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International Managerial Finance. Prepared by Keldon Bauer. The MNC and its Environment. In recent years, international finance has become an increasingly important element in the management of MNCs.

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international managerial finance

International Managerial Finance

Prepared by Keldon Bauer

the mnc and its environment
The MNC and its Environment
  • In recent years, international finance has become an increasingly important element in the management of MNCs.
  • Although the principles of managerial finance are applicable to MNCs, certain factors unique to the international setting tend to complicate the financial management of MNCs.
  • A simple comparison between a domestic U.S. firm and a U.S.–based MNC is given in Table 18.1.
the mnc and its environment cont
The MNC and its Environment (cont.)
  • During the 1990s, three important trading blocks emerged.
  • In 1992, the United States, Mexico and Canada signed the North American Free Trade Agreement (NAFTA).
  • In 1992, Western Europe also strengthened previously existing European Union by forming the European Open Market which included the adoption of a common currency called the EURO in January, 1999.
the mnc and its environment cont1
The MNC and its Environment (cont.)
  • In 1991, the Mercosur Group of South America, including the countries of Brazil, Argentina, Paraguay and Uruguay formed a trading block.
  • The General Agreement on Tariffs and Trade (GATT) is currently the most important international treaty governing trade.
  • It extends free trading rules to broad areas of economic activity and is policed by the World Trade Organization (WTO).
the mnc and its environment legal forms of business
The MNC and its Environment: Legal Forms of Business
  • In many countries outside the U.S., operating foreign subsidiaries can take two forms similar to a U.S. corporation.
  • In German-speaking nations, the two forms are the Aktiengesellschafts (A.G.) or the Gesellschaft mit beschrankter Haftung (GmbH).
  • In many other countries, the similar forms are Societe Anonymes (S.A.) or Societe a Responsibilite Limitee (S.A.R.L.).
the mnc and its environment legal forms of business cont
The MNC and its Environment: Legal Forms of Business (cont.)
  • One major difference however, is that it is often essential to enter into joint-ventures with private investors or with government-based agencies in the host country.
  • Such joint-venture laws can result in a substantial degree of management control by host countries and may result in disagreements among the partners as to the distribution of profits, the portions to be allocated for reinvestment, and the remittance of profits.
the mnc and its environment taxes
The MNC and its Environment: Taxes
  • From the perspective of a U.S.-based MNC, several factors related to taxation in foreign countries must be considered.
  • First, the level of foreign taxes needs to be examined.
  • Second, the definition of what constitutes taxable income must be ascertained.
  • Foreign tax rates and tax rules must be understood.
  • In general, U.S.–based MNCs may often take foreign taxes as a direct credit against U.S. tax liabilities.
the mnc and its environment financial markets
The MNC and its Environment: Financial Markets
  • During the past two decades the Euromarket—which provides for borrowing and lending currencies outside their country of origin—has grown rapidly and provides MNCs with an external opportunity to borrow or lend funds with little government regulation.
  • One aspect of the Euromarket is offshore centers, which is composed of cities or states (including London, Singapore, Nassau, and Hong Kong) that have achieved prominence as major centers for Euromarket business.
the mnc and its environment financial markets1
The MNC and its Environment: Financial Markets
  • In addition, a variety of new financial instruments – including currency and interest rate swaps, forward contracts, options contracts, and international commercial paper – have been created to facilitate international trade and finance.
  • The Euromarket is still dominated by the U.S. dollar.
  • However, other currencies such as the Euro, Swiss Franc, Japanese Yen, and British Pound have increased in importance.
financial statements translation of individual accounts
Financial Statements: Translation of Individual Accounts
  • Unlike domestic items in financial statements, international items require translation back into U.S. dollars.
  • Since 1982, all financial statements of U.S. MNCs have to conform to FASB No. 52.
  • Under FASB 52, the current rate method of translation is used.
financial statements translation of individual accounts cont
Financial Statements: Translation of Individual Accounts (cont.)
