Team assignment 4 (5 points) Charlotte, USLuxembourg CityTampere, Finland Sales US$5 million or US$ 5 million ÷ $1.5/€ = €3.33 million €15 million Costs

Team assignment 4 (5 points)

Charlotte, US Luxembourg City Tampere, Finland

Sales US$5 millionor

US$ 5 million ÷ $1.5/€ = €3.33 million

€15 million €15 million

Costs of sales US$ 5 million €3.33 million €15 million

Profit 0 €15 million - €3.33 million = €11.67 million

0

Tax rate (effective) 40% 10% 25%

Net profit 0 (1-10%) * €11.67 million = €10.50 million

0

• How would you price intra-firm exports of intermediate goods manufactured in Charlotte of US to the next production stage in Tampere, Finland, for maximizing total net profit? The exchange rate was $1.5/€ on the day when Charlotte-Luxembourg transaction was made. All profits should be translated into €. Fill the question marks in the table (3.5 points in total).


•Assuming no hedging techniques had been used, what would be the total net profit if the exchange rate on the day of Charlotte-Luxembourg transaction was $1.25/€? All profits should be translated into € (0.5 point).



US$ 5 million ÷ $1.25/€ = €4 million


Costs of sales US$ 5 million €4 million €15 million

Profit 0 €15 million - €4 million = €11 million

0


Net profit 0 (1-10%) * €11 million = €9.9 million

0


• In an effort to hedge foreign currency risk, you had previously bought a forward call option of $1.3/€ at an ignorable cost. The option can be exercised on the day of Charlotte-Luxembourg transaction, when the spot rate was $1.5/€. What would be the total net profit (0.5 point)? What would be the total net profit if the spot rate was $1.25/€ (0.5 point)? All profits should be translated into €.

• First, calculate the potential net profit under the call option rate if the option was exercised.

• When the spot rate was $1.5/€, the two alternative profit would be:• 1) exercise the option and use the call option rate of $1.3/€, the total profit would be €10.04 million;• 2) do not exercise the option and follow the spot rate of $1.5/€, the total profit (as calculated in question 1)

would be €10.50 million.• In order to make a higher profit, we should choose not to exercise the option.

• When the spot rate was $1.25/€, the two alternative profit would be:• 1) exercise the option and use the call option rate of $1.3/€, the total profit would be €10.04 million;• 2) do not exercise the option and follow the spot rate of $1.25/€, the total profit (as calculated in question 1)

would be €9.9 million.• In order to make a higher profit, we should choose to exercise the option.



US$ 5 million ÷ $1.3/€ = €3.85 million


Costs of sales US$ 5 million €3.85 million €15 million

Profit 0 €15 million - €3.85 million = €11.15 million

0


Net profit 0 (1-10%) * €11.15 million = €10.04 million

0

Sources:

Mark Gordon and Sabastian V. Niles, 2012, “Sovereign wealth funds: An overview”, in Karl P. Sauvant, Lisa E. Sachs, Wouter P.F. Schmit Jongbloed (eds.), Sovereign investment: Concerns and policy reactions, pp. 24-56. Oxford, UK: Oxford University Press.

Shai Bernstein, Josh Lerner and Antoinette Schoar, 2013, “The investment strategies of sovereign wealth funds”, Journal of Economic Perspectives, 27(2), pp. 219-237.

William L. Megginson, Miao You and Liyan Han, 2013. “Determinants of sovereign wealth fund cross-border investments”, Financial Review, 48(4), pp. 439-572.

Emerging phenomenon in international finance:

The rise of sovereign wealth funds (SWFs)

SWFs (cont’d)

SWFs are investment vehicles established by governments to invest a portion of their excess foreign exchange reserves in search of higher returns than are typically earned on official reserves.

They are generally invested in safe, low-return instruments such as U.S. Treasury bonds,

The primary economic purposes of these funds include: diversification of national wealth, revenue stabilization, sharing of national wealth across generations, and achieving equity-like investment returns.

