BF 464: International Finance

1. BF 464: International Finance Instructor: M. Nihat Solakoglu Offıce: LC105 Email: nsolakoglu@bilkent.edu.tr Office Phone: 0 312 266 2741

2. Why is IF important? • Will GE India Unit Catch Eyes of Citi, B of A?By  Will WadeAmerican Banker , September 20, 2004Bank of America Corp. and Citigroup Inc. may emerge as bidders for a big Indianoutsourcing operation that General Electric Co. is said to be trying to sell. • .... • The Wall Street Journal reported Friday that GE is hoping to sell all or part of GE Capital International Services, and that the price tag could reach $1billion. The operation has 12,000 employees in India and 5,000 in Hungary, Mexico, and China.

3. Why is IF important? • What does this mean for us? • Markets at Risk for Additional Shocks (WSJ – 021108) • By Michael M. Phillips and Yuka Hayashi TOKYO -- Global financial markets may suffer a relapse into the turmoil sparked by last year's collapse of securities backed by U.S. subprime mortgages, the world's top banking authorities warned. • The U.S. Federal Reserve and other central banks have pumped enough money into the banking system to help alleviate the worst of the initial phase of the credit crunch, and major banks have now accounted for tens of billions of dollars in losses that had been moldering in off-balance-sheet entities. But the U.S.-led economic slowdown and continued uncertainty about securities may lead banks to further reduce lending and choke off ...

4. Why is IF important? • US Federal Reserve verdict to set markets toneBy Chris Flood (Financial Tımes) • Published: September 19 2004 17:28 | Last updated: September 19 2004 17:28 • The central event for investors worldwide will be tomorrow’s meeting of the Federal Open Markets Committee, where US interest rates are widely expected to be increased to 1.75 per cent from 1.5 per cent. • Philip Shaw of Investec, the banking group, said: “All eyes will be trained on the accompanying statement to see whether the FOMC hints at a rate pause before the end of the year.” Sterling slips on soft housing dataBy Steve Johnson in London (Financial Times) Published: September 20 2004 11:28 | Last updated: September 20 2004 11:28Sterling weakened in European morning trade on Monday amid fresh signs that the UK housing market is slowing. ....... “This adds to the case for the Bank of England leaving rates unchanged for at least another month,” said James Knightley, economist at ING Financial Markets.

5. Why is IF important? • Europeans still take a dim view of the euro • By Ralph Atkins in Frankfurt(Financial Times – Jan 29th, 2007) • An overwhelming majority of citizens in the big eurozone countries believe the euro has damaged their national economies, highlighting the popular scepticism that still surrounds Europe’s eight-year-old monetary union. • More than two-thirds of the French, Italians and Spanish – and more than half of Germans – believe the single currency has had a “negative impact”, according to an FT-Harris poll. In France, just 5 per cent said the euro has had a positive effect on the French economy. Yen and sterling share the spotlight By Peter Garnham Published: January 26 2007 11:11 | Last updated: January 26 2007 17:03 The yen and sterling shared the spotlight this week as speculation over the future path of interest rates in Japan and the UK drove the currency markets. Early in the week, the yen fell to a near-four year low against the dollar, an all-time low against the euro and a fourteen-year low against the pound. The yen also dropped to a nine-year low against the Australian dollar. Analysts said the decision by the Bank of Japan to leave interest rates on hold at 0.25 per cent earlier in the month still weighed on the Japanese currency as investors continued to put on carry trades – funding long positions in high-yielding currencies by selling the low-yielding yen.

6. INTRODUCTIONTHE RISE OF THE MULTINATIONALCORPORATION • Today, companies operate within a global marketplace and faces with global competitors. • I. The MNC • A. Definition • a company with production and distribution facilities in more than one country. Ordinarily, • - a parent company at home country and • - multiple foreign subsidiaries

7. INTRODUCTIONTHE RISE OF THE MULTINATIONALCORPORATION Most MNE activity can be classified into two major categories: (1) trade (exports and imports) and; (2) foreign direct investment (FDI)80% of all FDI is made by the world’slargest 500 MNEs

8. INTRODUCTIONTHE RISE OF THE MULTINATIONALCORPORATION • Trade consists of exports and imports: • Exports: Goods and services produced in one country and then sent to another country • Imports: Goods and services produced in one country and bought in another country • Foreign Investment: Consists of companies investing funds to start or improve operations in another country.

9. INTRODUCTIONTHE RISE OF THE MULTINATIONALCORPORATION (2002 values)

10. THE RISE OF THE MULTINATIONALCORPORATION • FDI is the ownership and control of foreign assets. • FDI usually involves the ownership, whole or partially, of a company in a foreign country: a foreign subsidiary. • FDI is different from portfolio investment, which is the purchase of financial securities in other firms for the purpose of realizing a financial gain when these marketable assets are sold.

11. THE RISE OF THE MULTINATIONALCORPORATION • Reasons for FDI: • Increase sales and profits. • Enter rapidly growing markets. • Reduce costs. • Gain a foothold in economic blocs. • Protect domestic markets. • Protect foreign markets. • Acquire technological and managerial know-how.

