BUSN 445/645 – Outlines for chapters 1-4
Chapter 1: “Introduction: Multinational Enterprise and Multinational Financial Management”
I. Introduction
- All companies operate in an international market
- The U.S. is one economy in an extremely competitive, integrated economic system
- Money knows no international boundary
II. The Multinational Corporation
A. Definition: A company that is engaged in producing and selling goods or services in more than one country.
B. Classical trade theory and “Comparative Advantage”
C. Mobility of labor, resources and capital
D. Forces affecting international business
E. Evolution of the multinational
G. The global manager
III. The Internationalization of Business and Finance
A. Concerns
B. Consequences
IV. Multinational Financial Management in Theory and Practice
A. Main goal: maximize shareholder wealth
B. Criticisms: The “Octopus” effect
C. Functions of financial management
1. Investment
2. Financing
3. Man. Of cash flows
4. Dividends
5. Risk
D. Unique aspects of multinational financial management
E. Benefits
F. Three concepts as a foundation of finance (including international)
1. Arbitrage
2. Market efficiency
3. Capital asset pricing
G. The global financial marketplace
H. The role of the financial executive is to focus on:
1. Capital budgeting
2. Working capital management
3. Tax management
4. Capital market imperfections
I. Introduction
A. Anything that affects a nation’s economy is eventually reflected in the value of its currency.
B. Depreciation vs. appreciation
II. Setting the Equilibrium Spot Rate
A. The Exchange Rate is the price of one nation’s currency in terms of another.
Two ways of quoting each rate: Direct vs. Indirect
B. The Market Exchange Rate is an equilibrium rate that supply to demand in a particular market.
Ex: Mexican peso vs. U.S. Dollar
C. Changes in exchange rates:
1. Graphically
2. Calculating percent changes in value for the peso.
3. Calculating percent change for the dollar.
4. Other factors that affect demand and supply.
III. Expectations and the Asset Market Model of Exchange Rates
A. Today’s currency values depend on today’s economic conditions, but also expected future economic conditions.
B. The nature of money and currency values: money has purchasing power and liquidity.
The value of money depends on its purchasing power, and the demand for assets denominated in that currency.
C. Central banks and currency values: central banks affect the supply of a currency (fiat currencies)
Central bank credibility is of extreme importance.
1. Currency Boards: A system that replaces a central bank with a board that issues notes and coins that are convertible on demand into a foreign currency reserve at a fixed rate.
2. Dollarization: The complete replacement of the local currency with the dollar.
3. Expectations and currency values
IV. Central Bank Intervention
A. Real exchange rates: adjusted for inflation.
A rise in real exchange rates causes the price of foreign goods to fall, and helps consumers but hurts producers.
B. Foreign exchange market intervention: official purchases or sales of a currency.
C. Sterilized vs. un-sterilized intervention
D. Effects of intervention:
1. Sterilized – effects are small and temporary
2. Unsterilized – effects can be more substantial and lasting but increases inflation in one country while lowering it in another. Can also be irresponsible and counter-productive.
3. Coordinated attempts can have dramatic affects
I. Introduction: The system of exchange rates we have today is a result of the breakdown of the Bretton Woods system, in effect form 1944 through 1971.
II. Alternative Exchange Rate Systems
A. Free Float (or Clean Float) – When exchange rates are determined by the forces of supply and demand with no impediments.
1. Benefits
2. Costs
B. Managed Float – Designed to reduce the variability inherent in Clean Float through central bank intervention.
1. Daily fluctuations
2. “Leaning against the wind”
3. Unofficial pegging
C. Target Zone arrangement – Maintaining the value of a currency within a specified margin around a fixed central exchange rate.
D. Fixed-Rate Systems – Governments maintain target exchange rates within some fixed percentage. Requires coordination among countries, and often, severe controls.
-Bretton Woods was a system of fixed rates. It became untenable after a while, as the official rates were almost impossible to maintain, so official rates were changed.
