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Multinational Business Finance

Fifteenth Edition, Global Edition

Chapter 1
Multinational Financial
Management: Opportunities
and Challenges

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Learning Objectives
1.Explore the global financial marketplace—players
and playing field
2.Consider how the theory of comparative
advantage applies to multinational business
3.Examine how international financial
management differs from domestic financial
management
4.Discover the steps and stages of the
globalization process

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The Multinational Enterprise (MNE)

• The October–December 2014 quarter was a challenging one with
unprecedented currency devaluations. Virtually every currency in the world
devalued versus the U.S. dollar, with the Russian Ruble leading the way.
While we continue to make steady progress on the strategic transformation
of the company—which focuses P&G on about a dozen core categories
and 70 to 80 brands, on leading brand growth, on accelerating meaningful
product innovation and increasing productivity savings—the considerable
business portfolio, product innovation, and productivity progress was not
enough to overcome foreign exchange.

—P&G News Release, January 27, 2015

• A multinational enterprise (MNE) has operating branches, subsidiaries,
or affiliates located in foreign countries.
• Today, digital startups can become multinational enterprises in hours

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The Global Financial Marketplace

• Assets, institutions, and linkages comprise one method to
map global capital markets (see Exhibit 1.1).
• Assets are debt securities issued by governments (e.g.,
U.S. Treasury Bonds). These form the baseline for other
forms of financing.
• Institutions are the central banks, commercial, and
investment banks. Their health keeps the global financial
system stable.
• Linkages are the interbank networks using currency.
Without ready exchange of currencies the market is hard-
pressed to operate efficiently.
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Exhibit 1.1 Global Capital Markets

The global capital market is a collection of institutions (central banks, commercial banks,
investment banks, not-forprofit financial institutions like the IMF and World Bank) and
securities (bonds, mortgages, derivatives, loans, etc.), which are all linked via a global
network-the Interbank Market. This interbank market, in which securities of all kinds are
traded, is the critical pipeline system for the movement of capital.

For long description, see slide 30:

Appendix 1

The exchange of securities-the movement of capital in the global financial system-must all
take place through a vehicle-currency. The exchange of currencies is itself the largest of
the financial markets. The interbank market, which must pass-through and exchange
securities using currencies, bases all of its pricing through the single most widely quoted
interest rate in the world-LIBOR (the London Interbank Offered Rate).
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The Market for Currencies

• Most currencies are quoted against the dollar as in “so
many units per dollar.”
• Computer symbols (ISO-4217 codes) are used in digital
networks.
• Some currencies are known by more than one name.
• Exhibit 1.2 provides selected currency exchange rate
quotes.

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Exhibit 1.2 Selected Global Currency

Exchange Rates for January 2, 2018 (1 of 2)

For long description, see slide 31: Appendix 2

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Exhibit 1.2 Selected Global Currency

Exchange Rates for January 2, 2018 (2 of 2)

For long description, see slide 33: Appendix 3

Note that a number of different currencies use the same symbol (for example both China
and Japan have traditionally used the ¥ symbol, which means “round” or “circle,” for yen
and yuan respectively. All quotes are mid-rates, and are drawn from the Financial Times.
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Financial Globalization and Risk (1 of 2)

• Back in the halcyon pre-crisis days of the late 20th and
early 21st centuries, it was taken as self evident that
financial globalization was a good thing. But the subprime
crisis and Eurozone dramas are shaking that belief…
[W]hat is the bigger risk now—particularly in the
Eurozone—is that financial globalization has created a
system that is interconnected in some dangerous ways.
—“Crisis Fears Fuel Debate on Capital
Controls” Financial Times, December 15,
2011

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Financial Globalization and Risk (2 of 2)

• Risks must be explored, considered, and managed
– International monetary system is under constant scrutiny
– Large fiscal deficits can result in negative interest rates
– Exchange rates are constantly in flux
– Ownership and governance vary dramatically across the
world, particularly for the privately held or
family-owned business
– Global capital markets have become less open and
accessible
– Increasingly complicating financial management with
capital flows

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Eurocurrencies and Eurocurrency

