INTERNATIONAL FINANCE NOTES - COMPLETE AND IN DEPTH
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Course
(BS3393)
Institution
Aston University, Birmingham (Aston)
VERY DETAILED AND IN-DEPTH NOTES ON INTERNATIONAL FINANCE. NOTES ON:
INTERNATIONAL TRADE, FACTORS AFFECTING INTERNATIONAL TRADE, EXCHANGE RATE RISKS, INTERNATIONAL HEDGING, FINANCIAL TECH, AND SO ON.
- Companies that operate in an integrated fashion
(i.e. same goals/objectives) in various countries.
- Produce, buy, and sell goods across national
borders.
- Make foreign direct investments in many countries.
- Involved in the traditional aspects of international
trade (sourcing inputs and selling goods) and much
more
Goals of MNCs
- Maximize share-holders wealth → i.e. increasing the value of the company
- Financial managers throughout the MNC have a single goal of maximizing the value of the entire MNC.
o Some argue that a singular focus on shareholders’ wealth maximization is often too short-sighted.
▪ Should also be concerned with the well-being of society/environment etc
o Others argue that market participants all acting in their own self-interests lead to a stable equilibrium
that efficiently allocates resources.
- Conflict of interest arises when a corporation’s shareholders differ from its managers → AGENCY PROBLEM
o Agent (CEO); shareholder (PRINCIPAL)
o (SEE ACF) Agency costs are normally larger for MNCs than for purely domestic firms, due to:
▪ The difficulty in monitoring distant managers
▪ The different cultures of foreign managers
▪ The size of the larger MNCs
▪ The tendency of downplay short-term effects → e.g. having a sales offer to increase total sales
and revenue
- Subsidiary managers may be tempted to make decisions that maximize the values of their respective
subsidiaries → E.g. UK firms buying Polish produced Coca-Cola instead of UK produced benefits the Polish
Coca-Cola manager
Interference of goals
- Environmental constraints ➔ e.g. UK green initiative by 2030 → no new petrol/diesel cars → impacts car
manufactures sales; either adapt or lose.
- Regulatory constraints ➔ age restricted products, information on smoking packets (can deter customers)
- Ethical constraints ➔ need to understand the ethics and culture of the foreign country
Impact of management control
- The magnitude of agency costs can vary with the management style of the MNC.
- A centralized management style reduces agency costs.
- A decentralized style gives more control to those managers who are closer to the subsidiary’s operations and
environment
- Centralised management control:
o Manager A and Manager B listen to the
decisions made by the parent.
o A and B do not make any decisions → they
simply execute them
, - Decentralized management control:
o A and B make decisions and execute them
o Each subsidiary manager makes decisions
independently, with each manager trying to
achieve their own goal
- Reality:
o MNCs are both centralized and
decentralized
▪ Major decisions are centralized
▪ Day-to-day management is
decentralized
o Some MNCs attempt to strike a balance → allow subsidiary managers to make the key decisions for
their respective operations, but the parent’s management monitors the decision
- Various forms of corporate control can reduce agency costs
o Stock options → (SEE ACF) → allows CEO to own shares and benefit from company’s success (aligned)
o Hostile takeover threat → incentive for management to work harder and efficiently
o Investor monitoring → shareholders have voting rights and will monitor the performance of the
organisation
Risks in international business
- Exchange rate risk ➔ e.g. Apple ($), if £ falls, then Apple receive less $ per sale OR another e.g. cheaper
imports are available
- Foreign economies ➔ E.g. China cracking down on wealth flaunting
- Political risk ➔ the political relationship between the countries/political standpoint of foreign country etc.
o Difficult/impossible to trade with a country of there is no political relationship in place → e.g. North
Korea And Volvo
International business methods
- International trade involves exporting (to penetrate foreign markets and thus increase sales and shareholder
wealth) and importing (low cost supplies).
- Licensing (copyright) allows a firm to provide its technology in exchange for fees (royalty) or other benefits.
- Franchising obligate a firm to provide a specialized sales of service strategy, support assistance and possibly
an initial investment in exchange of periodic fees.
- Firms may also penetrate foreign markets by engaging in a joint venture (joint ownership and operation) with
firms that reside in those markets or create Special Purpose Vehicles (separate legal entities with shared
ownership).
- Acquisition of existing operations in foreign countries allow firms to quickly gain control over foreign
operations as well as a share of the foreign market → can be less hassle, especially if licenses are required.
- Firms can also penetrate foreign markets by establishing new foreign subsidiaries.
- Many MNCs use a combination of methods to increase international business.
o Any method of conducting business that requires investment in more than 10% of foreign operation
is referred to as a foreign direct investment (FDI).
o Below 10% of investment is referred to as portfolio investment
Theories of international business
1. Competitive advantage
2. Imperfect market theory
3. Product life cycle theory
,Theory of competitive advantage
- This theory explains why countries engage in international trade by determining what goods and services
countries should specialize in producing.
- Countries should specialize in producing goods where they have a lower opportunity cost – then there will be
an increase in economic welfare.
- This will prevail even if one country is more efficient in the production of all goods than the other country
(holding the countries has different relative efficiencies.
- The above example shows that by specializing, economic welfare can be enhanced.
- Criticisms:
o Cost of trade → transportation, export/import carry etc.
o External costs of trade → emissions etc.
o Diminishing returns/diseconomies of scale → fall in productivity due to lack of stimulation
o Static comparative advantage → opportunity cost isn’t constant; can change
o Dutch disease → exports may be too expensive for foreign country which reduces their price
competitiveness
o Trade – not a Pareto improvement → PI implies that both countries benefit with no harm which is not
necessarily true (e.g. UK bread producers out of a job etc.)
o Gravity theory → theory does not account for this; trading tends to be more prominent in closer
countries)
Imperfect market theory
- Violation of perfect market assumption leads to imperfect market.
- Assumptions of perfect market:
o Buyers and sellers are both price takers
o Companies sell virtually identical products
o Buyers and sellers have perfect information
o Multiple companies owns a small market share
o There is no entry or exit barrier
, International product life cycle
- New product for local demand → export to
meet foreign demand → establish a foreign
subsidiary → differentiate product from
competitors OR foreign business declines as
competitive advantage eliminated
Effects of Globalisation in INTERNATIONAL BUSINESS
- Economies, markets and people in different countries are interconnected
- Foreign competitors may enter their markets and use advantages gained from globalisation to out-compete
domestic companies
- Domestic companies may rely upon foreign suppliers or customers, so exchange rates will affect their profits
- Integrated global capital markets will affect the domestic company’s ability to acquire capital.
- Globalization introduces both opportunities and challenges:
o A larger investment opportunity set is available → The marginal return on projects for an MNC is
above that of a purely domestic company because of the expanded opportunity set of possible
projects from which to select.
o With greater investment opportunities, there is a greater need for investment capital → MNC may be
able to obtain capital funding at a lower cost through access to international markets
o Globalization introduces other tax systems, exchange rates, regulatory environments, and political
systems
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