E. The Current System – A Hybrid (see Exhibit 3.3, p. 68)
III. A History of the International Monetary System
A. The Gold Standard – A system used by most major countries throughout most of history.
-Gold is durable, storable, standardized, etc.
- Governments fixed the value of their currency in terms of gold.
- Price stability is the main benefit of this system.
B. Variations of the Gold Standard
1. The Classical Gold Standard
2. The Gold Exchange Standard
3. The Bretton-Woods System:
-
Created the IMF
- Created the IBRD
- Created the BIS
- Created SDRs
Bretton-Woods is also known as a “Modified Gold Exchange Standard.”
C. Post Bretton-Woods
1. Smithsonian Agreement (1971)
2. Variability in value of U.S. dollar from 1973 to the present
IV. The European Monetary System and Monetary Union (1979)
A. The Exchange Rate Mechanism (ERM) and the European Currency Unit (ECU)
1. The ECU – a “composite” currency
2. The ERM – a method of fixing currency values through “central rates”
B. European Monetary Union – began with the Maastricht Treaty
-created the euro in 1999, which replaced individual currencies by 2002.
C. The effects of EMU
1. Lower costs of doing business
2. No exchange rate risk
3. Coordination of monetary policy
4. The problem of seignorage
5. The value of the euro since inception
6. Some economic shocks have been intensified by the euro
V. Emerging Market Crises
A. Mexico (1994-5), Asia (1997), Russia (1998), Brazil (1998-9)
B. Many argue that the IMF had a lot to do with recent crises.
I. Introduction – The Balance of Payments (BOP) is a double-entry accounting system that includes all transactions between one country and all other countries. We also examine the underlying forces behind the flow of goods and services.
II. Balance of Payment Categories
A. All transactions are classified as either debits (currency outflows) or credits (currency inflows), and debits must equal credits.
1. Exports = credits, imports = debits
2. Capital inflows = credits, outflows = debits
3. Current Account + Capital Account + Official Reserves Account = BOP = 0
B. Current Account – The net flow of goods, services, income and unilateral transfers.
C. Capital Account –
1. Portfolio investments
2. Short-term investments
3. Direct investment
D. Official Reserves Account – foreign currencies, gold SDRs, etc.
E. Other BOP measures
1. Basic balance
2. Statistical discrepancy
III. The International Flow of Goods, Services and Capital
A. Domestic savings and investment and the capital account
(4.1) National Income = Consumption + Savings
(4.2) National Spending = Consumption + Investment
(4.3) National Income – National Spending = Savings – Investment
B. The link between the current and capital accounts
(4.4) National Income – National Spending = Exports – Imports
(4.5) Savings – Investment = Exports – Imports
Main Point: the only way to reduce a deficit is to raise national product relative to spending or increase savings relative to investment
C. Government budget deficits and current account deficits
(4.7) National Spending = Household Spending + Private Investment + Gov. Spending
and Household Spending = Net Income – Private Savings – Taxes
(4.8) Nat. Spending – Nat. Income = Private Inv. – Private Savings + Gov. Budget Deficit
(4.9) Curr. Acct. Balance = Private Savings Surplus – Gov. Budget Deficit
IV. Coping With a Current Account Deficit
A. Currency depreciation – one proposed solution. Overvalued currencies do tend to cause deficits which then put downward pressure on the currency value.
1. But if depreciation, by itself, were to reduce a deficit, we have to assume sluggish adjustment of nominal prices.
2. Lagged effects and the J-curve theory
3. Devaluation and inflation
4. U.S. deficits and demand for U.S. assets
B. Protectionism- another proposed solution: tariffs and quotas are the most common forms.
Results of protectionism: prices rise, standard of living falls, exports may fall, retaliation occurs. The only way to really reduce imports is to increase savings.
C. Ending foreign ownership of assets: forces imports = exports
But, interest rates rise, economic growth slows. Foreign capital helps us be more productive.
D. Boosting the savings rate: the only real solution, but difficult to do.
E. Current account deficits and unemployment: no real connection