This is no more than the slides that are literally taken over
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By: briancuylaerts • 5 year ago
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Introduction
Globalization
Typical economic models: closed economy (no interrelationships with the rest of the world)But, we live
and do business in a world with distinct countries more or less independent.
The world is becoming increasingly globalized
Globalization= increasing connectivity and integration of countries and corporations and the people within
them in terms of their economic, political, and social activities.
The international scope of business creates new opportunities for firms
The growth of international trade
1960: only about 20% of countries were open to trade (U.S., U.K., Western Europe)
The world was dominated by the western culture = 10% of the world's population having access to 80% of
the resources, while the rest of the world was underdeveloped
Early 1980s: belief in free markets leads to worldwide deregulation
1990: fall of the Iron Curtain + trade liberalizations
→the world becomes open. By 2000 more than 70% of countries are open to trade
→Result: growing trade flows between countries
Globalization of financial markets
Financial openness: in the 1980s many developed countries began liberalizing their capital markets
→countries allow foreigners to invest in their capital markets and allow their citizens to invest abroad
Advantages for MNC's(= multinational companies):
- Access to foreign capital
- Ability to reduce financing costs
Globalization and the MNC
Growing trade flows between countries = growing opportunities for MNCs
→MNC's are moving their production capacity to underdeveloped countries, minimizing labor costs, and
reexport these goods to the west where they are sold.
,Result of globalization
- Highly globalized and integrated world economy
o E.g. financial crisis in 2007 starting in the US housing market, leading to a global recession
- Continued liberalization of international trade
- Globalized production
- Integrated financial markets
→Important to understand the international setting in which firms are operating and how corporate
financial decisions are made.
Return/risk in an international setting
Multinational firms: operations beyond domestic national borders
Risk and return opportunities outside the domestic market
→How can we maximize the return on firm's investment, given an acceptable level of risk?
Borders complicate the job of the CFO
- Existence of national currencies
→exchange rates & exchange risks
- Segmentation of goods markets along national lines
- Existence of separate judicial systems
- Sovereign autonomy of countries
→political risk
- Separate (incompatible?) tax systems
→double or triple taxation
Exchange-rate risk= uncertainty about the value of an asset or
liability and is denominated in a foreign currency.
Why do most countries have there own money?
- Printing bank notes is a positive NPV activity
- National pride: Pound, Danes
- Monetary policy that is tailored to the local situation
Three key features of price
- Prices are not homogeneous internationally, even if labelled into a common currency
o Purchasing-power parity (PPP)
o Short term vs. long term
o Common feature: prices rise with GDP per capita
- Within a country: prices more homogeneous
- Sticky prices (price elasticity) → prices don’t adjust immediately to exchange rates.
Exchange rates
Short run exchange rate fluctuations
Little to do with the international prices in the countries involved
Appreciation of a currency does not lead to falling prices abroad or soaring prices at home to keep good
prices similar in both countries
,However, two main consequences:
- Affects the competitiveness and attractiveness of a country on the export or import market
- How do you value investments? Cfr. capital budgeting decisions
Consequence 1: Exchange rates and the import and export markets
Example of the impact:
Consider an electronic component priced at $10 in the U.S. that will be exported to India
Assume the exchange rate is 50 rupees to the U.S. dollar
Ignoring shipping and other transaction costs such as import duties for the moment, the $10 item would
cost the Indian importer 500 rupees.
$ strengthens against the Indian rupee to a level of 55
Assuming that the U.S. exporter leaves the $10 price for the component unchanged, its price would
increase to 550 rupees ($10 * 55) for the Indian importer
This may force the Indian importer to look for cheaper components from other locations
→The 10% appreciation in the dollar versus the rupee has thus diminished the U.S. exporter's
competitiveness in the Indian market
A garment exporter in India whose primary market is the U.S:
A shirt that the exporter sells for $10 in the U.S. market would fetch her 500 rupees when the export
proceeds are received.
Assume an exchange rate of 50 rupees to the $
If the rupee weakens to 55 versus the dollar, to receive the same amount
of rupees (500), the exporter can now sell the shirt for $9.09
→10% depreciation in the rupee versus the $ has therefore improved the Indian exporter's
competitiveness in the U.S. market
Consequence 2: Capital budgeting decisions
Exchange rate risks also affect asset values
Depending on where they live, investors will realize different return from
one given asset if the exchange-rate changes.
, Credit risk:
- Domestic: if a customer does not pay you, you go to court!
- Internationally: Two legal systems involved, which may be contradicting
→Business seeks the guarantees from financial institutions (banks, insurance etc.) because:
- Better placed to deal with credit risks shifted towards them
- Have an incentive to honor their commitments to preserve their reputation
Political risk:
- Transfer risks: currency controls by blocking exchange contracts (money stuck abroad)
- Expropriation= the seizure of private property by a public agency for a purpose deemed to be in
the public interest. In particular in strategic sectors (energy, transportation etc.)
International business: where are you taxed?
Governments want to touch all residents for a share of their income whether domestic or foreign
Idea is to tax anybody making money within their territory
Icelandic business sets up a shop in Luxembourg.
- Taxed in Luxembourg: it is a resident of Luxembourg
- Firm pays a dividend to its parent: both Luxembourg and Iceland may want to tax the parent
→Double taxation & Treaty shopping
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