1. INTERNATIONAL FINANCE Lecture 4

2. Overview Common methods to conduct international business. International trade Licensing, Franchising, Joint ventures, Acquisitions of existing operations, Establishing new foreign subsidiaries Investment opportunities Financing opportunities Marginal Returns and Marginal Costs International opportunities in Europe

3. International Flow of Funds Lecture 4

4. Lecture Objectives Opportunities in Latin America, Europe and Asia Provide a model for the valuation of MNC. To explain the key components of the balance of payments To explain how the international flow of funds is influenced by economic factors and other factors.

5. International Opportunities Opportunities in Latin America ¤ The North American Free Trade Agreement (NAFTA) of 1993 (US & MEXICO) ¤ The removal of investment restrictions involved many Latin American countries ¤ Some firms have capitalized by exporting goods. ¤ Others established subsidiaries in Mexico.

6. International Opportunities Opportunities in Asia ¤ The removal of investment restrictions in 1990s e.g. Pepsi, Coke, Apple, General Motors, Proctor & Gamble etc. ¤ The impact of the Asian crisis in 1997-1998 (Indonesia, Malaysia & Thailand) ¤ Many companies went bankrupt and faced capital outflows.

7. Exposure to International Risk International business usually increases an MNC’s exposure to:  exchange rate movements  foreign economies  political risk

8. Exchange Rate Movements Exchange of one currency in another to make payments Exchange rates fluctuate over time When a currency strengthens/ appreciates; products denominated in that currency becomes expensive to foreign customers Cause a decline in demand Decline in cash flows If the currency of parent company is strong so the remitted funds will convert into small amounts

9. Overview of an MNC’s Cash Flows Profile A: MNCs Focused on International Trade U.S.- based MNC U.S. Customers Payments for products U.S. Businesses Payments for supplies Foreign Importers Payments for exports Foreign Exporters Payments for imports

10. Overview of an MNC’s Cash Flows Profile B:MNCs Focused on International Trade and Licensing, Joint Ventures and Franchising U.S.- based MNC U.S. Customers Payments for products U.S. Businesses Payments for supplies Foreign Importers Payments for exports Foreign Exporters Payments for imports Foreign Firms Fees for services provided Fees for services received Foreign Firms

11. Overview of an MNC’s Cash Flows Profile C : MNCs Focused on International Trade, International Arrangements, and Direct Foreign Investment U.S.- based MNC U.S. Customers Payments for products U.S. Businesses Payments for supplies Foreign Importers Payments for exports Foreign Exporters Payments for imports Foreign Subsidiaries Funds remitted back Foreign Firms Fees for services provided Fees for services received Foreign Firms Investment funds Foreign Subsidiaries

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

13. E (CF j,t )=expected cash flows denominated in currency j to be received by the U.S. parent at the end of period t E (ER j,t )=expected exchange rate at which currency j can be converted to dollars at the end of period t k=the weighted average cost of capital of the MNC Valuation Model for an MNC Valuing International Cash Flows

14. Impact of Financial Management and International Conditions on Value An MNC will decide how much business to conduct in each country and how much financing to obtain in each currency. The MNC’s financial decisions determine its exposure to the international environment.  An MNC can control its degree of exposure to exchange rate effects, economic conditions, and political conditions with its financial management.

15. Balance of Payments

16. The balance of payments is a summary of transactions between domestic and foreign residents for a specific country over a specified period of time. It represents an accounting of a country’s international transactions by business, individual or government. Inflows of funds generate credits for the country’s balance, while outflows of funds generate debits. A balance of payment statement can be broken down into different parts, the most important are current account and capital account.

17. Balance of Payments A balance of payment statement can be broken down into different parts, the most important are current account and capital account. Balance of Payment Current Account Capital Account

18. Current Account The current account summarizes the flow of funds between one specified country and all other countries due to purchases of goods or services, or the provision of income on financial assets. Key components of the current account include the balance of trade, factor income, and transfer payments.

19. The capital account summarizes the flow of funds resulting from the sale of assets between one specified country and all other countries. Capital Account

20. The key components of the capital account are Direct Foreign Investment, Portfolio Investment, Other Capital Investment. Capital Account

21. Overview Opportunities in Latin America, Europe and Asia Provide a model for the valuation of MNC. MNC’s Cash flows with different aspects

22. Balance of Payment (Accounting of transactions) ¤ Current Account ¤ Capital Account Current Account (Purchase Summary) ¤ Balance of Trade ¤ Factor Income ¤ Transfer Payments Overview

23. Capital Account (Flow of funds; one country to other) ¤ Direct Foreign Investment ¤ Portfolio Investment ¤ Capital Investment Trade volume is different Over all the World is developing Source: Adopted from South-Western/Thomson Learning. 2006 Overview

24. Source: Adopted from South-Western/Thomson Learning. 2006