Solution Manual For
International Financial Management, 10th Edition EUN
Chapter 1-21
CHAPTER 1
GLOBALIZATION AND THE MULTINATIONAL FIRM
ANSWERS & SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS
QUESTIONS
1. Why is it important to study international financial management?
Answer: We are now living in a world where all the major economic functions, such as
consumption, production, investment, and financing, are highly globalized. It is thus essential
for financial managers to fully understand vital international dimensions of financial
management. This global shift is in marked contrast to a situation that existed when the authors
of this book were learning finance a few decades ago. At that time, most professors customarily
(and safely, to some extent) ignored international aspects of finance. This mode of operation
has become untenable since then.
2. How is international financial management different from domestic financial management?
Answer: There are three major dimensions that set apart international finance from domestic
finance. They are:
1. foreign exchange and political risks,
2. market imperfections, and
3. expanded opportunity set.
3. Discuss the major trends that have prevailed in international business during the last two
decades.
Answer: The 2000s brought a rapid integration of international capital and financial markets.
Impetus for globalized financial markets initially came from the governments of major countries
that had begun to deregulate their foreign exchange and capital markets. The economic
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,integration and globalization that began in the eighties and nineties are picking up speed in the
2000s. Trade liberalization and economic integration continued to proceed at both the regional
and global levels. Despite sovereign debt crisis in Europe, more EU member countries have
adopted the common currency, the euro, that effectively became the second global currency
after the U.S. dollar. In the last few years, however, economic nationalism has been gaining
some popularity, as exemplified by the Brexit decision of the United Kingdom and the so-called
―America First‖ policies of the Trump Administration. To the extent that economic nationalism is
a populist response to the global financial crisis and Great Recession, it may subside as the
world economy continues to recover.
4. How is a country‘s economic well-being enhanced through free international trade in goods
and services?
Answer: According to David Ricardo, with free international trade, it is mutually beneficial for
two countries to each specialize in the production of the goods that it can produce relatively
most efficiently and then trade those goods. By doing so, the two countries can increase their
combined production, which allows both countries to consume more of both goods. This
argument remains valid even if a country can produce both goods more efficiently in absolute
terms than the other country. International trade is not a ‗zero-sum‘ game in which one country
benefits at the expense of another country. Rather, international trade could be an ‗increasing-
sum‘ game from which all players become winners.
5. What considerations might limit the extent to which the theory of comparative advantage is
realistic?
Answer: The theory of comparative advantage was originally advanced by the nineteenth
century economist David Ricardo as an explanation for why nations trade with one another.
The theory claims that economic well-being is enhanced if each country produces what it has a
comparative advantage in producing relative to other countries, and then trade products.
Underlying the theory are the assumptions of free trade between nations and that the factors of
production (labor, technological know-how, and capital) are relatively immobile. To the extent
that these assumptions do not hold, the theory of comparative advantage may not realistically
describe international trade. In addition, free trade produces winners and losers and if the
losers are not compensated, free trade may faces political opposition from them.
6. What are multinational corporations (MNCs) and what economic roles do they play?
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,Answer: A multinational corporation (MNC) can be defined as a business firm incorporated in
one country that has production and sales operations in many other countries. Indeed, some
MNCs have operations in a few dozens of different countries. MNCs obtain financing from
major money centers around the world in many different currencies to finance their operations.
Global operations force the treasurer‘s office to establish international banking relationships, to
place short-term funds in several currency denominations, and to effectively manage foreign
exchange risk. By circumventing and also taking advantage of various market imperfections,
such as barriers to trade and barriers to flow of people and capital across countries, MNCs
contribute to greater integration of the world economy and ing more perfect functioning of global
markets.
7. Ross Perot, a former Presidential candidate of the Reform Party, which was a third political
party in the United States, had strongly objected to the creation of the North American Trade
Agreement (NAFTA), which nonetheless was inaugurated in 1994. Perot feared the loss of
American jobs to Mexico where it is much cheaper to hire workers. What are the merits and
demerits of Perot‘s position on NAFTA? Considering the recent economic developments in
North America, how would you assess Perot‘s position on NAFTA?
