Introduction to International

Financial Management
 Multinational Corporation (MNC)
• MNC is defined as firm that engages in some
form of international business
• Goal of Finance Manager in MNC: Maximizing
shareholder’s wealth
WHY STUDY INTERNATIONAL FINANCE?

• In today's world finance cannot be anything but

international
• Enormous growth in the volume of international trade
• Cross border capital flows and, in particular, direct
investment have also grown enormously
• Veritable revolution has been taking place in the
money and capital markets around the world
• Liberalization, deregulation, integration and
innovation have created a giant international financial
market which is extremely dynamic and complex
Contd…

WHY STUDY INTERNATIONAL FINANCE?

• Multilateral negotiations regarding phased removal of trade

barriers have made considerable progress and WTO had
emerged as a meaningful platform
• Post war, World trade has grown faster than World GDP
• Almost all countries getting integrated with the global economy
• Indian economy needs substantial amounts of foreign capital to
augment domestic savings
• Technology up-gradation in India will require continuing import
of foreign technology, hardware and software
• India’s increasing recourse to commercial borrowings and direct
and portfolio investments by nonresidents
Contd…

WHY STUDY INTERNATIONAL FINANCE?

• The efforts of Indian companies to diversify into exports of
engineering equipment and turnkey projects will have to
be supported by the ability to offer long term financing to
buyers
• A number of companies particularly in the Indian IT sector
have begun venturing abroad for strategic reasons either
as partners in joint ventures or by establishing foreign
subsidiaries
• India's growing dependence on international financial
markets
– Debt
– Equity
– FII investment
Contd…

WHY STUDY INTERNATIONAL FINANCE?

• Indian companies have also been venturing

abroad for setting up joint ventures and wholly
owned subsidiaries
• For those who are willing to master its
complexities the global financial market provides
endless opportunities for creative financial
management; for the unwary, it is a minefield
• Finance managers must come to grips with the
conceptual foundations and practical issues of
instruments and markets
 GLOBALIZATION
On or Off?

 Economic "globalization" refers to the increasing

integration of economies around the world, particularly
through the movement of goods, services, and capital
across borders. The term sometimes also refers to the
movement of people (labor) and knowledge (technology)
across international borders.
 The term "globalization" began to be used more
commonly in the 1980s, reflecting technological advances
that made it easier and quicker to complete international
transactions—both trade and financial flows.
Contd…

GLOBALIZATION
On or Off?
 There are countless indicators that illustrate how goods,
capital, and people, have become more globalized.
 The value of trade (goods and services) as a percentage
of world GDP increased from 42.1 percent in 1980 to
58.24% percent in 2019.
 Global exports were 334 billion dollars in 1971 while in
2021 the volume was $28.5 trillion dollars.
 The stock of Foreign direct investment increased from
6.5 percent of world GDP in 1980 to over 25 percent in
2011.
Contd…

GLOBALIZATION
On or Off?
 The ratio of global debt outstanding to world GDP, increased
from roughly 218 percent in 2000 to 256 percent in 2020.
 For a while after the 2007-08 financial crisis there was a
slowdown and reversal but the uptrend is back by now.
 Cross-border capital flows grew in 2010, first time since
2007, reaching $4.4 trillion but were 60% below their peak
in 2007.
 The number of migrant workers has increased from 78
million people (2.4 percent of the world population) in 1965
to 150 million people (2.9 percent of the world population)
in 2000, to 214 million (3.1%) in 2009 to 258 million in 2017
(4.2% of world population)
 THE FINANCE FUNCTION
• The finance function in a firm can be
conveniently divided into two sub-functions
viz. accounting and control and treasury
management
• Decisions taken by the treasurer have
implications for the controller and vice versa
Contd…

