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IFM-KGIM
An Introduction:
International Financial
Management
Dr. Daviender Narang
(ProfessorKGIM)
1
CHAPTER OVERVIEW:
I. The Rise of the Multinational
Corporation
II. The Internationalization of
Business and Finance
III. Multinational Financial Management:
Theory and Practice
International Financial 2
Multinational Corporation (MNC)
Foreign Exchange Markets
Dividend
Remittance
Exporting & Financing Investing
& Importing & Financing
Product Markets Subsidiaries International

Financial
Markets
PART 1 THE RISE OF THE
MULTINATIONAL CORPORATION
I. The MNC: Definition
A company with production and
distribution facilities in more than
one country.
THE RISE OF THE MULTINATIONAL
CORPORATION
A. Forces Changing Global Markets
Massive deregulation
Collapse of communism
Privatizations of stateowned industries
Revolution in information technology
Wave of M&A
Emergence of free market policies
Rise of Big Emerging Markets (BEMs)
CORPORATION
B. Prime Transmitter of Competitive
Forces in the Global Economy:
The MNC emphases group performance
such as
Global coordinated allocation of resources
Market – entry strategy
Ownership of foreign operations
Production, marketing and financial activities
CORPORATION
C. EVOLUTION OF THE MNC
Reasons to Go Global:
1. More raw materials
2. New markets
3. Minimize costs of
production
CORPORATION
RAW MATERIAL SEEKERS
Exploit markets in other countries
Historically first to appear
Modernday counterparts
British Petroleum
Exxon
CORPORATION
MARKET SEEKERS
Produce and sell in foreign markets
Heavy foreign direct investors
Representative firms:
IBM
MacDonald’s
Nestle
Levi Strauss
CORPORATION
COST MINIMIZERS
Seek lowercost production abroad
Motive: to remain cost competitive
Texas Instruments
Intel
Seagate Technology
CORPORATION
D. THE MNC: A BEHAVIORAL
VIEW
1. State of mind:
committed to producing,
undertaking investment
and marketing, and
financing globally.
CORPORATION
E. THE GLOBAL MANAGER
1. Understands political and
economic differences;
2. Searches for most cost
effective suppliers;
3. Evaluates changes on value
of the firm.
Part II The Internationalization of
Business and Finance
I. Globalization
A. Political and Labor Union
Concerns
B. Consequences of Global
Competition
Acceleration of the global economy
PART III. MULTINATIONAL FINANCIAL
MANAGEMENT: THEORY AND PRACTICE
I. THE MULTINATIONAL
FINANCIAL SYSTEM
A. Main Objective of MNC:
Maximize shareholder
wealth
B. Other Objectives Reflect
Ability to Link:
via affiliate transfer mechanisms
THEORY AND PRACTICE
C. Mode of Transfer:
Reflects freedom to select a
variety of financial channels.
D. Timing Flexibility:
Most MNC have some
flexibility in timing of fund
flows.
THEORY AND PRACTICE
E. Value
The ability to avoid national
taxes has led to controversy.
Goal of the MNC
The commonly accepted goal of an
MNC is to maximize shareholder
wealth.
We will focus on MNCs that are worked
Globally and that wholly own their
foreign subsidiaries.
Constraints
Interfering with the MNC’s Goal
As MNC managers attempt to maximize
their firm’s value, they may be
confronted with various constraints.
Environmental constraints.
Regulatory constraints.
Ethical constraints.
THEORY AND PRACTICE
II. FUNCTIONS OF FINANCIAL
MANAGEMENT
A. Two Basic Functions:
1. Financing
2. Investing
THEORY AND PRACTICE
B. Additional Factors Facing the
MNC Executive
1. Political risk
2. Economic risk
THEORY AND PRACTICE
III. THEORETICAL FOUNDATIONS
A. Useful Concepts from
Financial Economics:
1. Arbitrage
2. Market Efficiency
3. Capital Asset Pricing
THEORY AND PRACTICE
B. Importance of Total Risk
1. Adverse Impact
lower sales and higher
costs
2. Justifies hedging activities
of MNC
3. Diversification reduces risk
THEORY AND PRACTICE
IV. THE GLOBAL FINANCIAL
MARKET PLACE
A. Interlinkage by Computers
B. Market Acts as A Global
Referendum Process:
Currencies may rise or fall
International Economics
Introduction
The study of international economics has
never been as important as it is now.
At the beginning of the 21st century, nations are
more closely linked through trade in goods and
services, through flows of money, and through
investment in each others’ economies than ever
before.
Figure 11 shows that international trade for the
United States has roughly tripled in importance
compared with the U.S. economy as a whole.
Figure 1-1: Exports and Imports as a Percentage of U.S. National Income
What is International Economics About?
International economics deals with economic
interactions that occur between independent
nations.
The role of governments in regulating international trade and
investment is substantial.
Analytically, international markets allow governments to
discriminate against a subgroup of companies.
Governments also control the supply of currency.