Answer: Since the inception of NAFTA, many American companies indeed have invested
heavily in Mexico, sometimes relocating production from the United States to Mexico. Although
this might have temporarily caused unemployment of some American workers, they were
eventually rehired by other industries often for higher wages. At the same time, Mexico has
been experiencing a major economic boom. It seems clear that both Mexico and the U.S. have
benefited from NAFTA. Perot‘s concern appears to have been ill founded.
8. In 1995, a working group of French chief executive officers was set up by the Confederation
of French Industry (CNPF) and the French Association of Private Companies (AFEP) to study
the French corporate governance structure. The group reported the following, among other
things: ―The board of directors should not simply aim at maximizing share values as in the U.K.
and the U.S. Rather, its goal should be to serve the company, whose interests should be clearly
distinguished from those of its shareholders, employees, creditors, suppliers and clients but still
equated with their general common interest, which is to safeguard the prosperity and continuity
of the company‖. Evaluate the above recommendation of the working group.
Answer: The recommendations of the French working group clearly show that shareholder
wealth maximization is not a universally accepted goal of corporate management, especially
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,outside the United States and possibly a few other Anglo-Saxon countries including the United
Kingdom and Canada. To some extent, this may reflect the fact that share ownership is not wide
spread in most other countries.
9. Emphasizing the importance of voluntary compliance, as opposed to enforcement, in the
aftermath of such corporate scandals as those involving Enron and WorldCom, U.S. President
George W. Bush stated that while tougher laws might help, ―ultimately, the ethics of American
business depends on the conscience of America‘s business leaders.‖ Describe your view on
this statement.
Answer: There can be different answers to this question. If business leaders always behave
with a high ethical standard, many of the corporate scandals we have seen lately might not have
happened. Since we cannot fully depend on the ethical behavior on the part of individual
business leaders, the society should protect itself by adopting the rules/regulations and
governance structure that would induce business leaders to behave in the interest of the society
at large. But at the same time, we need to make sure that excessive regulations do not stymy
free enterprises, an important engine of economic growth. It is important to strike the right
balance.
10. Suppose you are interested in investing in shares of Samsung Electronics of Korea, which
is a world leader in mobile phones, TVs, and home appliances. But before you make investment
decision, you would like to learn about the company. Visit the website of Yahoo
(http://finance.yahoo.com) and collect information about Samsung Electronics, including the
recent stock price history and analysts‘ views of the company. Discuss what you learn about the
company. Also discuss how the instantaneous access to information via internet would affect
the nature and workings of financial markets.
Answer: As students might have learned from visiting the website, information is readily
available even for foreign companies like Samsung Electronics. Ready access to international
information helps integrate financial markets, dismantling barriers to international investment
and financing. Integration, however, may help a financial shock in one market to be quickly
transmitted to other markets.
11. Most companies make corporate decisions to maximize their profits, without taking into
consideration the possibly negative effects of corporate activities on the environments, thereby
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,contributing to climate change. How would you “incentivize” companies to change their behavior in such
a way that they would protect the environments?
Answer: Any measures that can induce self-interested companies to voluntarily take actions that will help
preserve the environments would qualify as answers for this question. Such incentivizing measures may
include government subsidies for production and purchase of electric vehicles, instead of those using
internal combustion engines, supply more “green” energies at lower prices so that companies can switch
from using “brown” energies generated by coals and oil to green energies for their own interests, promote
the presence of green activist investors in the board of directors, etc.
12. One of the major economic consequences of the covid-19 pandemic that started in early 2020 is the
unusually high inflation rates in most countries. In March, 2022, for instance, the annual inflation rate hits
8.5% in the U.S., the highest level since 1981, and 5.9% in EU, the highest level since the introduction of
the euro in 1999. In your opinion, how did inflation become so high during the covid era and what can be
done to reduce it?
Answer: Inflation became unusually high since early 2020 for the two reasons: global supply chain
disruptions, e.g., factory lockdowns in China, and expansionary monetary and fiscal policies in many
major countries, both related to the covid pandemic, with the Russian invasion of Ukraine in early 2022
exasperating the supply chain disruption, especially in energy and food markets. Inflation can be brought
under control by (i) reducing the aggregate demands that were boosted by near-zero interest rates and
massive fiscal stimulus in many major countries to deal with the negative economic impact of the
pandemic, and (ii) mitigating the supply chain disruptions by onshoring (domestic production), for
example, and also mitigating geopolitical risk around the world by diplomatic negotiations, to the extent
possible.