SWFs (cont’d)

billion

Hedge funds: $2.1 trillion

SWFs (cont’d)

Skyrocketing: They increased ten-fold in the last two decades from $500 billion in 1990 to

more than $6 trillion today (largely due to rising price of petroleum and appreciation of local currency such as Chinese RMB).

Unclear and myriad corporate objectives: First, as a source of capital for future generations Second, as a stabilizer by reducing the volatility of government revenues Finally, as holding companies, in which the government places its strategic

investments

SWFs (cont’d)

Largest exporter

12th largest exporter

SWFs (cont’d) SWFs played an important role by providing emergency liquidity to major U.S.

and European financial institutions at the outset of the recent financial crisis.

Selected Infusions of SWFs into the U.S. financial institutions during the global financial crisis 2007-09

For political concerns, SWFs typically did not receive special governance rights (e.g., board membership) although their ownership might be greater than many other owners.

Date Target company SWF(s) Investment size in billions of US$ (% in target)

2009/06/032007/12/19

Morgan Stanley China Investment Corporation (CIC) 1.2 (9.9%)5 (9.9%)

2008/07/282007/12/24

Merrill Lynch Temasek (Singapore) 3.4 (13.8%)4.4 (9.4%)

2008/02/01 JC Flowers China Investment Corporation (CIC) 4

2008/01/15

2007/11/27

Citigroup GIC (Singapore), KIA (Kuwait), Prince Alwaleed bin Talal (Saudi Arabia)

12.9 (9.3%)

7.5 (4.9%)

2007/05/22 Blackstone China Investment Corporation (CIC) 3 (9.7%)

SWFs (cont’d) Their cross-border investment strategies

Megginson et al (2013) studied a sample 1,590 investments in 78 target countries by 15 major SWFs during 1985-2011 and found that SWFs are purely, or primarily, commercially driven. More transactions came from SWFs from strong economic

performance, high degrees of openness to trade, and less developed local capital markets

SWFs are more likely to invest in countries with high levels of investor protection, strong economic performance, and well developed local capital markets

SWFs are more likely to invest in countries sharing the same culture and engaging in bilateral trade

All these findings are similar to other private foreign institutions

Country-specific advantages Country-specific advantages

International business environmentRegional vs. global

Triad and IB activitiesPolitics, culture, trade and finance

International business environmentRegional vs. global

Triad and IB activitiesPolitics, culture, trade and finance

Firm-specific advantages and firm managementOrganizationProductionMarketing

International HRMPolitical risk management

International financial management

Firm-specific advantages and firm managementOrganizationProductionMarketing

International HRMPolitical risk management

International financial management

Locational choice and regional management European Union, North America, Japan, and Emerging

Markets

Locational choice and regional management European Union, North America, Japan, and Emerging

Markets

Course structure

Classes 1-4

Classes 5-9

Class 10

Classes 11-14

The diamond model: Porter’s explanation of determinants of national competitiveness

From Mike Porter’s The competitive advantage of nations.

ChanceChance

Factor Conditions DemandConditions

Structure of firms and rivalry

CSAs in certain industries/products


ChanceChance



Human resources Quality, skills, and cost

Physical resources Land, water, mineral deposits, timber, hydro

power sources, and fishing grounds

Knowledge resources Scientific, technical, and market knowledge

Capital resources Amount, type, and cost of financial resources

Infrastructures Transportation, communications, health-care,

etc.


