Multinational Financial Management & International Trade & Currency Markets

Primary goal of MNCs

Maximizing shareholder wealth.

Agency problem in MNCs

The conflict of goals between managers and shareholders.

Example of an agency problem in an MNC

Expanding a subsidiary to increase managerial compensation rather than shareholder value.

How parent corporations reduce agency problems

With governance such as incentive payment packages.

How corporate control reduces agency problems

Through takeover threats, mutual funds, and pension funds.

Role of the Sarbanes-Oxley Act (SOX)

Created transparent managerial processes and required internal reporting systems for monitoring.

Centralized management in MNCs

Limits subsidiary manager power, reducing agency problems.

Disadvantage of centralized management in MNCs

Can lead to poor local decisions if parent managers lack local information.

Decentralized management in MNCs

Gives control to local managers closer to operations.

Disadvantage of decentralized management in MNCs

Increases agency costs because managers may focus on subsidiary goals over global value.

Theory of comparative advantage

Countries specialize in some goods and trade for others, allowing firms to expand globally.

Imperfect markets theory

Resource immobility creates opportunities for firms to exploit cost advantages abroad.

Product cycle theory

Firms expand abroad as products mature, eventually shifting production overseas to lower costs.

Six main methods to conduct international business

International trade, Licensing, Franchising, Joint ventures, Acquisitions, New subsidiaries.

Advantages and risks of international trade

Involves exporting/importing with minimal risk and little capital commitment.

Licensing in international business

Firms provide technology, patents, or trademarks in exchange for fees; requires no heavy investment.

Franchising in international business

A firm provides a business model, support, and brand rights in exchange for fees (e.g., McDonald's).

Joint venture

A co-owned business by two or more firms (e.g., General Mills and Nestle).

Main risk of acquiring existing operations abroad

High integration and cultural risk.

Advantage of establishing a new foreign subsidiary

Full control and local production.

Disadvantage of establishing a new foreign subsidiary

Requires large investment.

Methods of international business involving the most risk

Acquisitions and new subsidiaries are most risky; trade and licensing are least risky.

Variables in the domestic valuation model

Expected cash flows (E(CF$,t)), number of periods (n), and required return (k).

Factors making MNC valuation more complex

Multiple currencies and exchange rate uncertainty.

Exchange rate uncertainty

The unpredictability of currency exchange rates affecting international transactions.

Foreign cash flows conversion

E(CFj,t) × E(Sj,t), where E(Sj,t) is the expected exchange rate.

MNC valuation formula

V = ∑(t=1 to n) ∑(j=1 to m) E(CFj,t) × E(Sj,t) / (1 + k)^t

Balance of Payments (BOP)

A record of transactions between a country's residents and the world over time.

Three main accounts of the BOP

Current account, Financial account, Capital account.

Current account components

Payments for goods/services, Factor income (interest/dividends), Transfer payments (aid, gifts).

Balance of trade

The difference between total exports and imports.

Capital account

Includes transfers of financial assets (migration), patents, and trademarks across borders.

Financial account categories

Direct foreign investment (DFI), Portfolio investment, Other capital investment.

Examples of direct foreign investment (DFI)

Acquisition of foreign firms, new plant construction abroad, plant expansion abroad.

Events increasing international trade

Berlin Wall removal (1989), Single European Act (1980s), NAFTA (1993 → replaced by USMCA in 2018), GATT (1993), Euro adoption (1999), EU expansion (2004, 2007).

NAFTA changes

Removed North American trade barriers; replaced by USMCA in 2018.

Macroeconomic factors affecting trade flows

Cost of labor, Inflation, National income, Credit conditions.

Government policies affecting trade flows

Tariffs/quotas, Export subsidies (dumping), Piracy laws, Environmental/labor restrictions, Tax breaks, ownership laws, sanctions.

Exchange rates effect on trade flows

Appreciation worsens trade balance; depreciation improves it.

