1. INTERNATIONAL FINANCE
Lecture 5
INTERNATIONAL FINANCE

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

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

4. 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

5. International Flow of Funds
Lecture 5

6. 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.

7. 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.

8. 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

9. 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

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

11. 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

12. 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

13. 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

14. 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

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

16. 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.

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

18. Distribution of U.S. Exports and Imports

19. U.S. Balance of Trade Over Time

20. 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)

21. 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

22. 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

23. 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

24. 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)

25. 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