12. THE RISE OF THE MULTINATIONALCORPORATION FDI flows (1998 values)

13. THE RISE OF THE MULTINATIONALCORPORATION • Common misconceptions about MNEs: • MNEs have far-flung operations or earn most of their revenues overseas. • MNEs are globally monolithic and excessively powerful in political terms. • MNEs produce homogeneous products for the world market and through their efficient techniques are able to dominate local markets everywhere.

14. THE RISE OF THE MULTINATIONALCORPORATION • In fact, • MNEs earn most of their revenues in their home-regions. • The largest 500 MNEs are not spread around the world but clustered around the triad. • These MNEs engage not in global competition but in triad/regional competition; this rivalry effectively eliminates enduring political advantage. • MNEs adapt their products for the local market.

15. THE RISE OF THE MULTINATIONALCORPORATION • Rise of multinational corporation was not anticipated by classical trade theory (Smith, Ricardo) • Comparative Advantage - Each nation should specialize in the production and export of those goods that it can produce with highest relative efficiency and import those goods that other nations can produce relatively more efficiently. • Underlying assumption: Goods and services can move ınternationally, but factors of production (e.g. Capital, land and labor) are relatively immobile. • aExistence of MNCs is based on international mobility of certain factors of production. • aPrime transmitter of competitive forces is the MNCs (E.g. China)

16. THE RISE OF THE MULTINATIONALCORPORATION • B. EVOLUTION OF THE MNC • Reasons to Go Global: • 1. Raw materials • 2. More markets • 3. Minimize costs of production

17. THE RISE OF THE MULTINATIONALCORPORATION • 1. RAW MATERIAL SEEKERS • exploit markets in other countries • historically first to appear • modern-day counterparts • Anaconda Copper • Standard Oil • Exxon- Mobil

18. THE RISE OF THE MULTINATIONALCORPORATION • 2. MARKET SEEKERS • produce and sell in foreign markets • heavy foreign direct investors • representative firms: • IBM • Nestle • Levi Strauss

19. THE RISE OF THE MULTINATIONALCORPORATION • 3. COST MINIMIZERS • Seek lower-cost production abroad • Motive: to remain cost competitive • Representative firms: • Texas Instruments • Intel • Motorola

20. THE RISE OF THE MULTINATIONALCORPORATION • D. THE MNC: A BEHAVIORAL VIEW • Characterized by : • - its state of mind and • - not by its size and worldwide dispersion of its assets • Distinguishing characteristıcs from other firms is its commitment to seeking out, undertaking and integrating manufacturing, marketing, R&D and financing opportunities on a global, not domestic, basis. • Necessary complements to integration of worldwide operations are: • - flexibility • - adaptability • - speed

21. THE RISE OF THE MULTINATIONALCORPORATION • Key to international competitiveness is the ability of management to adjust to change and volatility at an ever faster rate. • “I am not here to predict the world. I am here to be sure I’ve got a company that is strong enough to respond whatever happens”. Jack Welch, ex-CEO of GE

22. THE RISE OF THE MULTINATIONALCORPORATION • 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.

23. PART II.MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICE • I. THE MULTINATIONAL FINANCIAL SYSTEM • A. Main Objective of MNC: • Maximize shareholder wealth as measured by share price. Hence, make financing and investment decisions that add as much value as possible • - Shareholders are the legal owners • - Minimize (hostile) takeover risks • - It is the best (or maybe the only) way to maximize economic benefits of all stakeholders

24. MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICE • II. FUNCTIONS OF FINANCIALMANAGEMENT • A. Two Basic Functions: • 1. Financing (Acquisition of funds) • 2. Investing (Allocation of those funds over time so that shareholder wealth is maximized) • B. Additional Factors Facing theMNC Executive • 1. Political risk • 2. Economic risk

25. MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICE • III. THEORETICAL FOUNDATIONS • A. Useful Concepts from Financial Economics: • 1. Arbitrage • 2. Market Efficiency • 3. Capital Asset Pricing

26. MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICE • Arbitrage: • Definition: Purchase of assets or commodities on one markets for immediate resale in another in order to profit from a price discrepancy. • e.g., Tax arbitrage - shifting of gains or losses from one tax jurisdiction to another

27. MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICE • Market Efficiency: • An efficient market is one in which the prices of traded securities readily incorporate new informatıon. • Hence, one cannot rely on historical prices or publicly available information to consistently benefit from trading.

28. MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICE • Capital Asset Pricing Model (CAPM): • Refers to the valuation of securities based on expected risks and return. • Assumes a specific relationship between risk (measured by return variability) and required asset return: “a stock’s required rate of return is equal to the risk-free rate of return plus a risk premium that reflects the riskiness of the stock after diversification.” Two source of variability: (a) Systematic (or non-diversifiable) risk: Marketwide influences that affect all sources (e.g. State of the economy) - relevant even for diversified investor - investor must be compensated for bearing that risk (b) Unsystematic (or diversifiable) risk: specific to given firm - irrelevant for diversified investor

29. MULTINATIONAL FINANCIAL MANAGEMENT: THEORY AND PRACTICE • Total risk is also important for the firm (not only systematic risk) • 1. Adverse Impact on expected cash flow • - lower sales and higher costs • 2. Justifies hedging activities ofMNC to reduce total risk • 3. International diversification reduces total risk