1

International Financial Management

C45.0030.001

T & R, 9:30 – 10:45 am

Tisch Hall, UC-59

Lubomir P. Litov

2

The instructor

•Fourth year Ph.D. in finance & economics @ Stern.

•Spent 2 years as investment banker in Bulgaria, Austria, & UK working on privatization deals for major European industrial firms, banks, & investment companies.

•Interests in int’l corporate governance, int’l mergers & acquisitions, cross-border valuation.

3

Today’s Agenda

1. Overview of syllabus & forms.

2. Important Deadlines.

3. Overview of the material we will cover this semester. • Q: Why is important to study international finance?• Q: How is it different from domestic finance?

4. Start with analysis of the global financial environment.

4

Objectives of the course•Explore int’l financial markets

– Main players.

– Main instruments.

– Market structure.

•Multinational Companies–distinct exposures multinationals face?

–available financial tools to address these risks?

–Capital budgeting?

–Managing capital internationally?

–Investment & Capital Structure Decisions?

•International investor–cost & benefits of int’l diversification.

–Instruments for diversification.

5

Syllabus•Blackboard – online software we will use.

•Textbook.

•Textbook website.

•Requirements:– Course participation (10%)– Case study team presentation (15%)– Individual case study write-up (10%)– Five Quizzes (35%)– Final Exam (30%)

6

Syllabus•Case studies (12): textbook or business publications.

•One-minute memos.

•Problem sets

•Coming Deadlines–09/04: 1. seating chart; 2. turn in info sheet.–09/09: 1. Form/ change teams; 2. Presentation dates lottery.

7

Important dates-Case study presentations

-Quizzes

#1

(9/25)

#2

(10/2)

#3

(10/9)

#4

(10/14)

#5

(10/16)

#6

(10/23)

#7

(10/28)

#8

(10/30)

#9

(11/11)

#10

(11/13)

#11

(11/18)

#12

(12/04)

#1

(9/23)

#2

(10/7)

#3

(10/21)

#4

(11/6)

#5

(11/25)

8

Course topics

I Globalization History of Forex Rates

Balance of Payments

II Parity Conditions

Exchange ate

Determination

Forex Markets Forex Derivatives

III Transaction Exposure

Operating Exposure

Translation Exposure

IV Global Cost of Capital

Global Equity Global Debt Interest rate Swaps

V Foreign Direct Investment

Capital Budgeting Risk Adjustments

Cross-border

M & A

Int’l Portfolio

VI Tax Management

Working Capital Management

9

Why study int’l finance?

•Globalization & integration of economies around the globe.

•Consume products in country A, made in country B, by company in country C, w/ financing from country D.

–e.g. Canadian buys Phillips TV, made in Indonesia, w/ financing from a Dutch bank.

10

What is different about int’l finance?•Presence of additional costs (think of risks)

– Foreign exchange risks •profits may melt down when unexpected unfavorable exchange rate movements.

–Venezuelan strike. Currency: -46 % 2002.

–Malaysia introduces capital controls, 1998. Fixed rate @ 3.8/US$ vs. 4+/US$ pre- announcement of capital controls.

– Country risks.•Russia: bureaucrats don’t enforce law consistently.

–Q: what’s more important –law existence or enforcement?

– Credit risks•Not easy to seize collateral abroad due to legal restrictions.

11

Political (or Country) Risk…

•Governments have right to regulate movement of goods, people, & capital. Laws can change unexpectedly….

– E.g. Russian GKO Default triggered the August 1998 Russian crisis

– Venezuelan strike. Government forced some plants, e.g. Coca Cola, to re-open despite labor/ management opposition.

– Africa: AIDS concerned governments regulate pricing of AIDS treatment medicines (Pfizer, Glaxo Welcome)

12

What is different about int’l finance?•Presence of additional opportunities

– Arbitrage market imperfections•Restrictions on flows of capital, people, merchandise.

•Transportation costs.

•Tax differences –German car manufacturers in US.

–Chinese A- & B-shares. Chinese can purchase only A-shares, foreigners, B-shares.

–Short-selling not allowed in many stock markets.

–Expand opportunity set•Diversification (both company & investor)

•Source capital, work force, merchandise w/ lower cost.

13

Chinese A- & B- shares premium?