Interest Rates (1 of 2)
• Eurocurrencies (a major linkage in the global and capital
markets)
– These are domestic currencies of one country on deposit in
a second country
– The Eurocurrency markets serve two valuable purposes:
▪ Eurocurrency deposits are an efficient and convenient
money market device for holding excess
corporate liquidity
▪ The Eurocurrency market is a major source of short-term
bank loans to finance corporate working
capital needs (including export and import financing)

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Eurocurrencies and Eurocurrency

Interest Rates (2 of 2)
• The eurocurrency market is relatively free from governmental
regulation and interference.
• Interest rate is referred to as the LIBOR.
– Oftentimes a low spread exists with deposit and loan
rates.

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The Theory of Comparative

Advantage (1 of 7)
• The theory of comparative advantage provides a basis
for explaining and justifying international trade in a model
world assumed to enjoy:
– free trade;
– perfect competition;
– no uncertainty;
– costless information; and
– no government interference.

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The Theory of Comparative

Advantage (2 of 7)
• The theory contains the following
features:
– Exporters in Country A sell goods or services to
unrelated importers in Country B
– Firms in Country A specialize in making products that
can be produced relatively efficiently, given Country
A’s endowment of factors of production, that is, land,
labor, capital, and technology
– Firms in Country B do likewise, given the factors of
production found in Country B
– In this way the total combined output of A and B
is maximized

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The Theory of Comparative

Advantage (3 of 7)
– Because the factors of production cannot be moved
freely from Country A to Country B, the benefits of
specialization are realized through international trade
– The way the benefits of the extra production are
shared depends on the terms of trade, the ratio
at which quantities of the physical goods are
traded
– Each country’s share is determined by supply and
demand in perfectly competitive markets in the two
countries
– Neither Country A nor Country B is worse off than
before trade, and typically both are better off, albeit
perhaps unequally
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The Theory of Comparative

Advantage (4 of 7)
• Although international trade might have approached the
comparative advantage model during the nineteenth
century, it certainly does not today, for the following
reasons:
– Countries do not appear to specialize only in those
products that could be most efficiently produced by
that country’s particular factors of production (as a
result of government interference and ulterior
motivations)
– At least two factors of production – capital and
technology – now flow directly and easily between
countries
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The Theory of Comparative

Advantage (5 of 7)
– Modern factors of production are more numerous than in
this simple model
– Although the terms of trade are ultimately determined by
supply and demand, the process by which the terms are set
is different from that visualized in traditional trade
theory
– Comparative advantage shifts over time, as less developed
countries become developed and realize their
latent opportunities
– The classical model of comparative advantage did not
really address certain other issues, such as the
effect of uncertainty and information costs, the role of
differentiated products in imperfectly competitive
markets, and economies of scale
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The Theory of Comparative

Advantage (6 of 7)
• Comparative advantage is however still a relevant theory
to explain why particular countries are most suitable for
exports of goods and services that support the global
supply chain of both MNEs and domestic firms.
• The comparative advantage of the 21st century, however,
is one based more on services, and their cross-border
facilitation by telecommunications and the Internet.
• The source of a nation’s comparative advantage is still
created from the mixture of its own labor skills, access to
capital, and technology.

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The Theory of Comparative

Advantage (7 of 7)
• Many locations for supply chain
outsourcing exist today.
• It takes a relative advantage in costs, not just an absolute
advantage, to create comparative advantage.
• Clearly, the extent of global outsourcing is reaching out to
every corner of the globe.

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What Is Different About International

Financial Management?
• Exhibit 1.3 summarizes the differences.
– Culture and history differ among countries
– Corporate governance
– Greater levels of foreign exchange and political risks
– Financial theory and applications are modified in the
global versus domestic marketplace
– Specialized and complicated financial instruments
become tools of the trade

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Exhibit 1.3 What Is Different About