  • The current rate method is implemented in two steps:
    • First, each subsidiary’s balance sheet and income statements are measured in terms of their functional currency.
    • Second, balance sheet items are translated at the closing date exchange rate and all income statement items are translated at average rates.
risk exchange rate risk
Risk: Exchange Rate Risk
  • Exchange rate risk is the risk caused by varying exchange rates between two currencies.
  • The foreign exchange rate between the U.S. dollar (US$) and Swiss Franc (SF) is expressed as follows:
    • US $1 = SF 1.4175
    • SF 1 = US $0.7055
  • The usual exchange rate quotation in international markets is given as SF1.4175/US$.
risk exchange rate risk cont
Risk: Exchange Rate Risk (cont.)
  • Under the current system of floating exchange rates, the value of any two major currencies with respect to one another is allowed to fluctuate on a daily basis.
  • For smaller country currencies, however, exchange rates are fixed or semi-fixed with respect to one of the major currencies.
  • The spot exchange rate is the rate of exchange between any two currencies on a given day.
risk exchange rate risk cont1
Risk: Exchange Rate Risk (cont.)
  • The forward exchange rate is the rate of exchange between two currencies at some specific future date.
  • These rates and their relationships can be described as shown in Figure 18.2 on the following slide.
  • Although a number of factors can influence exchange rate movements, by far the most important influence is differing inflation rates between two currencies, where the currency with the higher rate of inflation will decline relative to the country with the lower rate.
risk exchange rate risk cont2
Risk: Exchange Rate Risk (cont.)
  • Although several economic and political factors influence foreign exchange rate movements, by far the most important explanation for long-term changes is differing inflation between two countries.
  • Countries that experience high inflation rates will see their currencies decline in value (depreciate) relative to the currencies of countries with lower inflation rates.
risk exchange rate risk cont3
Risk: Exchange Rate Risk (cont.)
  • It is also useful to describe the difference between accounting exposure and economic exposure.
  • Accounting exposure is the risk resulting from the effects of changes in foreign exchange rates on the translated value of a firm’s financial statements.
  • Perhaps more importantly, economic exposure is the risk resulting from the effects of changes in foreign exchange rates on the firm’s value.
risk exchange rate risk cont4
Risk: Exchange Rate Risk (cont.)
  • In general, it is possible for management to insure against these risks and exposures through hedging.
  • The decision as to whether management will hedge and the extent to which they do depends largely upon management’s attitude toward risk.
risk political risks
Risk: Political Risks
  • Political risk results from the discontinuity or seizure of an MNCs operations in a host country due to the host’s implementation of specific rules and regulations.
  • Macro politicalrisk is the subjection of all foreign firms to political risk by a host country because of political change, revolution, or adoption of new policies.
  • Micro political risk is the subjection of an individual firm, a specific industry, or companies from a particular country to political risk.
risk political risks cont
Risk: Political Risks (cont.)
  • Although many least developed and developing nations present great opportunities for MNCs, these nations are also more unstable and more politically risky than their developed nation counterparts.
  • The negative approaches are generally used by firms in attractive industries such as oil, gas, and mining.
  • The best approaches are positive approaches, which have, which have both economic and political aspects.
long term investment and financing decisions
Long-Term Investment and Financing Decisions
  • Foreign Direct Investment
    • Foreign Direct Investment (FDI) is the transfer of capital, managerial, and technical assets from an MNCs home country to a host country.
    • An MNC can be a 100% equity participant (resulting a wholly-owned subsidiary) or less (leading to a joint venture project with foreign participants).
    • FDI projects are subject not only to business, financial, inflation, and exchange rate risk, but also to the additional element of political risk.
long term investment and financing decisions cont
Long-Term Investment and Financing Decisions (cont.)
  • Investment Cash Flows and Decisions
    • A number of factors must be considered when estimating cash flows in foreign projects.
    • First, elements relating the parent company’s investment in a subsidiary and the concept of taxes must be considered.