Weak currency disadvantages

Competitors counterprice, effects differ across currencies, intra-company trade may offset benefits.

J-curve effect

Trade balance worsens short-term after depreciation but improves in the long term.

Role of the IMF

Stabilizes exchange rates, provides temporary funds, promotes trade and mobility of capital.

World Bank function

Makes development loans, profit-oriented.

WTO

Created from GATT; reduces trade restrictions and settles disputes.

IFC

Promotes private enterprise, provides loans and equity investment.

BIS

Facilitates cooperation on international transactions, supports less-developed countries.

Gold standard

A system (1876-1913) where currencies were convertible into gold at fixed rates.

Bretton Woods Agreement

(1944-1971) Fixed exchange rates tied to gold, ±1% allowed.

Smithsonian Agreement

(1971) Devalued USD, allowed ±2.25% fluctuations.

Floating exchange rate system

Since 1973: exchange rates determined by market, with some central bank intervention.

Spot market

The immediate trade of currencies at current rates.

Immediate trade of currencies

The immediate trade of currencies at current rates.

USD dominance in FX markets

It is widely used where local currencies are weak or restricted.

Factors affecting bid/ask spreads

Order costs (+), Inventory costs (+), Competition (-), Volume/liquidity (-), Currency risk (+).

Forward contracts

Agreements to trade currency at a set rate on a future date.

Futures contracts

Standardized contracts for set volumes of currency at a future settlement date.

Options contracts

Provide rights (not obligations) to buy/sell currency at a set price within a time period.

Eurocurrencies

Deposits of currency outside the home country (e.g., Eurodollars).

LIBOR

Benchmark interbank lending rate for short-term loans.

Eurocredit loans

Foreign-currency loans, typically 5 years, with interest tied to inflation/currency.

Syndicated loans

Large loans shared by multiple banks under a lead bank.

International bonds issuance by MNCs

To access stronger demand, finance projects in specific currencies, or secure lower interest rates.

Foreign bonds vs Eurobonds

Foreign bonds = issued in local markets, denominated in that local currency. Eurobonds = issued abroad but denominated in a different currency.

Risks affecting international bonds

Interest rate risk, Exchange rate risk, Liquidity risk, Credit risk.

Reasons firms issue stock abroad

To enhance global image, match international operations, and attract investors.

Yankee stock offerings

Foreign firms issuing stock in the U.S.

ADRs

Certificates representing foreign stock, traded in U.S. markets with dividends and voting rights.

Major financial crises examples

Asian crisis (1997), Global credit crisis (2008), Greek debt crisis (2010), Turkish lira crisis (2018).

Currency depreciation effect

Another currency must appreciate.

Percentage change in currency value calculation

𝑆𝑡 − 𝑆𝑡−1 / 𝑆𝑡−1.

FX risk

Volatility in exchange rates, measured by the standard deviation of changes.

Demand for foreign currency

Local buyers wanting foreign goods.

Supply of foreign currency

Foreigners exchanging to buy domestic goods.

Equilibrium exchange rate establishment

Where demand = supply.

Main factors influencing spot rates

e = f(∆INF, ∆INT, ∆INC, ∆GC, ∆EXP).

Relative inflation effect on FX rates

Higher inflation → demand for foreign goods rises → domestic currency weakens.

Relative interest rates effect on FX rates

Higher U.S. rates attract investors, strengthening the dollar.

Real interest rates consideration

High nominal rates may mask high inflation, discouraging investors.

Relative income levels effect on FX rates

Higher income increases imports, pressuring the domestic currency.

Government influence on FX rates

Through barriers, interventions, and macro policies.

Expectations effect on FX markets

Markets react quickly to news about inflation, interest, or political events.

Institutional currency speculation

By buying undervalued currencies, shorting overvalued ones, or using derivatives.

Carry trade strategy

Borrow in low-interest currency, invest in high-interest currency for profit.