THE FINANCE FUNCTION

 THE EMERGING CHALLENGES
 To keep up-to-date with significant environmental changes and
analyze their implications for the firm.
 To understand and analyze the complex interrelationships between
relevant environmental variables and corporate responses - own
and competitive - to the changes in them.
 To be able to adapt the finance function to significant changes in the
firm's own strategic posture.
 To take in stride past failures and mistakes to minimize their adverse
impact.
 To design and implement effective solutions to take advantage of the
opportunities offered by the markets and advances in financial
theory.
 Key questions of International Financial
Management
• Where in the world we should locate our
plants?
• Which global market should we seek to
penetrate?
• Where in the world should we raise our
financing?
 Difference between Domestic and International
Financial Management
Concept International Domestic
Culture, history and Each foreign country is Each country has a known
Institutions unique and not always base
understood by
management
Corporate Governance Foreign countries Regulations and
regulations and institutions are well known
institutional practices are
uniquely different
Foreign Exchange Risk MNCs face it due to their No subsidiaries only risk is
subsidiaries as well as import/export of
export or import of competitors
competitors
Political Risk Huge because of their Negligible political risk
subsidiaries or high profile
Modifications of domestic MNCs use modified Limited used of derivatives
finance financial instruments like because of low forex and
options, forwards, futures political risk
etc.
 Free Trade
Q1.What is Free trade?
Q2. Does free trade applied to goods and
services only?
Q3. Does Free Trade benefit society?
 Free Trade
• Ans 1.
– You can trade without any frictions
– Borders are irrelevant: No tariffs or taxes
– Since, courtiers employ taxes to protect their businesses in reality there
are “freer” trade agreements instead of free trade agreements
• Ans 2.
– It also applies to free trade of : land, labour and capital
– Land is not transferrable but ownership is
• Ans 3. It’s ambiguous because it depends upon how society
define benefit
– Example if benefit means increasing standard of living of people one
way to measure it could be increases in wages
 Why Firms Pursue International Business