    • Also, the parent must consider the risk that the repatriation of cash flows will be blocked.
    • Finally, the risk of international cash flows must also be considered.
long term investment and financing decisions cont1
Long-Term Investment and Financing Decisions (cont.)
  • Capital Structure
    • Because of their greater access to capital, MNCs have lower costs of long-term financing.
    • Some studies have suggested that MNCs have higher debt ratios, while other studies have found the opposite to be true.
    • Part of this might be explained that MNCs based in different countries and regions may have access to currencies and markets, resulting in variances in capital structures for these MNCs.
long term investment and financing decisions cont2
Long-Term Investment and Financing Decisions (cont.)
  • Long-Term Debt
    • An international bond is a bond that is initially sold outside the country of the borrower and often distributed in several countries.
    • A foreign bond is an international bond that is sold primarily in the country of the currency of issue.
    • A Eurobond is an international bond that is sold primarily in countries other than the country of the currency in which the issue is denominated.
long term investment and financing decisions cont3
Long-Term Investment and Financing Decisions (cont.)
  • Equity Capital
    • One way for MNCs to raise equity is to have the parent’s stock distributed internationally and owned by shareholders in different countries.
    • In recent years, the Euroequity market has continued to evolve and develop.
    • The Euroequity market is the capital market around the world that deals in international equity issues.
    • London has become the center of Euroequity activity.
short term financial decisions
Short-Term Financial Decisions
  • Like purely domestic firms, MNCs have access to accounts payable, accruals, bank and non-bank sources of short-term funds.
  • In addition, MNCs have access to the local economic market for both short and long-term funding.
  • Finally, the subsidiary’s borrowing and lending opportunities are often greater since it can rely on the potential backing of the parent company.
short term financial decisions cont
Short-Term Financial Decisions (cont.)
  • The Eurocurrency market is the portion of the Euromarket that provides short-term, foreign-currency financing to subsidiaries of MNCs.
  • Unlike borrowing in domestic markets, where only one currency and a nominal interest rate is involved, financing in the Euromarket may involve several currencies and both nominal and effective interest rates.
short term financial decisions cont1
Short-Term Financial Decisions (cont.)
  • Effective interest rates in the international context, is the rate equal to the nominal rate plus (or minus) any forecast appreciation (or depreciation) of a foreign currency relative to the currency of the MNC parent.
short term financial decisions cash management
Short-Term Financial Decisions: Cash Management
  • In its international cash management, the MNC can respond to exchange rate risk by hedging its undesirable cash and marketable securities exposures or by certain adjustments in its operations.
  • Hedging strategies are techniques used to offset or protect against risk.
  • These strategies are summarized in Table 18.5 on the following slide.
short term financial decisions credit and inventory management
Short-Term Financial Decisions: Credit and Inventory Management
  • Because MNCs compete for the same global markets, it is essential that they offer attractive credit terms to potential customers.
  • With respect to inventory management, MNCs must consider a number of factors related to both economics and politics, including exchange rate fluctuations, tariff and non-tariff barriers, and varying laws and regulations.
mergers and joint ventures
Mergers and Joint Ventures
  • International mergers and joint ventures, especially those involving European firms acquiring assets in the U.S., increased significantly beginning in the 1980s.
  • Moreover, a fast-growing group of MNCs recently emerged based in the so-called newly industrialized countries (including Singapore, South Korea, and China’s Hong Kong).
  • Still others are operating from emerging nations (such as Brazil, China, Mexico, India, and Thailand).
mergers and joint ventures cont
Mergers and Joint Ventures (cont.)
  • Foreign direct investments (FDI) in the U.S. have also gained popularity in recent years.
  • Most FDI comes from Britain, Canada, France, the Netherlands, Japan, Switzerland, and Germany and is concentrated in manufacturing, petroleum, and trade/service sectors.
  • Developing countries, too, have been attracting FDI and a number of these nations have adopted specific policies and regulations aimed at controlling the inflows of foreign investments.