MINI CASE: NIKE AND SWEATSHOP LABOR
Nike, a company headquartered in Beaverton, Oregon, is a major force in the sports
footwear and fashion industry, with annual sales exceeding $ 30 billions, more than half of
which now come from outside the United States. The company was co-founded in 1964 by Phil
Knight, a CPA at Price Waterhouse, and Bill Bowerman, college track coach, each investing $
500 to start. The company, initially called Blue Ribbon Sports, changed its name to Nike in 1971
and adopted the ―Swoosh‖ logo—recognizable around the world—originally designed by a
college student for $35. Nike became highly successful in designing and marketing mass-
appealing products such as the Air Jordan, the best selling athletic shoe of all time.
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, Nike has no production facilities in the United States. Rather, the company manufactures
athletic shoes and garments in such Asian countries as India, Indonesia, and Vietnam using
subcontractors, and sells the products in the U.S. and international markets. In each of those
Asian countries where Nike has production facilities, the rates of unemployment and under-
employment are relatively high. The wage rate is very low in those countries by U.S.
standards—the hourly wage rate in the manufacturing sector is less than $ 2 in each of those
countries, compared with about $ 38 in the United States. In addition, workers in those countries
often operate in poor and unhealthy environments and their rights are not particularly well
protected. Understandably, host countries are eager to attract foreign investments like Nike‘s to
develop their economies and raise the living standards of their citizens. Recently, however, Nike
came under worldwide criticism for its practice of hiring workers for such a low rate of pay—
―next to nothing‖ in the words of critics—and overlooking poor working conditions in host
countries.
Initially, Nike denied the sweatshop charges and lashed out at critics. But later, the
company began monitoring the labor practice at its overseas factories and grading the factories
in order to improve labor standards. Nike also agreed to random factory inspections by
disinterested parties.
Discussion points
1. Do you think the criticism of Nike is fair, considering that the host countries are in dire
needs of creating jobs?
2. What do you think Nike‘s executives might have done differently to prevent the
sensitive charges of sweatshop labor in overseas factories?
3. Do firms need to consider the so-called corporate social responsibilities in making
investment decisions?
Suggested Solution to Nike and Sweatshop Labor
Obviously, Nike‘s investments in such Asian countries as China, Indonesia, and Vietnam
were motivated to take advantage of low labor costs in those countries. While Nike was
criticized for the poor working conditions for its workers, the company has recognized the
problem and has substantially improved the working environments recently. Although Nike‘s
workers get paid very low wages by the Western standard, they probably are making
substantially more than their local compatriots who are either under- or unemployed. While
Nike‘s detractors may have valid points, one should not downplay the fact that the company is
making contributions to the economic welfare of those Asian countries by creating job
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, opportunities and also helping earn hard currencies that can be used to fund economic growth
of those countries.
APPENDIX 1A. GAIN FROM TRADE: THE THEORY OF COMPARATIVE ADVANTAGE
PROBLEMS
1. Country C can produce seven pounds of food or four yards of textiles per unit of input.
Compute the opportunity cost of producing food instead of textiles. Similarly, compute the
opportunity cost of producing textiles instead of food.
Solution: The opportunity cost of producing food instead of textiles is one yard of textiles per
7/4 = 1.75 pounds of food. A pound of food has an opportunity cost of 4/7 = .57 yards of
textiles.
2. Consider the no-trade input/output situation presented in the following table for Countries X
and Y. Assuming that free trade is allowed, develop a scenario that will benefit the citizens of
both countries.
