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Summary International Corporate Finance
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- Vrije Universiteit Brussel (VUB)
Summary of International Corporate Finance for MA1 Business Engineering at the VUB.
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International Corporate FinanceChapter 1: Introduction
International Finance or the Existence of Borders:
What is the truest definition of globalization?
ð Princess Diana’s death:
“An English princess with an Egyptian boyfriend crashes in a French tunnel, driving a
German car with a Dutch engine, driven by a Belgian who was drunk on Scottish whisky,
followed closely by Italian Paparazzi, on Japanese motorcycles; treated by an American
doctor, using Brazilian medicines.”
Borders still matter in Finance:
• 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 ↔ Globally integrated entity
Globalization:
The world is becoming increasingly globalized:
ð Globalization: increasing connectivity and integration of countries and corporations
and the people within them in terms of their economic, political, and social activities.
ð 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 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
à The world becomes open. By 2000 more than 70% of countries are open to trade
à Result: growing trade flows between countries
The globalization of financial markets:
• Financial openness: in the 1980s, many developed countries began liberalizing their
capital markets.
o Countries allow foreigners to invest in their capital markets and allow their
citizens to invest abroad
1
, • Advantages for MNC (Multinational Corporations)’s:
o Access to foreign capital
o Ability to reduce financing costs
Globalization and the MNC:
• Growing trade flows between countries = growing opportunities for MNC’s
o 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:
Foreign Direct Investment:
• 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
2
, • Globalized production
• Integrated financial markets
à 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:
1. Existence of national currencies
à exchange rates & exchange risks
2. Segmentation of goods markets along national lines
3. Existence of separate judicial systems
4. Sovereign autonomy of countries
à Political risk
5. Separate (incompatible?) tax systems → double or triple
taxation
Exchange-rate risk:
Why do most countries have their own money?
1. Printing bank notes is a positive NPV activity
2. National pride: Pound, Danes
3. Monetary policy that is tailored to the local situation
ð Exchange-rate risk: uncertainty about the value of an asset or liability and is
denominated in a foreign currency.
Segmentation of consumer-goods markets – The Big Mac standard:
Three key features of prices:
1. 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
2. Within a country: prices more homogeneous
3. Sticky prices (price elasticity)
3
, 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, there are two main consequences:
1. Affects the competitiveness and attractiveness of a country on the export or import
market.
2. How do you value investments? Cfr. capital budgeting decisions.
Importance of the import market:
Importance of the export market:
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