• Theory of Comparative Advantage

• Imperfect Market Theory
• Product Cycle Theory
 Rise of International Company
• International Business activity is not new
• Transfer of goods and services across countries has been taking place
since thousands of years like spice routes from Asia to Europe
• However, since World War II, international trade has increased
tremendously
• United nation estimated in 2012 that over 82,000 parent companies
around the world are MNCs
• One of the prominent theory for increased number of MNCs is the
doctrine of Comparative advantage propounded by Adam Smith and
David Ricardo
• Example: Suppose US and Mexico are two trading partners and they
trade only two goods i.e. Food and Electronics with following
Productivity
Items in terms ofUSoutput per man hourMexico
Food 2 lbs/hr 0.4 lbs per hour
Electronics 0.04 units/hr 0.03 units/hr
 Rise of International Company
• It can be seen that US is 5 times more efficient at producing
goods and 1.33 times more efficient at producing electronics
• Theory assumes that goods and services can move internationally
but factors of production like capital, labor and land are immobile
• The drawback of theory is that it considers significant differences
among countries in terms of resource endowments and economic
skills , however, it considers differences among individual
corporate strategies to be of secondary importance
• Contrary to theory in today’s world differences among
corporations are becoming more important than aggregate
differences among countries
• Even small companies becoming global is making the old
analytical framework largely obsolete
 contd..
• Factors of production especially capital and
labor are now freely moving globally where
they are getting higher returns
• Technology and knowledge are becoming a
global pool, companies like GE, Siemens,
Bayers, IBM and Mcknisey and Co. are shifting
part of their operations to Asian countries like
India and China
 Growth in MNCs
• During 1980s and 1990s fundamental political,
technology, regulatory and economic forces radically
changed the global competitive environment:
– Massive Deregulations
– The collapse of communism
– Privatization of companies around the world
– Revolution in IT
– Waves of M&As, LBOs and takeovers
– Adoption of free market policies by emerging markets
 contd..
• Heightened competitiveness of international business
environment has compelled firms in Europe and elsewhere
to undergo process of restructuring to remain competitive
• Rise of China has been the most dramatic change in
International Business which has attracted highest amount
of FDI and has become world’s second largest economy in
terms of GDP.
• Cheap labor has made China to be one of the largest
exporting country to world
• It has led to lot of companies around the world to set up
their manufacturing facilities in China
 Evolution of MNCs
• Various Considerations that prompted rise of MNCs are:
1. Search for raw material:
– British, French and Dutch firms established colonial rules based on it.
– Modern day counterparts are large oil and mining companies like British Petroleum (BP) and
Standard Oil, mineral companies like Anglo-American, Eramet and Anaconda Copper to name
a few
2. Market Seeking
– Either to sell unique products, processes and technologies or to increase economies of scale
– Companies like IBM, Volkswagen, Unilever, Coca-Cola etc.
3. Cost Minimization
– Lower cost of production sites like Hong Kong, India, China, Vietnam etc.
4. Knowledge Seeking
– Some firms enter foreign markets to gain information and experience that is expected to prove
useful elsewhere like Japanese companies
5. Keeping Domestic Customers
– Following Volkswagen set up Brazilian production, many ancillary units set up their businesses
in Brazil to supply components
6. Exploiting Financial Market Imperfections
– Ability to reduce taxes , currency volatilities and reduce risk through diversification
 Agency problem in MNC
• For example establishing subsidiary in a particular country may be manager’s personal
preference rather than it’s potential benefit to
shareholder
• Cost of Agency problem is high in MNC as compared to purely domestic firm because:
– Monitoring managers in distant subsidiary is difficult
– Foreign subsidiary managers raised in different cultures may not follow uniform rules
– Sheer size of large MNCs can create larger agency problems
– Subsidiary managers may pursue goals which may be good for subsidiary but may not be good
from MNC perspective
• Parent Control of Subsidiary:
– ESPOs
– Including Institutional Investors in Board
– Enactment of Sarbanes-Oxley Act 2002
 Management Structure of MNC
• Centralized
– Low agency cost due to better control of subsidiaries
– Disadvantage is managers in parent company may
not be acquaint with all the countries where
subsidiaries are located and hence may take poor
decisions
• Decentralized
– High Agency Cost
– Better local decision making
 How Firms engage in International Business
• International Trade
• Licensing
– IGA Inc. which operates more than 3000 supermarkets in U.S.A has licensing agreement to
operate supermarkets in China and Singapore
– Walt Disney is original owner of cartoons like Mickey Mouse, Donald duck etc. But has
given license to merchandisers to manufacture these products
• Franchising
– McDonald's, Pizza hut, Subway etc.
– It is mainly for services and ownership gets transferred unlike in licensing which is mainly
for products
• Joint Ventures
– Mahindra Renault, Bharti AXA
• Acquisition of Existing operations
– Google has done many acquisitions to expand it’s business in Russia, China, Australia,
Brazil
• Establishing New Foreign Subsidiaries
– Audi India, BMW India, HSBC Bank India
 Foreign Direct Investment (FDI)
• Method of increasing International business extends from simple
approach of international trade to more complex approach of acquiring
businesses
• Any method of increasing International business that requires a direct
investment in foreign operations is normally referred to as Foreign Direct
investment
• International trade and licensing usually are nor considered as FDI as they
do not involve direct investment in foreign operations
• Franchising and joint venture require limited amount of foreign
investment
• Foreign acquisitions and establishments of new foreign subsidiaries
require substantial investment in foreign operations and represent large
portion of FDI
• Many MNCs use combination of methods to increase international trade
Cash Flow Diagrams for MNC
Valuation Model for MNC: International Cash Flows

m

E CF$,t    E CF j ,t  E S j ,t  
j 1
 where CFj,t represents the amount of cash flow denominated in a
particular foreign currency j at the end of period t,

 Sj,t represents the exchange rate at which the foreign currency

(measured in dollars per unit of the foreign currency) can be
converted to dollars at the end of period t.
Uncertainty Surrounding MNC cash Flows

1. Exposure to international economic

conditions
2. Exposure to international political risk
3. Exposure to exchange rate risk
Uncertainty of MNC Cost of Capital
• If there is uncertainty surrounding MNCs Cash
Flows it’s investors would seek higher returns
which would increase it’s cost of capital