INPUT/OUTPUT WITHOUT TRADE
_______________________________________________________________________
Country
X Y Total
________________________________________________________________________
I. Units of Input (000,000)
_______________________ ______________________________
Food 70 60
Textiles 40 30
________________________________________________________________________
II. Output per Unit of Input (lbs or yards)
____________________________________________________
Food 17 5
Textiles 5 2
________________________________________________________________________
III. Total Output (lbs or yards) (000,000)
____________________________________________________
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, Food 1,190 300 1,490
Textiles 200 60 260
________________________________________________________________________
IV. Consumption (lbs or yards) (000,000)
___________________________________________________
Food 1,190 300 1,490
Textiles 200 60 260
________________________________________________________________________
Solution:
Examination of the no-trade input/output table indicates that Country X has an absolute
advantage in the production of food and textiles. Country X can ―trade off‖ one unit of
production needed to produce 17 pounds of food for five yards of textiles. Thus, a yard of
textiles has an opportunity cost of = 3.40 pounds of food, or a pound of food has an
opportunity cost of 5 /17 = .29 yards of textiles. Analogously, Country Y has an opportunity
cost of = 2.50 pounds of food per yard of textiles, or = .40 yards of textiles per pound
of food. In terms of opportunity cost, it is clear that Country X is relatively more efficient in
producing food and Country Y is relatively more efficient in producing textiles. Thus, Country X
(Y) has a comparative advantage in producing food (textile) is comparison to Country Y (X).
When there are no restrictions or impediments to free trade the economic-well being of
the citizens of both countries is enhanced through trade. Suppose that Country X shifts
20,000,000 units from the production of textiles to the production of food where it has a
comparative advantage and that Country Y shifts 60,000,000 units from the production of food
to the production of textiles where it has a comparative advantage. Total output will now be
(90,000,000 × 17 =) 1,530,000,000 pounds of food and [(20,000,000 × 5 =100,000,000) +
(90,000,000 × 2 =180,000,000) =] 280,000,000 yards of textiles. Further suppose that Country
X and Country Y agree on a price of 3.00 pounds of food for one yard of textiles, and that
Country X sells Country Y 330,000,000 pounds of food for 110,000,000 yards of textiles. Under
free trade, the following table shows that the citizens of Country X (Y) have increased their
consumption of food by 10,000,000 (30,000,000) pounds and textiles by 10,000,000
(10,000,000) yards.
INPUT/OUTPUT WITH FREE TRADE
__________________________________________________________________________
Country
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, X Y Total
__________________________________________________________________________
I. Units of Input (000,000)
_______________________________________________________
Food 90 0
Textiles 20 90
__________________________________________________________________________
II. Output per Unit of Input (lbs or yards)
______________________________________________________
Food 17 5
Textiles 5 2
__________________________________________________________________________
III. Total Output (lbs or yards) (000,000)
_____________________________________________________
Food 1,530 0 1,530
Textiles 100 180 280
__________________________________________________________________________
IV. Consumption (lbs or yards) (000,000)
_____________________________________________________
Food 1,200 330 1,530
Textiles 210 70 280
__________________________________________________________________________
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, CHAPTER 2 INTERNATIONAL MONETARY SYSTEM
ANSWERS & SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS
QUESTIONS
1. Explain Gresham‘s Law.
Answer: Gresham‘s law refers to the phenomenon that bad (abundant) money drives good
(scarce) money out of circulation. This kind of phenomenon was often observed under the
bimetallic standard under which both gold and silver were used as means of payments, with the
exchange rate between the two fixed.
2. Explain the mechanism which restores the balance of payments equilibrium when it is
disturbed under the gold standard.
Answer: The adjustment mechanism under the gold standard is referred to as the price-specie-
flow mechanism expounded by David Hume. Under the gold standard, a balance of payment
disequilibrium will be corrected by a counter-flow of gold. Suppose that the U.S. imports more
from the U.K. than it exports to the latter. Under the classical gold standard, gold, which is the
only means of international payments, will flow from the U.S. to the U.K. As a result, the U.S.
(U.K.) will experience a decrease (increase) in money supply. This means that the price level
will tend to fall in the U.S. and rise in the U.K. Consequently, the U.S. products become more
competitive in the export market, while U.K. products become less competitive. This change will
improve U.S. balance of payments and at the same time hurt the U.K. balance of payments,
eventually eliminating the initial BOP disequilibrium.
3. Suppose that the pound is pegged to gold at 6 pounds per ounce, whereas the franc is
pegged to gold at 12 francs per ounce. This, of course, implies that the equilibrium exchange
rate should be two francs per pound. If the current market exchange rate is 2.2 francs per
pound, how would you take advantage of this situation? What would be the effect of shipping
costs?
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