PONTIFICIA UNIVERSIDAD JAVERIANA CALI

FACULTY OF ECONOMICS AND ADMINISTRATIVE SCIENCES

DEPARTMENT OF ACCOUNTING & FINANCE

Course Code: 300ANB004 Title: International Finance

Instructor: Dr S Prabakaran E Mail – jopraba@gmail.com
Office: 4 (Department of Account & Finance) Cells – 3008270437

CHAPTER I: MULTINATIONAL FINANCIAL MANAGEMENT: AN OVERVIEW

Duration of teaching hours – 5 to 6 Hours
Class work Tutorial – 1 Hour:
No. of Quiz – ONE

CLASSROOM DEEDS (Important)

1. Mobile – Don’t use Mobile During Class Hours - switch on condition – NO (even in Vibration mode). It should be in switch
OFF Mode. (Only Zoom connection)
2. During class - Navigation in social networks, watch football, listening songs or engaging in other courses is not permitted
during the class.
3. Assignment - Submit as per the deadline, otherwise you will get ZERO for the late submission.
4. Structure of the assignment (Each and every question have the following steps) A. Given data’s, B. Formula, C. Line
Diagram, D. Calculations, E. Result and F. Comments (Min 2 to 3 lines)
5. Assignments - Submit only by handwritten and sending through electronic (E – mail) submission.
6. Attendance (Present) – Min 80% - Less then – will not allow for 1st, 2nd and Final Examination.
7. Take the notes during the class. (as per my instructions).
8. Respect to them others, their Professor, their colleagues and the personal of support of the University (cleaners, operators,
auxiliary, Secretaries, monitors, vigilant).
9. And respect for all institutional regulations.
10. Discipline – VVIP (Secondary - Subject)
11. Presentation of material: Provide the Materials
12. During the class hours, your audio should be in mute mode and video should be in unmute. (VVIP)
13. If you have any question during the class, you must use the Raise Hand option to ask your question, before unmuting your
audio. Then, I will ask your questions to clarify your doubts.
14. Finally, during the class, please keep your internet connection with good network connection.

Abstract: - International financial management is important even to companies that have no international business because these
companies must recognize how their foreign competitors will be affected by movements in exchange rates, foreign interest rates,
labor costs, and inflation. Such economic characteristics can affect the foreign competitors’ costs of production and pricing
policies. This chapter provides background on the goals of an MNC and the potential risk and returns from engaging in
international business.

The specific objectives of this chapter are to:

 Identify the management goal and organizational structure of the MNC,
 Describe the key theories that justify international business,
 Explain the common methods used to conduct international business, and
 Provide a model for valuing the MNC.

AGENDA: -

MULTINATIONAL FINANCIAL MANAGEMENT: AN OVERVIEW

1. How the International Finance link with Corporate Finance?

2. Introduction: - International (Multinational Finance – MF) is the branch of (International) economics that
studies the dynamics of exchange rates, foreign investment, global financial system, and how these affects
international trade.
 What is Technology Transfer?
• Developed Countries - Norway, Australia, Switzerland, Germany, Singapore, Canada, Netherlands,
Denmark, Hong Kong, Sweden, United States, Ireland, United Kingdom, New Zealand, Japan, France, Italy,
Belgium, and South Korea and etc…