There are several issues that recur throughout the
study of international economics.
Financial Crises
The Financial crises can be broadly classified
as currency (balance of payments) crises and
banking crises.
Spillover effects in other countries
Crises in one country, rapidly transmitted to
others countries.
Mexican Crises (199495)
East Asian Crises (199798)
Russian Crises (1998)
Financial Crises
Currency Crises
A run on official foreign exchange reserves
(Exerting downward pressure)
Due to deterioration in economic fundamentals
Overheating and generation of selffulfilling
expectations of the economy
Banking Crises
Fundamental weakness of several commercial
banks
Currency and bank crises tend to be associated with
each other and often take place together.
Financial Flows to Developing Countries
Bond Finance
Domestic or Foreign currency
Bank Finance:
Syndicated loans, LIBOR
Foreign Direct Investment
Official flows
Grants, Aids, Loans from IMF, World Bank
Evolution of Trade Theory
The Age of Mercantilism
Classical Trade Theory
Factor Proportions Trade
Theory
International Investment and
Product Cycle Theory
The New Trade Theory:
Strategic Trade
The Theory of International
Investment
Mercantilism
Mixed exchange through trade with
accumulation of wealth
The way for a nation to become rich and
powerful was to export more than its
imported
Conducted under authority of
government
Demise of mercantilism inevitable
Country’s wealth depended upon its
holdings of treasure
England (15001750) – wanted to force
colonies to buy goods
Contribution – “favorable” balance of
trade exports exceed imports. Does this
exist? U.S. has “unfavorable” balance in
textile and apparel
The Theory of Absolute Advantage
Adam Smith (1776)
Father of Free Trade
One country is said to have an absolute
advantage over another in the production of a
particular good if it can produce that good
using smaller quantities of resources than can
the other country (i.e. efficiency)
If a country has an absolute advantage in all
areas, that country does not need to trade
Ricardo’s theory of Comparative Advantage
Country will export that product in which it
has a comparative labor productivity
The Theory of Comparative Advantage
The notion that although a country may produce both
products more cheaply than another country, it is
relatively better at producing one product than the
other
Deals with relative differences in productivity of labor
among nations
Applies even if one country is at an absolute
disadvantage relative to another country in the
production of every good
Both countries gain from trade even if one of them is
more efficient than the other in producing everything
Classical Trade Theory Contributions
Adam Smith—Division of Labor
Industrial societies increase output using same
laborhours as preindustrial society
David Ricardo—Comparative
Advantage
Countries with no obvious reason for trade can
specialize in production, and trade for products
they do not produce
Gains From Trade
A nation can achieve consumption levels beyond
what it could produce by itself
Factor Proportions Trade Theory
Developed by Eli Heckscher
Expanded by Bertil Ohlin
Considers Two Factors of Production
Labor
Capital
A country that is relatively labor
abundant (capital abundant) should
specialize in the production and
export of that product which is
relatively labor intensive (capital
intensive).
H-O Theory
Capital abundant countries (ex. US) will
export capital intensive products (ex.
nonwovens)
Labor abundant countries (ex. China)
will export labor intensive products (ex.
Apparel)
Porter’s Model of competitive Advantage
Why does a nation become the home
base for successful international
competitors in an industry?
Why are firms based in a particular
nation able to create and sustain
competitive advantage against the
world’s best competitors in a particular
field?
Porter’s Model of competitive Advantage
Economic Integration
Economic integration is an agreement
among nations to decrease or eliminate
trade barriers and classified as:
Preferential trade arrangement
Free trade area
Custom Union
Common market or an Economic union
Tariff and Non Tariff Barriers to Trade
Tariff are most commonly used as a fool
for trade restraint.
A tariff is a custom duty as a tax
imposed on imports or exports.
Protective tariff
Revenue tariff
Nontariff measures
Quotas
IFM-KGIM
The International
Monetary System
45
A BRIEF HISTORY OF THE INTERNATIONAL
MONETARY SYSTEM
I. THE USE OF GOLD
A. Desirable properties
B. In short run: High production costs limit
changes.
C. In long run: Commodity money insures
stability.
A BRIEF HISTORY
II.The Classical Gold Standard
(18211914)
A. Major global currencies on gold
standard.
1. Nations fix the exchange rate
in terms of a specific amount
of gold.

