• 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
• Closed economy ↔ Global integrated entity
• 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
• 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
• 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:
• Access to foreign capital
• Ability to reduce financing costs
• Growing trade flows between countries = growing opportunities for MNC’s
→ 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 – FDI
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
,Why do most countries have their own money?
Printing bank notes is a positive NPV activity
National pride: Pound, Danes
Monetary policy that is tailored to the local situation
Exchange-rate risk: uncertainty about the value of an asset or liability and is denominated
in a foreign currency
Three key features of prices
Prices are not homogeneous internationally, even if labeled into a common currency
• Purchasing-power parity (PPP)
• Short term vs. long term
• Common feature: prices rise with GDP per capita
Within a country: prices more homogeneous
Sticky prices (price elasticity)
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
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
Two types of political risks
• Transfer risks: currency controls by blocking exchange contracts (money stuck
abroad)
• Expropriation: In particular in strategic sectors (energy, transportation etc.)
• How does one estimate the probability of this happening and the size of the value
loss?
, 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
History of international markets
Money or the least cost medium of exchange
• Use for buying and selling. Could you consider a world or trade without money?
Trade with money easier and faster: lower cost
Flexibility in purchasing other goods you need
• Three conditions for money to be successful medium of exchange:
Storable
Stable purchasing power (PP)
Easy to handle
Transfer purchasing power over time with low-risk
Primitive economies
• Domestic animals as unit of account (pecunia = pecus = cattle) but hard to carry
• Precious metals as a means of payment:
Easy to transport than cattle
Does not rust
Production costly enough to ensure demand
• Gold and silver money defined by its weight:
As (Rome’s basic currency), Lira, Libra, Pound
Over time: no longer near the value of silver because of debasing
Debasing of currency & Seigniorage
• Lords then became poachers themselves
• In 1290, King Philip IV of France did not have enough money to pay for his wars, so
he began to debase the currency by increasing the seigniorage he extracted from
melting new coins
• Called in Flanders Flup de munteschroder/Flup the coinscratcher
• Threatening of the stability of the money’s purchasing power
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