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 • Developing Countries – Afghanistan, Bangladesh, Brazil, Chile, China, Colombia, Cuba, Ecuador, India,
Indonesia, Iraq, Jamaica, Malaysia, Mexico, Pakistan, Panama, Peru, South Africa, Sri Lanka, Swaziland, ,
Thailand and etc…
• Under developing Countries - Angola, Benin, Cape Verde, Ethiopia, Mali, Somalia, Central African
Republic, Gambia, Sudan, Tanzania, Malawi and etc…
 What is International Trade?
 Special about IF.
3. MNEs – Definition - A multinational enterprise (MNE) is defined as one that has operating subsidiaries,
branches or affiliates located in foreign countries.
4. Types of MNEs
 Raw Material Seekers
 Market Seekers
 Cost Minimisers
5. The International Financial Environment
6. Difference Between the Domestic and International Finance
 Cultural, History and Institutions
 Corporate Governance
 Foreign Exchange Risk
 Political Risk
 Modification of finance Theories
 Modification of Domestic Financial Instruments
7. Trade Preference Dilemma (with Intermediation - Benefit)
8. Goals of MF Management
 Shareholders’ Wealth Maximization Model - In a Shareholder wealth maximization model (SWM), a firm
should strive to maximize the return (minimize the risk) to shareholders, as measured by the sum of capital gains and
dividends, for a given level of risk.
 Stakeholders’ Capitalism Model - Controlling shareholders also strive to maximize long-term return to equity.
However, they are more constrained by other powerful stakeholders. (Labour Unions, Government Intervention).
 Operational Goals of MNEs - The MNE must determine for itself proper balance between three common operation
financial objectives.
 Maximization of consolidated after tax income.
 Minimization of the firm’s effective global tax burden.
 Correct positioning of the firm’s income, cash flows, and available funds as to country and currency.
9. Managing the MNC - The commonly accepted goal of an MNC is to maximize shareholder wealth.
Managers employed by the MNC are expected to make decisions that will maximize the stock price and
therefore serve the shareholders. Some publicly traded MNCs based outside the United States may have
additional goals, such as satisfying their respective governments, banks, or employees. However, these
MNCs now place more emphasis on satisfying shareholders so that they can more easily obtain funds from
shareholders to support their operations.
 Facing Agency Problems - Managers of an MNC may make decisions that conflict with the firm’s goal to
maximize shareholder wealth. For example, a decision to establish a subsidiary in one location versus another may
be based on the location’s appeal to a manager rather than on its potential benefits to shareholders. A decision to
expand a subsidiary may be motivated by a manager’s desire to receive more compensation rather than to enhance
the value of the MNC. This conflict of goals between a firm’s managers and shareholders is often referred to as the
agency problem. The costs of ensuring that managers maximize shareholder wealth (referred to as agency costs) are
normally larger for MNCs than for purely domestic firms.
 Parent Control of Agency Problems - The parent corporation of an MNC may be able to prevent
agency problems with proper governance. It should clearly communicate the goals for each subsidiary to
ensure that all subsidiaries focus on maximizing the value of the MNC rather than their respective
subsidiary values. The parent can oversee the subsidiary decisions to check whether the subsidiary
managers are satisfying the MNC’s goals. The parent can also implement compensation plans that reward
the subsidiary managers who satisfy the MNC’s goals. A common incentive is to provide managers with the
MNC’s stock (or options to buy the stock at a fixed price) as part of their compensation, so that they benefit
directly from a higher stock price when they make decisions that enhance the MNC’s value.
 Corporate Control of Agency Problems - There are also various forms of corporate control that can
help prevent agency problems and therefore ensure that managers make decisions to satisfy the MNC’s
shareholders. If the MNC’s managers make poor decisions that reduce its value, another firm may be able
to acquire it at a low price and will likely remove the weak managers. In addition, institutional investors
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 such as mutual funds or pension funds that have large holdings of an MNC’s stock have some influence
over management because they can complain to the board of directors if managers are making poor
decisions. They may attempt to enact changes in a poorly performing MNC, such as the removal of high-
level managers or even board members. The institutional investors may even work together when
demanding changes in an MNC because an MNC would not want to lose all of its major shareholders.
 Management Structure of an MNC - The magnitude of agency costs can vary with the management style of
the MNC. Centralized management style can reduce agency costs because it allows managers of the parent to control
foreign subsidiaries and therefore reduces the power of subsidiary managers. However, the parent’s managers may
make poor decisions for the subsidiary if they are not as informed as subsidiary managers about financial
characteristics of the subsidiary. Alternatively, an MNC can use a decentralized management style, is more likely to
result in higher agency costs because subsidiary managers may make decisions that do not focus on maximizing the
value of the entire MNC. Yet, this style gives more control to those managers who are closer to the subsidiary’s
operations and environment. To the extent that subsidiary managers recognize the goal of maximizing the value of
the overall MNC and are compensated in accordance with that goal, the decentralized management style may be
more effective. Given the obvious tradeoff between centralized and decentralized management styles, some MNCs
attempt to achieve the advantages of both styles. That is, they allow subsidiary managers to make the key decisions
about their respective operations, but the parent’s management monitors the decisions to ensure that they are in the
best interests of the entire MNC.
 How the Internet Facilitates Management Control – The Internet is making it easier for the
parent to monitor the actions and performance of its foreign subsidiaries.
10. Why Firms Pursue International Business
