TCHE425

INTERNATIONAL
FINANCIAL
MANAGEMENT
 INTERNATIONAL
FINANCIAL
MANAGEMENT

Mrs. Nguyen Thi Nhu Hao, MSc.

Email: nguyenthinhuhao.cs2@ftu.edu.vn
Office hour: Office hours are available by appointment. Please
email me to schedule a time.
Why International Financial Management?
Why International Financial Management?
Why International Financial Management?
Why International Financial Management?
What special about “International Financial
Management?”
Three major dimensions set internaitonal finance apart from domestic
finance
1. Foreign exchange risk and political risks
2. Market imperfections
3. Expanded opportunity set
Sovereign nations have the right to issue currencies, impose taxes, and
regulate movements of people, goods and capital across their borders.
What special about “International Financial
Management?”
Foreign exchange risk is the risk of facing uncertain future exchange
rates
• Businesses, individuals and households may also be seriously
exposed to uncertain exchange rates
• Exchange rates among major currencies (e.g. U.S. dollar, Japanese
yen, Bristish pound and Euro) fluctuate continously in an
unpredictable manner.
• Exchange rate uncertainty influences all major economic functions,
including consumption, production and investment.
What special about “International Financial
Management?”
What special about “International Financial
Management?”
Political risk arises from potential losses to the parent firm
resulting from adverse political developemnts in the host country.
• Ranges from unexpected changes in tax rules to outright
exproporiation of assets held by foreigners.
• Arises from the fact that a sovereign country can change the
”rules of the game” and the afftected parties may not have
effective resource.
• Especially relevant in those countries without a traditional rule of
law.
What special about “International Financial
Management?”
Market imperfections may be described as various frictions, such as
transaction costs and legal restrictions, that prevent the markets form
functioning perfectly.
• World markets are highly imperfect
➢ Numerous barriers hamper the free movement of people,
goods, services, and capital across national boundaries (e.g.
legal restrictions, excessive transaction and transportation
costs, information asymmetry and discriminatory taxation)
• Restrict the extent to which investors can diversify their portfolios.
What special about “International Financial
Management?”
Firms may benefit from an expanded opportunity set when they
venture into the arena of global markets.
• Firms can gain from greater economies of scale when their tangible
and intangible assets are deployed on a global basis.
• True for corporations, as well as individual investors.
• “It just doesn’t make sense to play in only one corner of the
sandbox”
Goals for International Financial
Management
• The focus is to provide today’s financial managers with an
understanding of the fundamental concepts and the tools necessary
to be effective global managers.
• Fundamental goal of sound financial management is shareholder
wealth maximization, which means the firm makes all business
decisions and investments with an eye toward making the owners of
the firm (i.e. shareholders) better off financially.
International vs. Domestic Financial
Management
Aims of the course

• This course is designed to provide students with a comprehensive

introduction and overview with focus on the international
environment in which Multinational Corporations (MNCs) operate,
the conceptual framework within which MNCs make key financial
decisions.
• Throughout the course students will be equipped with knowledge
about the international financial environment, the internaitonal
financial management, and MNCs; explore issues relating to the
exchange rate risk management; and have a comprehensive
understanding and be able to make financial decisions on long-term
and short-term capital management in the international financial
environment and in Vietnam.
Aims of the course

• This course will help you understand the issues facing the modern
corporate manager. Since managers of MNCs will need to understand
the environment before they can manage their company, a
background on the international environment is first provided, and
then the text builds on the managerial aspects from a corporate
perspective.
• The course presumes an understanding of basic corporate finance.
Syllabus Plan
Session Date Topics covered
1 05/08 Internatinal Financial Management: An Overview
2 08/08 Internaitonal Financial Markets
3 12/08 Foreign Direct Investment
4 16/08 Exchange Rate Determination
5 19/08 Multinational Capital Budgeting
6 23/08 International Arbitrage and International Parity Condition
7 26/08 Multinational Capital Structure and Cost of Capital
8 30/08 Currency Derivatives
9 02/09 Measuring Exposure to Foreign Exchange Fluctuations
10 05/09 Managing Transaction Exposure
11 09/09 Managing Economic Exposure and Translation Exposure
12 12/09 Long-term Debt Financing
13 16/09 Short-term Debt Financing
14 19/09 International Cash Management
15 23/09 Revision
Assessment

Proportion Form of Assessment

Class Participant 10%

Quizzes (10%)
Group Assignment 30% Group Assignment
(20%)
MCQs and short
Final test 60% answer/ essay
questions
Readings
• Madura, Jeff, 2021, International Financial Management, 14th edition,
Cengage Learning.
• Eiteman, David K., Stonehill, Arthur I., and Moffett, Michael H., 2021,
Multinational Business Finance, 15th edition, Pearson.
INTERNATIONAL FINANCIAL
MANAGEMENT

CHAPTER 1
INTERNATIONAL
FINANCIAL
MANAGEMENT
– AN OVERVIEW
Lecture Objectives

• 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.
Multinational Corporations
Multinational Corporations