A BRIEF HISTORY
2. Maintenance involved the
buying and selling of gold at that
price.
3. Disturbances in Price Levels:
Would be offset by the price
specie*flow mechanism.
* specie = gold coins
A BRIEF HISTORY
a. Pricespecieflow mechanism
adjustments were automatic:
1.) When a balance of payments
surplus led to a gold inflow;
2.) Gold inflow led to higher
prices which reduced surplus;
3.) Gold outflow led to lower
prices and increased surplus.
A BRIEF HISTORY
III. The Gold Exchange Standard
(19251931)
A. Only U.S. and Britain allowed
to hold gold reserves.
B. Others could hold both gold, dollars
or pound reserves.
A BRIEF HISTORY
C. Currencies devalued in 1931
led to trade wars.
D. Bretton Woods
Conference
called in order to avoid
future protectionist and
destructive economic policies
A BRIEF HISTORY
V.The Bretton Woods System (19461971)
1. U.S.$ was key currency;
valued at $1 1/35 oz. of
gold.
2. All currencies linked to that price in
a fixed rate system.
A BRIEF HISTORY
3. Exchange rates allowed to fluctuate
by 1% above or below initially set
rates.
B. Collapse, 1971
1. Causes:
a. U.S. high inflation rate
b. U.S.$ depreciated sharply.
A BRIEF HISTORY
V.PostBretton Woods System (1971Present)
A. Smithsonian Agreement, 1971:
US$ devalued to 1/38 oz. of gold.
By 1973: World on a freely floating
exchange rate system.
A BRIEF HISTORY
B. OPEC and the Oil Crisis (1973774)
1. OPEC raised oil prices four fold;
2. Exchange rate turmoil resulted;
3. Caused OPEC nations to earn
large surplus BOP.
A BRIEF HISTORY
4. Surpluses recycled to debtor
nations which set up debt
crisis of 1980’s.
C. Dollar Crisis (197778)
1. U.S. BOP difficulties
2. Result of inconsistent
monetary policy in U.S.
A BRIEF HISTORY
3. Dollar value falls as confidence
shrinks.
D. The Rising Dollar (198085)
1. U.S. inflation subsides as the Fed
raises interest rates
2. Rising rates attracts global capital to
U.S.
A BRIEF HISTORY
3. Result: Dollar value
rises.
E. The Sinking Dollar:(198587)
1. Dollar revaluated slowly
downward;
2. Plaza Agreement (1985)
G5 agree to depress US$
further.
A BRIEF HISTORY
3. Louvre Agreement (1987)
G7 agree to support the
falling US$.
F. Recent History (1988Present)
1. 1988 US$ stabilized
2. Post1991 Confidence
resulted in stronger
dollar
3. 19931995 Dollar value
falls
THE EUROPEAN MONETARY SYSTEM
I. INTRODUCTION
A. The European Monetary System
(EMS)
1. A targetzone method
(1979)
2. Close macroeconomic
policy coordination required.
B. EMS Objective:
to provide exchange rate
stability to all members by
holding exchange rates
within specified limits.
C. European Currency Unit (ECU)
a “cocktail” of European currencies
with specified weights as the unit of
account.
1. Exchange rate mechanism
(ERM)
each member determines mutually
agreed upon central cross rate for
its currency.
2. Member Pledge:
to keep within 15%
margin above or below
the central rate.
D. EMS ups and downs
1. Foreign exchange
interventions:
failed due to lack of
support by coordinated
monetary policies.
2. Currency Crisis of Sept. 1992
a. System broke down
b. Britain and Italy
forced towithdraw
from EMS.
G. Failure of the EMS:
members allowed political
priorities to dominate
exchange rate policies.
H. Maastricht Treaty
1. Called for Monetary
Union by 1999 (moved to
2002)
2. Established a single
currency:
the euro
3. Calls for creation of a single
central EU bank
4. Adopts tough fiscal