14

The Global Financial Environment

(or chapter 1)

15

Agenda:•What is globalization process?

•How globalization moves a business from domestic to global?

•What are the main risk exposures that arise in multinational businesses?

•How globalization affects corporate governance and the value creation for stakeholders?

16

Globalization process?

•The structural and managerial changes/challenges experienced by a firm as it moves from domestic to global.

17

The Globalization Process

Mexican Suppliers Canadian Buyers

Phase Two: International Trade

Are Canadian buyers creditworthy?Will payment be made in US$ or C$?

Are Mexican suppliers dependable?Will Trident pay US$ or Mexican pesos?

U.S. Suppliers(domestic)

U.S. Buyers(domestic)

Phase One: Domestic Trade

All payments in US dollars;All credit risk under U.S. law

Honeywell(US)

18

Exchange rate changes

Time

Accounting exposureChanges in reported owners’ equityin consolidated financial statementscaused by a change in exchange rates

Operating exposureChanges in cash flows due tochanges in exchange rates

Transaction exposureImpact of settling outstanding obligations entered into before changein exchange rates to be settled after change in exchange rates

Risk Exposures

19

Foreign Direct Investment Sequence

Honeywell Intl(US)

Explore Competitive Advantage Abroad

Enjoy Competitive Advantage@ Home

Licensing,Managerial Contract

Asset Acquisition Abroad

Mergers & Acquisitions“Greenfield” Investment

Produce Home & Export Produce Abroad

Joint Venture Subsidiary

Greater Foreign Presence

GreaterForeignInvestment

20

FDI Strategies•Greenfield Investment: A long-term physical investment in productive capability in that country

•Cross-Border Acquisition: Identification, valuation, tender, and post-acquisition management of an existing going-concern.

•Joint Venture Investment:Combining investment capital and managerial know-how to reach specific opportunities.

21

Multinational Enterprises (MNE)

•Incorporated in one country w/ production & sales in other countries.

•More than 60,000 MNE w/ 500K + foreign affiliates.

•Many MNE source raw materials in country A, obtain financing in country B, produce w/ labor & capital in country C, & sell output in various national markets.

22

1999 Top MNE

1 General Electric US

2 Exxon Mobil US

3 Royal Dutch/ Shell Group Holland/ UK

4 General Motors US

5 Ford Motor US

6 Toyota Japan

7 Daimler Chrysler Germany

8 TotalFina France

9 IBM US

10 BP UK

23

How important multinationality can be?Answer: ask Mr. Jurgen Schremmp…(DaimlerChrysler CEO)

-8000

-6000

-4000

-2000

0

2000

4000

6000

8000

10000

12000

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Pretax Income Pretax Income (Domestic) Pretax Income (Foreign)

24

(Divergent) Managerial Objectives•What is the goal of management goal?

–Shareholder Wealth Maximization•Max. shareholder value.

–Corporate Wealth Maximization •Max. all stakeholders value .

•Cronysm– Asset re-allocation to family related firms.

•Politically Connected Firms– or the case of senator Agnelli

25

Corporate Governance •Relationship among stakeholders used to determine control the strategic directions of a company.

•Failures– “Rubber stamp” board of directors.– Interlocking directorates.– Dual classes vs. one-share-one-vote class of stock.– Pyramidal Structures.

•Relevance in emerging markets (Russia & China).

26

Corporate Governance

Shareholders

Firm(management)

Banks Employees

Shareholders

Main Bank Firm(management)

The Anglo-American Model has beenfrequently criticized as focusing onshort-term profitability rather than

long-term growth.

Shareholder Value Max VS. Corporate Value Max.

The Non-Anglo-American Modelhas come under increasing criticismfor its lack of accountability to equityinvestors – its shareholders – while

focusing on the demands of toodiffuse a group of stakeholders.

27

Be big and … politically connected…

28

Think about it…•SWM vs. CVM

•Leverage buyouts?

•Conglomerates?

•Interlocking directorates?

•High leverage?

•Stock options for the CEO?

29

Int’l finance from Investors’ Perspective

•Costs & Benefits of International Portfolio Diversification

– as we discussed in the replies…

•Behavioral Biases– home bias: even though there is a benefit to financial diversification overseas, still US investors stick to their own…– melting pot or salad bowl: US foreign direct investments are correlated with the countries of origin.