International Financial Management?
Concept International Domestic
Culture, history, and Each foreign country is unique and not always Each country has a known base case
institutions understood by MNE management
Corporate Foreign countries’ regulations and institutional Regulations and institutions are well
governance practices are all uniquely different known
MNEs face foreign exchange risks due to Foreign exchange risks from
Foreign exchange their subsidiaries, as well as import/export import/export and foreign competition
risk and foreign competitors (no subsidiaries)
MNEs face political risk because of their Negligible political risks
foreign subsidiaries and high profile
Political risk of domestic
Modification MNEs must modify finance theories like Traditional financial theory applies
finance theories capital budgeting and the cost of capital
because of foreign complexities
Modification of domestic MNEs utilize modified financial instruments Limited use of financial instruments
financial instruments such as options, forwards, swaps, and letters and derivatives because of few foreign
of credit exchange and political risks

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Market Imperfections: A Rationale for the

Existence of the Multinational Firm (1 of 2)
• MNEs strive to take advantage of imperfections in
national markets for products, factors of production, and
financial assets.
• Imperfections in the market for products translate into
market opportunities for MNEs.
• Large international firms are better able to exploit such
competitive factors as economies of scale, managerial
and technological expertise, product differentiation, and
financial strength than their local competitors.

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Market Imperfections: A Rationale for the

Existence of the Multinational Firm (2 of 2)
• Strategic motives drive the decision to invest abroad and
become a MNE and can be summarized under the
following categories:
– Market seekers
– Raw material seekers
– Production efficiency seekers
– Knowledge seekers
– Political safety seekers
• These categories are not mutually exclusive.

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The Globalization Process

• Stage I: early domestic phase growing into the
international trade phase (Exhibit 1.4)
• Stage II: A successful firm will continue to grow from
simple international trade to the multinational phase
characterized by production and investment both at
home and abroad (Exhibit 1.5)
• The increase in foreign subsidiaries increases currency
risks and exposures (Exhibit 1.6)
• Growth may be limited by the twin agency problems of
corporate insiders and the rulers of sovereign states
(Exhibit 1.7)
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Exhibit 1.4 Ganado Corp: Initiation

of the Globalization Process

For long description, see slide 34: Appendix 4

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Exhibit 1.5 Ganado’s Foreign Direct

Investment Sequence

For long description, see slide 35: Appendix 5

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Exhibit 1.6 Selected Consolidated

Income Results for Ganado (U.S.)
As a U.S.-based multinational company, Ganado must consolidate the financial results
(in this case, sales and earnings from the income statements) of its foreign subsidiaries.
This requires converting foreign currency values into U.S. dollars.

For long
description, see
slide 36:
Appendix 6

Ganado, for the year shown, generated 57% of its global sales in the United States, with
those U.S. sales making up 56% of its consolidated profits. From quarter to quarter and
year to year, both the financial performance of the individual subsidiaries will change in
addition to exchange rates.
* This is a simplified consolidation. Actual consolidation accounting practices require a
number of specific line item adjustments not shown here.
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Exhibit 1.7 The Limits of Financial

Globalization
There is a growing debate over whether many of the insiders and rulers of organizations
with enterprises globally are taking actions consistent with creating firm value or
consistent with increasing their own personal stakes and power.

For long description, see slide 38: Appendix 7

If these influential insiders are building personal wealth over that of the firm, it will indeed
result in preventing the flow of capital across borders, currencies, and institutions to
create a more open and integrated global financial community.
Source: Constructed by authors based on “The Limits of Financial Globalization,” Rene
M. Stulz, Journal of Applied Corporate Finance, Vol. 19, No. 1, Winter 2007, pp. 8–
15.
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Copyright

This work is protected by United States copyright laws and is

provided solely for the use of instructors in teaching their
courses and assessing student learning. Dissemination or sale of
any part of this work (including on the World Wide Web) will
destroy the integrity of the work and is not permitted. The work
and materials from it should never be made available to students
except by instructors using the accompanying text in their
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restrictions and to honor the intended pedagogical purposes and
the needs of other instructors who rely on these materials.

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Appendix 1
Long Description for a diagram of global capital markets linked through
the Interbank market.
The diagram is of the global capital markets and the London Interbank
Market or LIBOR in which all kinds of securities are traded.
• The Interbank market is in the center with three bank boxes around it.
• There is an inverse triangle, titled currency, linking the three bank boxes
with LIBOR.
• The bank on the left has three arrows emanating from it, toward
boxes named mortgage loan, corporate loan and corporate bond.
• The bank on the right has three arrows springing toward boxes titled
public debt, private debt and private equity.
• The bank at the bottom has two arrows headed toward boxes titled
central banks and institutions.