standards
I. Costs / Benefits of A Single Currency
A. Benefits
1. Reduces cost of doing
business
2. Reduces exchange rate
risk
THE EUROPEAN MONETARY
SYSTEM
B. Costs
1. Lack of national
monetary flexibility.
ALTERNATIVE EXCHANGE RATE SYSTEMS
I. FIVE MARKET MECHANISMS
A. Freely Floating
(“Clean Float”)
1. Market forces of
supply and demand
determine rates.
2. Forces influenced by
a. price levels
b. interest rates
c. economic growth
3. Rates fluctuate randomly
over time.
B. Managed Float (“Dirty Float”)
1. Market forces set rates
unless excess volatility
occurs.
2. Then, central bank determines
rate.
C. TargetZone Arrangement
1. Rate Determination
a. Market forces constrained
to upper and lower
range of rates.
b. Members to the arrangement
adjust their national economic
policies to maintain target.
D. Fixed Rate System
1. Rate determination
a. Government maintains target
rates.
b. If rates threatened, central
banks buy/sell currency.
c. Monetary policies
coordinated.
E. Current System
1. A hybrid system
a. Major currencies:use freely
floating method
b. Other currencies move in and
out of various fixedrate
systems.
International Financial Flows
CHAPTER OVERVIEW
I. BALANCEOFPAYMENT
CATEGORIES
II. THE INTERNATIONAL
FLOW OF GOODS,
SERVICES,AND CAPITAL
III. COPING WITH CURRENT
ACCOUNT DEFICITS
PART I. BALANCE-OF-PAYMENT
CATEGORIES
A. THE BALANCE OF PAYMENTS
(BOP)
1. PURPOSE:
Measures all financial and
economic transactions over
a specified period of time.
BALANCE-OF-PAYMENT CATEGORIES
2. Doubleentry bookkeeping
a. Currency inflows = credits
earn foreign exchange
b. Currency outflows = debits
expend foreign exchange
3. Three Major Accounts:
a. Current
b. Capital
c. Official Reserves
4. Current Account
records net flow of goods,
services, and unilateral
transfers.
5. Capital Account
a. Function: records public
and private investment and
lending.
b. Inflows = credits
c. Outflows = debits
5. Capital Account (con’t)
d. Transactions classified as
1.) portfolio
2.) direct
3.) short term
6. Official Reserves Account
a. Function:
1.) measures changes in
international reserves
owned by central banks.
2.) reflects surplus/deficit of
a.) current account
b.) capital account
6. Official Reserves Account (con’t)
b. Reserves consist of
1.) gold
2.) convertible securities
7. Net Effects:
a. Sum of all transactions
must be zero:
1.) current account
2.) capital account
3.) official reserves
8. The Balanceofpayment
measures
a. Some Definitions:
1.) Basic Balance
a.) consists of current
account and long
term capital flows.
1.) Basic Balance (con’t)
b.) emphasizes long
term trends.
1.) Basic Balance (con’t)
c.) excludes shortterm capital
flows that heavily depend on
temporary factors.
2.) Net Liquidity Balance:
measures the change in
private domestic borrowing
or lending require to keep
payments equal without
adjusting official reserves.
3.) Official Reserve Transactions
Balance
measures adjustments
needed by official
reserves.
PART II. THE INTERNATIONAL FLOW OF
GOODS, SERVICES, AND CAPITAL
II. LINKS FROM INTERNATIONAL
TO DOMESTIC FLOWS
A. Global Linkages
set of basic macroeconomic
identities which link:
domestic spending and
production to current and
capital accounts
THE INTERNATIONAL FLOW OF GOODS,
SERVICES, AND CAPITAL
B. Domestic Savings and Investment
and the Capital Account
1. National Income Accounting
a. National Income (NI) is
either spent (C) or
saved (S)

