms from low price competitors
-less jobs in traded goods sector
-higher cost of operating in US reduces FDI in the US slowing job creation
61. Advantages of weak dollar: -US exports more competitive in foreign markets
-US firms are more competitive domestically against higher priced imports
-US gains jobs in traded goods sector
-Lower cost of operating in the US increases FDI in the US boosting job creating by
foreign firms
62. Disadvantages of a weak dollar: -dollar prices of imports rises
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-reduced price competition leads to higher prices for domestic products which
increases inflation
-Cost to US firms and individuals of foreign investment is higher
-foreign capital fleeing a weak currency leads to higher US interest rates
63. The demand for dollars is driven by (wrt Euros): -Trade: Europeans desire to
purchase american goods
-International capital flows: European firms and consumers interest in investing in the
US
-Inverse relationship between exchange rate and the quantity demanded of dollars.
64. The supply of dollars is driven by (wrt Euros): -Trade: Americans desire to
purchase European goods
-International capital flows: American firms and consumers interest in investing in
European assets
-Positive relationship between the exchange rate and the quantity demanded of
dollars
65. Factors that influence exchange rates (5): -relative inflation rates -relative
interest rates
-relative income levels
-government controls -
expectations
66. Government Controls: Foreign exchange barriers, foreign exchange
intervention, trade barriers, impact on macro variables including inflation, interest
rates, and

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income
(anything that influences supply and demand for currency)
67. Expectations: If investors expect a currency to appreciate, they may rush to
buy it now. By acting on those expectations you make the expected effect occur.
68. Why does a gov intervene in forex market?: Smooth exchange rate
movements: reduce volatiltiy in the forex markets, smooth out business cycles
Establish implicit exchange rate boundaries: keep FX rates relatively stable to foster
trade or promote FDI
Respond to temporary disturbances: use intervention to offset unanticipated shocks
that distort the market
69. Direct intervention: government/ central bank can directly exchange its
currency for another currency to affect supply and demand and the FX rate
(relies on reserves)
70. Indirect intervention: Recall that changes in the exchange rate can be
influenced by relative inflation rates, relative interest rates, relative income
levels, gov controls, expectations.
71. Fixed exchange rate system: exchange rates are either held constant or
allowed to fluctuate within very narrow margins

Adv: no concern about changes in exchange rates when engaging in trade, FDI or
portfolio investment

Dis: risk that gov/ central bank decides to revalue or devalue currency
72. Revaluation: increase the value of the currency against other currencies
73. Devaluation: decrease the value of the currency against other currencies
74. Freely flowing: exchange rates are determined by market forces without
intervention of governments

Adv: insulation from macroeconomic problems of other countries, more flexibility in

policies

Dis: exchange rate risk, economic problems can become worse by floating
exchange rates
75. Managed float/ "dirty" float: lies somewhere between fixed and freely floating.
76. Dollarization: Currency of another country circulates as legal tender

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Ex. El Salvador
77. Currency board: based on explicit legislative commitment to exchange
domestic currency for a specified currency at a fixed exchange rate combined
with restrictions to issuing authority to ensure fulfillment of its obligations

Ex. Hong Kong

78. Conventional Peg: Currency is fixed to another currency or basket of
currencies. Country authorities can use direct or indirect intervention. Exchange
rate fluctuates around a narrow margin of 2%.

Ex. Saudi Arabia and China

79. Pegged exchange rate within horizontal bands: The value of the currency is
maintained within certain margins of fluctuation around a fixed margin greater
than 2%.

Ex. Kazakhstan
80. Crawling Peg: The currency is adjusted periodically in small amounts at a fixed
rate or in response to changes in selective quantitative indicators (inflation)

Ex. Bolivia
81. Managed Float: largely market determined without a predictable path for the
rate. Intervention is direct or indirect and serves to moderate excessive
fluctuations.

Ex. Mexico
82. Free floating: market determined. Intervention occurs less than 3 times in 6
months, lasts less than 3 days and aims to address disorderly market conditions

Ex. Japan, US, Eurozone

83. Derivative Securities: securities that derive their value from an underlying
security or asset

Ex: forwards, futures, options, swaps

84. Hedgers: want to avoid price variation by locking in a purchase price, give up
opportunity to benefit from favorable price changes in order to protect
themselves
85. Speculators: attempt to profit from a change in prices
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86. Forward Market: involves contracting today for the future purchase/ sale of
foreign exchange
87. Long forward position: buying a foreign currency forward. They make money
when prices rise
88. Short forward position: selling a foreign currency forward. Make money when
prices go down.
89. Forward premium (or discount): percentage deviation from the spot rate

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