ChanceChance



Composition of the home demand Various niches, buyer sophistication

The size and growth of the home demand

Internationalization of domestic demand


ChanceChance



Competitive downstream industries through efficient, early, or rapid access to cost-effective inputs;

Competitive related industries that can coordinate and share activities in the value chain

Competing products/services Complementary products/services


ChanceChance



The ways in which firms are managed and choose to compete

The motivations of companies and their employees and managers

The competition intensity in the respective industry


ChanceChance



Chance events are occurrences that are outside of control of a firm

New inventions Political decisions by foreign governments Wars Significant shifts in world financial markets or

exchange rates Discontinuities in input costs such as oil shocks Surges in world or regional demand Major technological breakthroughs


ChanceChance



Government influences

Subsidies Education policies The regulation or deregulation

of capital markets The establishment of local

product standards and regulations

The procurement of goods and services

Tax laws Antitrust regulation

ChanceChance



CSAs: Cluster-specific advantages

CSAs in certain industries/products

Clustering: Interconnection and Concentration of All These Factors

An example: CSAs for American ICT multinationals such as Google.

ChanceChance



CSA for ICT industries/products

Factor conditions:•Plenty of high-quality computer sciences and engineering graduates•Abundant VC capital network

Chance events:•PC revolution•WWW revolution

Supporting industries and institutions:•HR intermediaries: e.g., Smart Valley Inc.•High-standard universities: e.g., Stanford•Information sharing networks: e.g., Enterprise Network; Software Industry Coalition.•Collective lobbyists for deregulation and low tax: e.g., Regulatory Forum; Council on Tax and Fiscal Policy

Structure of firms and rivalry:•Information sharing across IT researchers is common•Risk-taking and entrepreneurship is a local culture embedded in the wild west California style

Demand conditions:•Relatively richer consumers•Sophisticated buyers located in the founding district of ICT industries

Government:•Public R&D funding: e.g.,

SBIR, DARPA, etc.•Public VCs: e.g., CalPERS•Tax exempt for selected VC

activities.

An example: CSAs for American ICT multinationals such as Google.

Silicon Valley

Limitations of the Diamond ModelThe rise of the Great Lakes area as a cluster of auto industry

An example: North Am auto industry Canadian railways and ports of entry/exist serving the US markets

LA-Long BeachLA-Long Beach

Asia’s pacific ports

Up to 58 hours closer

5 days

An example: North Am auto industry (cont’d):Oil reserves in Canada; Oil pipelines between Canada and US; Auto

industry in the US.

GDP US$15 trillion

3 billion bbl per year just for running vehicles, not including production etc.

GDP US$15 trillion

3 billion bbl per year just for running vehicles, not including production etc.

GDP US$1.7 trillion

GDP US$1.7 trillion

An example: North Am auto industry (cont’d)Free-trade agreement

FTA since Jan 1988NAFTA since Jan 1994

The double diamond: Regional integration of multiple countries

e.g., oil reserves

e.g., the largest vehicle market with high purchasing power

e.g., a decent market with high purchasing power

Prince Rupert and Vancouver in British Columbia as ports of entryCN and CP railways as inter-state transportation

e.g., skilled labor

Pacific gateway initiative

Keep the border open

(NA)FTA since 1988

Chance events

Chance events

An extension: Multiple diamond model

The Finnish miracle: Nokia

Source: Anil Hira, 2012, “Secrets behind the Finnish miracle: the rise of Nokia”. International Journal of Technology and Globalization, 6(1/2), pp. 38-64.


Nokia 2/3 of the Information and

Communications Technology (ICT) sector in Finland

1/5 of exports 3–4% of GDP 45% of business sector R&D (research

and development), and 1/3 of national R&D

conducts 60% of its research in Finland employs 20,000 in Finland, half of whom

are in R&D The Finnish ICT cluster includes 6000

firms, of which 200 are first-tier subcontractors of Nokia. ICT constitutes 10% of GDP (up from 4% in 1990).


The story of Nokia is compelling because Finland was not the context (in regard to natural comparative advantage) in which one would expect to see leadership as an international R&D hub.

Finland is an odd place for the emergence of a global competitor in IT. a small domestic population of 5.2 million a relatively remote location a traditional economy based on natural resources

(lumber, pulp, and paper) Yet, there were signs of previous Finnish capacity to

develop globally competitive products requiring high value-added and levels of skill, e.g., The School of Decorative Arts and the Society of Crafts and Design in Helsinki.