• A multinational corporation (MNC) is a firm that has been

incorporated in one country and has production and sales
operations in other countries.
– Approximately 60,000 MNCs in the world with over 500,000
foreign affiliates.
Managing the MNC

• Managers are expected to make decisions that maximize the

shareholders’ wealth.
• Multinational companies whose parents fully own 100% of the capital of
foreign subsidiaries (the parent company in the U.S. is the sole owner of
the subsidiary), which is a common form of ownership of multinational
companies based in the U.S.
• In this course, we’d discover multinational companies based in countries
other than the United States.
Managing the MNC
How Business Disciplines Are Used to Manage the MNC
•Common finance decisions include:
oWhether to discontinue operations in a particular country
oWhether to pursue new business in a particular country
oWhether to expand business in a particular country
oHow to finance expansion in a particular country

•Finance decisions are influenced by other business discipline functions:

oMarketing
oManagement
oAccounting and information systems
Managing the MNC
Agency Problems
• The conflict of goals between managers and shareholders
• Agency Costs:
o Definition: Cost of ensuring that managers maximize shareholder
wealth.
o Costs are normally higher for MNCs than for purely domestic firm
for several reasons:
• Monitoring managers of distant subsidiaries in foreign
countries is more difficult.
• Foreign subsidiary managers raised in different cultures may
not follow uniform goals.
• Sheer size of larger MNCs can create large agency problems.
Managing the MNC
Agency problem
• Parent control of agency problems
Parent corporation of an MNC should clearly communicate the goals
for each subsidiary to ensure managers focus on maximizing the value
of the subsidiary.
• Corporate control of agency problems
Entire management of the MNC must be focused on maximizing
shareholder wealth.
• Sarbanes-Oxley Act (SOX)
Ensures a more transparent process for managers to report on the
productivity and financial condition of their firm.
SOX Methods to improve reporting

Enacted in 2002, the Sarbanes-Oxley Act (SOX) ensures a more

transparent process for managers to report on the productivity and
financial condition of their firm.
How SOX Improved Corporate Governance of MNCs?
• Establising a centralized database of information
• Ensuring that all data are reported consistently among subsidiaries
• Implementing a system that automatically checks for unsual
discrepancies relative to norms
• Speeding the process by which all departments and subsidiaries have
access to all the data they need
• Making executives more accountable for financial statements
Management Structure of MNC
The magnitude of agency costs varies with the MNC’s management
style.
Centralized management style:
• Allows managers of the parent to control foreign subsidiaries and
therefore redue the power off subsidiary managers.
• Reduce agency costs.
Decentralized management style:
• Gives more control to subsidiary managers who are closer to the
subsidiary’s operation and environment.
• Increase agency costs.
Centralized management style
Decentralized management style
Why MNCs 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.
Why MNCs Pursue International Business?

Theory of Competitive Advantage

• Some countries have a technology advantage and other countries
have an advantage in the cost of basic labor.
• Countries tend to use their advantages to specialize in the production
of goods that can be produced with relative efficiency.
• A country that specializes in some products may not produce other
products, so trade between countries is essential.
• Comparative advantages allow firms to penetrate foreign market.
• Policy implication is that liberalization of international trade will
enhance the welfare of the world’s citizens.
Why MNCs Pursue International Business?

Imperfect Markets Theory

• If each country’s markets were closed to all other countries: there
would be no international business
• In extreme case, if markets are perfect then the factors of
productions are easily trandsferdable:
✓This eliminates the comparative cost advantage which is
rationale for international trade.
• In real world, market are imperfect where factors of production are
somewhat immobile:
✓Costs and often other restrictions effect the transfer of labor and
other resources used for production
✓Provide an incentive for firms to seek out foreign opportunities
Why MNCs Pursue International Business?
Product cycle theory
• According to this theory, firm first established its operation in home
market
• Because information about home markets and competition is more
readily available.
• Firm’s product is perceived by foreign consumers to be superior to
that available within their own countries, the firm may accommodate
foreign consumers by exporting.
• If the firm’s product becomes very popular in foreign countries, it
may produce the product in foreign markets, thereby reducing its
transportation costs.
• Firm’s foreign business diminishes or expands over time will depend
on how successful it is at maintaining some advantage over its
competition.
Why MNCs Pursue International Business?

International Product Life Cycle

How Firms Engage in International Business?

MNCs use several methods to conduct international business:

• International Trade
• Licensing
• Franchising
• Joint Ventures
• Acquisitions of Existing Operations
• Establishment of new
Why MNCs Pursue International Business?

International Trade
• Relatively conservative approach that can be used by firms to:
✓Penetrate markets (by exporting)
✓Obtain supplies at a low cost (by importing)
• Minimal risk – no capital at risk.
Why MNCs Pursue International Business?