 Theory of Comparative Advantage - When a country specializes in some products, it may not produce other
products, so trade between countries is essential. This is the argument made by the classical theory of comparative
advantage.
 Imperfect Markets Theory - If each country’s markets were closed from all other countries, there would be no
international business. At the other extreme, if markets were perfect, so that the factors of production (such as labor)
were easily transferable, then labor and other resources would flow wherever they were in demand. The unrestricted
mobility of factors would create equality in costs and returns and remove the comparative cost advantage, the
rationale for international trade and investment. However, the real world suffers from imperfect market conditions
where factors of production are somewhat immobile. There are costs and often restrictions related to the transfer of
labor and other resources used for production. There may also be restrictions on transferring funds and other
resources among countries. Because markets for the various resources used in production are “imperfect,” MNCs
such as the Gap and Nike often capitalize on a foreign country’s resources. Imperfect markets provide an incentive
for firms to seek out foreign opportunities.
 Product Cycle Theory
 According to this theory, firms become established in the home market because of some perceived advantage
over existing competitors, such as a need by the market for at least one more supplier of the product. Because
information about markets and competition is more readily available at home, a firm is likely to establish itself
first in its home country.
 Foreign demand for the firm’s product will initially be accommodated by exporting.
 As time passes, the firm may feel the only way to retain its advantage over competition in foreign countries is to
produce the product in foreign markets, thereby reducing its transportation costs.
 The competition in the foreign markets may increase as other producers become more familiar with the firm’s
product.
 The firm may develop strategies to prolong the foreign demand for its product.
 A common approach is to attempt to differentiate the product so that other competitors cannot offer the same
product.
11. How Firms Engage in International Business
 International trade - International trade is a relatively conservative approach that can be used by firms to
penetrate markets (by exporting) or to obtain supplies at a low cost (by importing). This approach entails minimal
risk because the firm does not place any of its capital at risk. If the firm experiences a decline in its exporting or
importing, it can normally reduce or discontinue this part of its business at a low cost.
 Licensing - Licensing obligates a firm to provide its technology (copyrights, patents, trademarks, or trade names)
in exchange for fees or some other specified benefits. For example, AT&T and Verizon Communications have
licensing agreements to build and operate parts of India’s telephone system.
 Franchising - Franchising obligates a firm to provide a specialized sales or service strategy, support assistance,
and possibly an initial investment in the franchise in exchange for periodic fees. For example, McDonald’s, Pizza
Hut, Subway Sandwiches, Blockbuster Video, and Dairy Queen have franchises that are owned and managed by
residents in many foreign countries.
 Foreign Direct Investment - Foreign direct investment occurs when a company INVESTS RESOURCES AND
PERSONNEL TO BUILD OR PURCHASE AN OPERATION IN ANOTHER COUNTRY. This turns the firm into
a multinational company (MNC). A wholly owned subsidiary is a firm that is owned 100% by a foreign firm. This is
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 a major decision for an organization because costs and risks of direct investment are greater than with franchising or
licensing. Although governments usually welcome foreign direct investment, they are also often concerned about
this type of investment for several reasons.
 Joint ventures - A joint venture is a venture that is jointly owned and operated by two or more firms. Many firms
penetrate foreign markets by engaging in a joint venture with firms that reside in those markets. Most joint ventures
allow two firms to apply their respective comparative advantages in each project. For example, General Mills, Inc.,
joined in a venture with Nestlé SA, so that the cereals produced by General Mills could be sold through the overseas
sales distribution network established by Nestlé.
 Acquisitions of existing operations - Firms frequently acquire other firms in foreign countries as a means of
penetrating foreign markets. For example, American Express recently acquired offices in London, while Procter &
Gamble purchased a bleach company in Panama. Acquisitions allow firms to have full control over their foreign
businesses and to quickly obtain a large portion of foreign market share.
 Establishing new foreign subsidiaries - Firms can also penetrate foreign markets by establishing new
operations in foreign countries to produce and sell their products. Like a foreign acquisition, this method requires a
large investment. Establishing new subsidiaries may be preferred to foreign acquisitions because the operations can
be tailored exactly to the firm’s needs. In addition, a smaller investment may be required than would be needed to
purchase existing operations. However, the firm will not reap any rewards from the investment until the subsidiary is
built and a customer base established.
(Cash Flow Diagrams for MNCs)
12. Valuation Model for an MNC - The value of an MNC is relevant to its shareholders and its debtholders.
When managers make decisions that maximize the value of the firm, they maximize shareholder wealth
(assuming that the decisions are not intended to maximize the wealth of debtholders at the expense of
shareholders). Since international financial management should be conducted with the goal of increasing the
value of the MNC, it is useful to review some basics of valuation.
 Domestic Model
 Valuing International Cash Flows - Carolina Co. has expected cash flows of $100,000 from local business
and 1 million Mexican pesos from business in Mexico at the end of period t. Assuming that the peso’s value is
expected to be $.09. Find out the value of the MNC.
 Valuation of an MNC That Uses Many Currencies
 Uncertainty Surrounding an MNC’s Cash Flows
 Exposure to International Economic Conditions
 Exposure to International Political Risk
 Exposure to Exchange Rate Risk.