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Appendix 2 (1 of 2)
Long Description for a table displaying selected global currency exchange rates.

The table displays selected global currency exchange rates as of January 2, 2018. There are seven columns titled
country, currency, symbol, code, currency equal to one dollar, currency equal to one euro, currency equal to one
pound.

The data from the table are presented below:

A table has 21 rows and 7 columns. The columns have the following headings from left to right. Country, Currency,
Symbol, Code, Currency to equal 1 Dollar, Currency to equal 1 Euro, Currency to equal 1 Pound, . The row entries are
as follows. Row 1. Country, Argentina. Currency, peso. Symbol, Ps. Code, ARS. Currency to equal 1 Dollar, 18.535.
Currency to equal 1 Euro, 22.3254. Currency to equal 1 Pound, 25.1697. Row 2. Country, Australia. Currency, dollar.
Symbol, A dollar sign. Code, AUD. Currency to equal 1 Dollar, 1.2769. Currency to equal 1 Euro, 1.538. Currency to
equal 1 Pound, 1.734. Row 3. Country, Brazil. Currency, real. Symbol, R Dollar sign. Code, BRL. Currency to equal 1
Dollar, 3.2634. Currency to equal 1 Euro, 3.9307. Currency to equal 1 Pound, 4.4315. Row 4. Country, Canada.
Currency, dollar. Symbol, C Dollar sign. Code, CAD. Currency to equal 1 Dollar, 1.2505. Currency to equal 1 Euro,
1.5062. Currency to equal 1 Pound, 1.6981. Row 5. Country, Chile. Currency, peso. Symbol, Dollar sign. Code, CLP.
Currency to equal 1 Dollar, 607.145. Currency to equal 1 Euro, 731.3062. Currency to equal 1 Pound, 824.4772. Row
6. Country, China. Currency, yuan. Symbol, The yuan symbol is a capital Y with 2 horizontal bars across the Y’s vertical
bar.. Code, CNY. Currency to equal 1 Dollar, 6.4967. Currency to equal 1 Euro, 7.8253. Currency to equal 1 Pound,
8.8222. Row 7. Country, Czech Republic. Currency, koruna. Symbol, Kc. Code, CZK. Currency to equal 1 Dollar,
21.1802. Currency to equal 1 Euro, 25.5115. Currency to equal 1 Pound, 28.7617. Row 8. Country, Denmark.
Currency, krone. Symbol, Dkr. Code, DKK. Currency to equal 1 Dollar, 6.18. Currency to equal 1 Euro, 7.4439.
Currency to equal 1 Pound, 8.3922.