Licensing
• Obligates a firm to provide its technology (copyrights, patents,
trademarks, or trade names) in exchange for fees or some other
specified benefits).
• Firm able to generate more revenue from foreign countries without
establishing any production plants in foreign countries or
transporting goods to foreign countries.
• Licensing allows firms to use their technology in foreign markets
without a major investment in foreign countries and without the
transportation costs that result from exporting.
• It is difficult for the firm providing the technology to ensure quality
control in the foreign production process.
Why MNCs Pursue International Business?

Franchising
• Obligates firm to provide a specialized sales or service strategy,
support assistance, and possibly an initial investment in the franchise
in exchange for periodic fees.
• Franchising by an MNC often requires a direct investment in foreign
operations, it is referred to as a direct foreign investment.
Why MNCs Pursue International Business?

Joint Ventures
• A venture that is jointly owned and operated by two or more firms.
• A firm may enter the foreign market by engaging in a joint venture
with firms that reside in those markets.
• Allows two firms to apply their respective cooperative advantages in
a given project.
Why MNCs Pursue International Business?

Acquisitions of Existing Operations

• Acquisitions of firms in foreign countries allows firms to have full
control over their foreign businesses and to quickly obtain in a large
portion of foreign market share.
• Subject to the risk of large losses because of larger investment.
• It may be difficult to sell the operations if the foreign subsidiary
performs poorly.
• Partial international acquisitions requires a smaller invesment and
limits the potential loss to the firm if the project fails.
• Firm will not have complete control over operations that are only
partially acquired.
Why MNCs Pursue International Business?

Establishment of New Foreign Subsidiaries

• Firms can penetrate markets by establishing new operations in
foreign countries.
• Large investment required.
• Firm will not reap any rewards from the investment until the
subsidiary is built and a customer base established.
Why MNCs Pursue International Business?

Summary of Methods
• Any method of increasing international business that requires a
direct investment in foreign operations is referred to as direct foreign
investment (DFI).
• International trade and licensing usually not included.
• Foreign acquisitation and establishment of new foreign subsidiaries
represent the largest portion of DFI.
Cash Flows Diagram for MNCs
Valuation Model for an MNC

Domestic Model
 E (CF$,t )
n
V =  
t =1  (1 + k )
t

Where:
• V represents present value of expected cash flows.
• E(CF$,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
Valuation Model for an MNC

Domestic Model
Dollar Cash flows
• The dollar cash flows in period t represent funds received by the firm
minus funds needed to pay expenses or taxes to reinvest in the firm.
Cost of Capital
• The required rate of return (k) in the denominator of the valuation
equation.
• A weighted average of the cost of capital on all the firms projects.
Valuation Model for an MNC
Multinational Model


E (CF$,t ) =  E (CF j ,t ) E (S j ,t ) 
m

j =1
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.
Valuation Model for an MNC
Multinational Model
• Valuation of an MNC that uses two currencies:
Could measure its expected dollar cash flows in any period by
multiplying the expected cash flow in each currency by the expected
exchange rate at which that currency would be converted to dollars
and then summing those two periods.
• Valuation of an MNC that uses multiple currencies:


E (CF$,t ) =  E (CF j ,t ) E (S j ,t ) 
m

j =1

oDrive an expected dollar cash flow value for each currency

oCombine the cash flows among currencies within a given period
Valuation Model for an MNC
Multinational Model
Carolina Co. expects cash flow of $100,000 from its local business and
1 million Mexican pesos from its business in Mexico at the end of
period t. Assuming that the peso’s value is expected to $0.09 when
converted into dollars, how much is the expected dollar cash flows?


E (CF$,t ) =  E (CF j ,t ) E (S j ,t ) 
m

j =1
Valuation Model for an MNC
Multinational Model
Valuation of an MNC’s cash flows over multiple periods
• Apply single period process to all future periods
• Discount the estimated total dollar cash flow for each period at the
weighted cost of capital

N
σm
j=1[E CFj,t × E Sj,t ]
V=෍
(1 + k)t
j=1
Valuation Model for an MNC
Uncertainty Surrounding MNC Cash Flows
Exposure to international economic conditions: if economic
conditions in a foreign country weaken, purchase of products decline
and MNC sales in that country may be lower than expected.
Exposure to international political risk: a foreign government may
increase taxes or impose barriers on the MNC’s subsidiary.
Exposure to exchange rate risk: if foreign currencies related to the
MNC subsidiary weaken against the U.S. dollar, the MNC will receive a
lower amount of dollar cash flows than was expected.
Valuation Model for an MNC
How an MNC’s valuation is exposed to uncertainty
Potential Effects of International Economic
Conditions
How Uncertainty Affects the MNC’s Cost of
Capital
How Uncertainty Affects the MNC’s cost of capital
• Due to increase in uncertainty of an MNC’s future cash flows,
investors may only be willing to invest in the MNC if they can expect
to receive a higher rate of return (increasing MNC’s cost of obtaining
capital) and the MNC’s valuation decreases.
• The uncertainty surrounding economic conditions that influence cash
flows declines, the uncertainty surrounding cash flows of MNCs also
declines and results in a lower required rate of return and cost of
capital for MNCs, valuation of MNCs increases.