INTERNATIONAL FINANCE Lecture 5 INTERNATIONAL FINANCE

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

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

Overview 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

International Flow of Funds Lecture 5

Lecture Objectives 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.

Key components of Current Account Balance of Trade It captures simply the difference between exports and imports. Merchandise trade involve the exports and imports of tangible products. Service trade represents the tourism and other products like insurance, legal and consultancy.

Key components of Current Account Balance of Trade A deficit in the balance of trade shows that the value of goods & services exported is less than the value of imported goods & services. Before 1990s the balance of trade focused merchandising Afterwards included services

Key components of Current Account Factor Income Represents the inflow and outflow of income (Interest and Dividend) Factor income received by the investors of any country i.e. the inflow of funds Factor income paid by any country is the outflow of funds from that country

Key components of Current Account Transfer Payments Aids Gifts Grants from one country to the other

The U.S. Current Account in 2003 (in billions of $) (1) U.S. exports of goods + $712 + (2) U.S. exports of services + 292 + (3) U.S. income receipts + 275 = (4) Total U.S. exports & income receipts = $1,279 (5) U.S. imports of goods – $1,263 + (6) U.S. imports of services – 246 + (7) U.S. income payments – 259 = (8) Total U.S. imports & income payments = $1,768 (9) Net transfers by the U.S. – $68 (10) Current account balance = (4) – (8) – (9) – $557

Components of Capital Account Direct Foreign Investment Investment in fixed assets in foreign countries Can be used for the conduct of business operations It includes firm’s acquisitions of the foreign companies Construction of new plants for manufacturing Expansion of an existing plant in the foreign country

Components of Capital Account Portfolio Investments Represents the long term transactions of financial assets Bonds and stocks Like purchasing a Netherland stock of company “ABC” by US investor Without changing control of the company

Components of Capital Account Portfolio Investments If US firm purchases all stocks of company ABC in acquisition so i.e. Direct Foreign Investment Since it involve transfer of control

Key components of Capital Account Capital Investment Transactions involving short term financial assets Money market financial instruments Developed countries rely heavily on trade

International Trade Flows Some countries are more dependent on trade than others. The trade volume of a European country is typically between 30 – 40% of its GDP, while the trade volume of U.S. (and Japan) is typically between 10 – 20% of its GDP. Nevertheless, the volume of trade has grown over time for most countries.

Distribution of U.S. Exports across Countries (in billions of $)

Distribution of U.S. Exports and Imports

U.S. Balance of Trade Over Time

Trade Agreements Many agreements have been made to reduce trade restrictions: 1988 U.S. and Canada free trade pact North American Free Trade Agreement (NAFTA) for Canada, Mexico and US General Agreement on Tariffs and Trade (GATT) for 117 nations Single European Act and the European Union in 1990s (single currency)

Trade Disagreements However, even without tariffs and quotas, governments seem always able to find strategies that can give their local firms an edge in exporting: If the job prospects of people are affected: they have strong opinions about international trade policy On the other hand people are in the favor of free trade since it increases competition

Trade Disagreements Firms in one country are not subject to different environmental & labor laws Firms in one country are allowed to bribe while not in other country Dumping is involved in few countries where the export products are produced with the help of Government subsidies. Tax breaks for specific industries from Government

The Outsourcing of Services Technology support of computer system by US to India where labor costs are low Affects balance of trade since the service is purchased in another country Allows MNCs to do operations at lower costs However it shifts jobs to other countries Criticized by the people who lose their jobs

Overview Balance of Payment (Accounting of transactions) Current Account Capital Account Current Account (Purchase Summary) Balance of Trade (Imports & Exports) Factor Income (Cash Inflows & outflows) Transfer Payments (Aid, Gift, Grants)

Overview Capital Account (Flow of funds; one country to other) Direct Foreign Investment Portfolio Investment Capital Investment Trade Agreements NAFTA, GATT, EU Trade Disagreements Tariffs, Quotas, Job loss Rules are different (Child labor, Bribe, etc) Outsourcing Source: Adopted from South-Western/Thomson Learning. 2006