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Appendix 2 (2 of 2)
Row 9. Country, Egypt. Currency, pound. Symbol, The pound symbol is a capital cursive letter L with a horizontal line
going across it’s middle.. Code, EGP. Currency to equal 1 Dollar, 17.713. Currency to equal 1 Euro, 21.3714. Currency to
equal 1 Pound, 24.0942. Row 10. Country, Euro. Currency, euro. Symbol, the euro symbol is a capital c with 2 horizontal
bars across its middle.. Code, EUR. Currency to equal 1 Dollar, 0.8302. Currency to equal 1 Euro, 1. Currency to equal 1
Pound, 1.1274. Row 11. Country, India. Currency, rupee. Symbol, Rs. Code, INR. Currency to equal 1 Dollar, 63.4468.
Currency to equal 1 Euro, 76.4216. Currency to equal 1 Pound, 86.158. Row 12. Country, Indonesia. Currency, rupiah.
Symbol, Rp. Code, IDR. Currency to equal 1 Dollar, 13517.5. Currency to equal 1 Euro, 16281.8453. Currency to equal 1
Pound, 18356.2021. Row 13. Country, Israel. Currency, shekel. Symbol, Shk. Code, ILS. Currency to equal 1 Dollar,
3.4585. Currency to equal 1 Euro, 4.1658. Currency to equal 1 Pound, 4.6965. Row 14. Country, Japan. Currency, yen.
Symbol, The yen symbol is a capital Y with 2 horizontal bars across the Y’s vertical bar.. Code, JPY. Currency to equal 1
Dollar, 112.15. Currency to equal 1 Euro, 135.08. Currency to equal 1 Pound, 152.29. Row 15. Country, Kenya. Currency,
shilling. Symbol, K S h. Code, KES. Currency to equal 1 Dollar, 103.25. Currency to equal 1 Euro, 124.3646. Currency to
equal 1 Pound, 140.2091. Row 16. Country, Malaysia. Currency, ringgit. Symbol, RM. Code, MYR. Currency to equal 1
Dollar, 4.0195. Currency to equal 1 Euro, 4.8415. Currency to equal 1 Pound, 5.4583. Row 17. Country, Mexico.
Currency, new peso. Symbol, Dollar sign. Code, MXN. Currency to equal 1 Dollar, 19.515. Currency to equal 1 Euro,
23.5058. Currency to equal 1 Pound, 26.5005. Row 18. Country, New Zealand. Currency, dollar. Symbol, NZ Dollar sign.
Code, NZD. Currency to equal 1 Dollar, 1.4066. Currency to equal 1 Euro, 1.6942. Currency to equal 1 Pound, 1.9101.
Row 19. Country, Nigeria. Currency, naira. Symbol, N equal sign. Code, NGN. Currency to equal 1 Dollar, 359.5.
Currency to equal 1 Euro, 433.0178. Currency to equal 1 Pound, 488.1858. Row 20. Country, Norway. Currency, krone.
Symbol, NKr. Code, NOK. Currency to equal 1 Dollar, 8.1381. Currency to equal 1 Euro, 9.8023. Currency to equal 1
Pound, 11.0511. Row 21. Country, Philippines. Currency, peso. Symbol, P. Code, PHP. Currency to equal 1 Dollar,
49.92. Currency to equal 1 Euro, 60.1286. Currency to equal 1 Pound, 67.7892.

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Appendix 3
Long Description for a diagram of global capital markets linked through
the Interbank market.
The diagram is of the global capital markets and the London Interbank
Market or LIBOR in which all kinds of securities are traded.
• The Interbank market is in the center with three bank boxes around it.
• There is an inverse triangle, titled currency, linking the three bank boxes
with LIBOR.
• The bank on the left has three arrows emanating from it, toward
boxes named mortgage loan, corporate loan and corporate bond.
• The bank on the right has three arrows springing toward boxes titled
public debt, private debt and private equity.
• The bank at the bottom has two arrows headed toward boxes titled
central banks and institutions.

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Appendix 4
Long Description for a diagram represents Ganado Corporation’s entry
into the globalization process.
The diagram represents the globalization process as occurring in two
phases. Phase 1 consists of domestic operations. The domestic U.S.
suppliers provide materials to Ganado Corporation in Los Angeles,
California, and Ganado sends products to U.S. buyers, who represent
the domestic customers. Phase 1 involves all U.S. dollar-denominated
transactions under U.S. credit laws and practices. Phase 2 consists of
expansion into international trade. Ganado receives materials from
international suppliers in Mexico, and Ganado sends products to
international customers in Canada. Ganado must determine if
transactions will be carried out in the Mexican peso, Canadian dollar, or
U.S. dollar. Ganado must also determine if suppliers and customers are
creditworthy.
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Appendix 5
Long Description for a diagram of Ganado’s foreign direct investment sequence.

Ganado’s foreign direct investment sequence consists of five stages. Each new stage requires greater
foreign investment, which requires putting more and more capital at risk. Each new stage also requires
a greater foreign presence, which requires a higher level of managerial intensity. During each stage,
Ganado has two alternatives. The following list outlines the five stages. For each stage, the alternatives
are in order of increasing foreign presence.
• First stage: Change competitive advantage, or exploit existing advantage abroad.
• Second stage: Exploit an existing advantage abroad by exporting goods produced
at home or having production abroad.
• Third stage: Start production abroad through licensed manufacturing or by controlling
and owning assets abroad.
• Fourth stage: Control and own assets abroad through a joint venture or through a
wholly owned subsidiary.
• Fifth stage: Launch a wholly owned subsidiary through greenfield investment or through
acquisition of a foreign enterprise.

