CHAPTER 1 International Flow of Funds

1. CHAPTER 1 International Flow of Funds

2. 1 Multinational Financial Management: An Overview Chapter Objectives This chapter will: • Identify the management goal and organizational structure of the Multinational Corporation (MNC). • Describe the key theories that justify international business • Explain the common methods used to conduct international business • Provide a model for valuing the MNC 2

3. Multinational Corporation: Firms that engage in some form of international business 3

4. Facing Agency Problems Agency Problem: conflict of goals between managers and shareholders. Agency Conflict Reduced by: Parent control of agency problems Corporate control of agency problems Sarbanes-Oxley Act (SOX) of 2002

5. Management Structure of MNC Centralized Decentralized

6. Why Firms Pursue International Business Theory of Competitive Advantage: specialization increases production efficiency. Imperfect Markets Theory: factors of production are somewhat immobile providing incentive to seek out foreign opportunities. Product Cycle Theory: as a firm matures, it recognizes opportunities outside its domestic market.

7. Exhibit 1.2 International Product Life Cycles 7

8. How Firms Engage in International Business International trade Licensing Franchising Joint Ventures Acquisitions of existing operations Establishing new foreign subsidiaries

9. Valuation Model for an MNC: Domestic Model • where E(CF$,t) represents expected cash flows to be received at the end of period t, • n represents the number of periods into the future in which cash flows are received, and • k represents the required rate of return by investors. 9

10. Valuation Model for an MNC: International Cash Flows • 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. 10

11. Exhibit 1.3 Cash Flow Diagrams for MNCs 11

12. Uncertainty Surrounding MNC Cash Flows Exposure to international economic conditions Exposure to international political risk Exposure to exchange rate risk

13. Balance of Payments • Summary of transactions between domestic and foreign residents for a specific country over a specified period of time. • Current Account: summary of flow of funds due to purchases of goods or services or the provision of income on financial assets. • Capital Account: summary of flow of funds resulting from the sale of assets between one specified country and all other countries over a specified period of time.

15. Current Account Payments for merchandise and services Factor income payments Transfer payments

16. Capital and Financial Accounts Direct foreign investment Portfolio investment Other capital investment Errors and omissions

17. Factors Affecting International Trade Flows • Inflation: current account decreases if inflation increases relative to trade partners. • National Income: current account decreases if national income increases relative to other countries. • Government Policies • Subsidies for exporters • Restrictions on imports • Lack of restriction on piracy • Exchange Rates: current account decreases if currency appreciates relative to other currencies

18. Factors Affecting DFI Changes in Restrictions Privatization Potential Economic Growth Tax Rates Exchange Rates

19. Exhibit 2.7 Distribution of Global DFI across Regions in 2007-2008

20. Factors Affecting International Portfolio Investment Tax rates on Interest or Dividends Interest Rates Exchange Rates