NI = C + S (5.1)

b. National spending (NS) is
divided into personal
spending (C) and
investment (I)
NS = C + I (5.2)
c. Subtracting (4.2) (4.1)
NI NS = S I (5.3)
If NI >NS, S > I which implies
that surplus capital spent
overseas.
d. In a freelyfloating system,
excess saving = the capital
account balance
e. Implications:
1. A nation which produces
more than it spends will
save more than it invests
domestically with a net
capital outflow producing a
capital account deficit.
2. A nation which spends more
than it produces has a net
capital inflow producing a
capital account surplus.
3. A healthy economy will tend to
run a current account deficit.
C. THE LINK BETWEEN THE
CURRENT AND CAPITAL
ACCOUNTS
1. Beginning identity
NI NS = X M (5.4)
where X = exports
M = imports
XM=current account
balance (CA)
2. Combining (5.3) + (5.4)
S I = X M (5.5)
3. If S I = Net Foreign
Investment (NFI)
NFI = X M (5.6)

4. Implications:
a. If CA is in surplus, the
nation must be a net
exporter of capital.
b. If CA is a deficit, the nation
is a major capital importer.
c. When NS > NI, the excess
must be acquired through
foreign trade.
d. Solutions for Improving CA
deficits:
1.) Raise national income
(output)
relative to domestic
investment (I).
2.) Increase (S) relative to
domestic investment (I).

D. GOVERNMENT BUDGETS AND
CURRENT ACCOUNT DEFICITS
1. CURRENT ACCOUNT BALANCE
CA = Saving Surplus Gov’t
budget deficit

2. CA Deficit means
the nation is not saving
enough to finance (I) and the
deficit.
3. CA Surplus means
the nation is saving more
than needed to finance its (I)
and deficit.
PART III. COPING WITH THE CURRENT ACCOUNT
DEFICIT
I. POSSIBLE SOLUTIONS
UNLIKELY TO WORK:
A. Currency Depreciation
B. Protectionism

COPING WITH THE CURRENT ACCOUNT DEFICIT
II.CURRENCY DEPRECIATION
A. U.S. Experience:
Does not improve the trade
deficit.

B. Depreciations are ineffective
because
1. It takes time to affect trade.
2. JCurve Effect
states that a decline in
currency value will initially
worsen the deficit before
improvement.

THE J - CURVE
Net Trade balance
change Currency improves
in trade depreciation
balance
0 TIME
Trade balance
initially deteriorates

III. PROTECTIONISM
A. Trade Barriers used:
1. Tariffs
2. Quotas
B. Results:
Most likely will reduce both
X and M.
C. FOREIGN OWNERSHIP
one protectionist solution would
place limits on or eliminate
foreign ownership leading to
capital inflows.

D. STIMULATE NATIONAL SAVING
change the tax regulations and
rates.

III. SUMMARY: CURRENTACCOUNT
DEFICITS
neither bad nor good inherently
1. Since one country’s exports
are another’s imports, it is
not possible for all to run a
surplus

2.Deficits may be a solution to
the problem of different
national propensities to save
and invest.

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