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Appendix 6 (1 of 2)
Long Description for two tables illustrate consolidated sales and earnings for Ganado.
Each table shows a consolidation of the global sales and income earned. The table for
sales has columns for the following values from left to right: country, currency, sales in
millions of the local currency, average exchange rate, sales in millions of U.S. dollars, and
percent of total. The table reads as follows.
A table has 4 rows and 6 columns. The columns have the following headings from left to
right. Country, Currency, Sales in Local Currency, Average Exchange Rate, Sales in U.S.
Dollars, Percentage of Total. The row entries are as follows. Row 1. Country, United
States. Currency, U.S. dollar. Sales in Local Currency, 300. Average Exchange
Rate, blank. Sales in U.S. Dollars, 300. Percentage of Total, 57. Row 2. Country, Europe.
Currency, European euro. Sales in Local Currency, 120. Average Exchange Rate, 1.12
dollars is equal to 1 euro. Sales in U.S. Dollars, 134.4. Percentage of Total, 26. Row 3.
Country, China. Currency, Chinese renminbi. Sales in Local Currency, 600. Average
Exchange Rate, renminbi 6.60 is equal to 1 dollar. Sales in U.S. Dollars, 90.9. Percentage
of Total, 17. Row 4. Country, Totals. Currency, blank. Sales in Local Currency, blank.
Average Exchange Rate, blank. Sales in U.S. Dollars, 525.3. Percentage of Total, 100.

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Appendix 6 (2 of 2)
The table for earnings has columns for the following values from left to right: country,
currency, earnings in millions of the local currency, average exchange rate, earnings in
millions of U.S. dollars, and percent of total. The table reads as follows.
A table has 4 rows and 6 columns. The columns have the following headings from left to
right. Country, Currency, Earnings in Local Currency, Average Exchange Rate, Earnings
in U.S. Dollars, Percentage of Total. The row entries are as follows. Row 1. Country,
United States. Currency, U.S. dollar. Earnings in Local Currency, 28.6. Average
Exchange Rate, blank. Earnings in U.S. Dollars, 28.6. Percentage of Total, 0.56. Row 2.
Country, Europe. Currency, European euro. Earnings in Local Currency, 10.5. Average
Exchange Rate, 1.12 dollars is equal to 1 euro. Earnings in U.S. Dollars, 11.8. Percentage
of Total, 0.23. Row 3. Country, China. Currency, Chinese renminbi. Earnings in Local
Currency, 71.4. Average Exchange Rate, renminbi 6.60 is equal to 1 dollar. Earnings in
U.S. Dollars, 10.8. Percentage of Total, 0.21. Row 4. Country, Totals. Currency, blank.
Earnings in Local Currency, blank. Average Exchange Rate, blank. Earnings in U.S.
Dollars, 51.2. Percentage of Total, 1.

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Appendix 7
The diagram consists of a rectangle labeled, “The Twin Agency Problems
Limiting Financial Globalization.” The bottom-left corner of the rectangle is
labeled “Lower Firm Value (possibly higher insider value).” The top-right corner
of the rectangle is labeled, “Higher Firm Value (possibly lower insider value).”
The top-left corner of the rectangle is labeled, “Actions of Rulers of Sovereign
States.” The bottom right corner of the rectangle is labeled, “Actions of
Corporate Insiders.” Two arrows extend from Lower Firm Value along the edges
of the rectangle. The first arrow extends upward from Lower Firm Value to
Actions of Rulers of Sovereign States. The second arrow extends rightward
from Lower Firm Value to Actions of Corporate Insiders. Two arrows extend
from Higher Firm Value along the edges of the rectangle. The first arrow
extends downward from Higher Firm Value to Actions of Corporate Insiders.
The second arrow extends leftward from Higher Firm Value to Actions of Rulers
of Sovereign States.

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