A double diamond model between Finland and the Soviet Union (SU) from 1950 and 1990 The Soviet Union’s demand for reparations as a

result of Finnish alliance with the Germans in WWII – $300 million (75% in telecom-related production, etc.).

Lack of foreign exchange led to increase in efficiency

Not eligible for the European Marshall Plan aid for tech transfers, motiving Nokia to build proprietary tech capacity

The SU accounted for 15-25% of Finnish foreign trade in 1950s some 40% in 1990, when the SU collapsed.


In 1967, with the encouragement of the government, the Nokia Corporation, including FCW, FRW, and the original Nokia wood mill activities, was officially launched.

Industry structure: Good cooperation

1964-71, Nokia – Salora Oy on radio and phone 1975, Nokia – Salora on branding and promotion activities 1979, Nokia – Solora built a joint venture of Mobira Oy (mobile radio), precursor

of today’s Nokia Telecommunications (NTC)

Expanding military and public sector 1969, expansion of highway traffic led to construction of a nationwide mobile

network based on manual Car Mobile Telephone (CMT) technology 1972, Post, Telephone and Telegraph public agency (PPT) offered the first

mobile phone services on the CMT network However, there was still significant gap in supply-demand. Private players such

as Televa Oy entered into the business, which was taken over by Nokia in 1981.


The Nordic quadruple diamond model The Nordic Mobile Telephone Group (Nordisk Mobil Telefon or

NMT), including both private and public partners from Finland, Sweden, Norway, and Denmark, was established in 1969 to develop a new mobile telephone system. Full automatic operation and charging System and terminal compatibility among all four countries Full roaming capability among all four countries Mobile-to-mobile calls High reliability Similar use and same facilities as conventional fixed phone Privacy protection Open specs, with no exclusive supplier rights

By 1980s, the Nordic countries constituted the largest world market in terms of mobile phone subscribers.

By taking over Mobira, another Finnish mobile phone manufacturer, and Finland’s largest electrical wholesaler, and Swedish Ericsson Group’s data divison, Nokia became the largest IT group in Scandinavia.

Ericsson’s data division

Mobira


The European multiple (>4) diamond model

Nokia’s successful expansion in the Nordic countries led to Nokia’s shift of focus on the entire Europe It started sourcing external finance in Switzerland In 1982, promoted by the Nordic countries and the

Netherlands, the European Conference of Postal and Telecommunications Administrations (CEPT), formed a new standards group, Groupe Special Mobile (GSM), to standardize the emerging wireless industry across Europe.

In 1987, Nokia joined the forces with France’s Alcatel and West Germany’s AEG to promote GSM as an European standard.

In 1988, the European Economic Community (EEC), the precursor of EU, as an European standard, which would become an international standard.

Finland became one of the earliest adopter of this pan-European standard by building nationwide GSM.

The SU

The SU-Finland double diamond 1950-90

Finnish Government

The SU government

Finnish industry structure and supporting institutions

Finland-based resources

The SU-based resources The SU customers

The rise of Nokia and wireless

industry

Finnish customers

The SU industry structure and supporting institutions

Swedish, Norwegian, and Danish

The Nordic quadruple diamond since 1969s

Finnish Government

Swedish, Norwegian, and Danish governments



Swedish, Norwegian, and Danish resources

The Swedish, Norwegian, an Danish customers


industry

Finnish customers

Swedish, Norwegian, and Danish industry structure and supporting institutions

Europe

The European multiple (>4) diamond since 1980s

Finnish Government

European government



European resources European customers


industry

Finnish customers

European industry structure and supporting institutions

Next class

Documents

Team assignment 4 (5 points) Charlotte, USLuxembourg CityTampere, Finland Sales US$5 million or US$ 5 million ÷ $1.5/€ = €3.33 million €15 million Costs