, 1 INTRODUCTION TO IFM
1.1 REMINDER: FINANCIAL MANAGEMENT
Financial management consist of 3 sets of decisions:
- Investment decisions: in what does a firm invest?
Page | 1 - Financing decisions: how does a firm finances its operations?
- Risk management decisions: how to hedge risks that affect profitability?
1 predefined objective = shareholders wealth maximization
→ This is the most important corporate objective in Anglo-Saxon countries
→ Does not have to be the case
1.2 WHAT DOES INTERNATIONAL FINANCIAL MANAGEMENT REFER TO?
International financial management refers to the role of the finance director in a company with
international activities.
The international finance director takes the same decisions as the regular finance director BUT:
- Considers more opportunities: investments can be done in many countries, they can raise funds in
many capital markets, can choose other securities
- Takes into account additional market imperfections: legal restrictions, transportation and
transaction costs, taxes, … are different from country to country
- Assesses and hedges additional risks: currency risk, political risk
1.3 MOTIVATIONS
FACT 1 : We are living in a highly globalized world
The KOF globalization index measures globalization for every
country in the world.
→ Distinguishes between:
o Economic globalization: “long distance flows of goods,
capital and services …”
o Social globalization: “spread of ideas, information,
images and people”
o Political globalization: “diffusion of government policies:
ability to engage in international political cooperation”
International financial openness
→ Index based on both the numbers and the severity of
restrictions on capital flows
FACT 2 : For a large number of companies, international activities have become an important part
of their total activity.
Case of multinational companies (MNCs)
→ MNC undertake foreign direct investments (FDIs). FDIs are investments involving a certain measure
of control of a foreign business
“The term MNC suggest a firm obtaining raw materials from one national market and financial capital from another, producing
goods with labor and capital equipment in a third country, and selling the finished product in yet other national markets. Indeed,
some MNCs have operations in dozens of different countries. MNCs obtain financing from major money centers around the world in
many different currencies to finance their operations. “
,1.4 THE INVESTMENT DECISION
How does the international dimension affect the investment decision?
National markets are more and more but not perfectly
integrated.
The same investment in different countries does Page | 2
not have the same value: taking the best
investment decisions involves to take into
account cross-country differences.
o Level of cash flows: taxes, cost of labor,
legal restrictions, exchange rates, …
o Risk: currency risk, political risk, …
1.5 THE FINANCING DECISION
How does the international dimension affect the financing decision?
National markets are more and more but not perfectly
integrated.
The same security issued to obtain funds does
not have the same cost everywhere: taking the
best financing decision involves to take into
account cross-country differences that affect
the cost of capital.
If you want to save on the cost of capital then you have
to issue securities in countries with less restrictions on
cash flow.
1.6 THE RISK MANAGEMENT DECISION
1.6.1 CURRENCY RISK
Companies with international activities are exposed to
currency risk.
Risk of a sudden change in an exchange rate.
Fluctuations in exchange rates can affect a firm’s cash
flows and value.
Ex. Suppose your company is based in the US, sells goods whose
price is dominated in US dollar to Japan ↓ of the JPY-USD exchange
rate: ↑ in the yen value of your goods relative to other suppliers, ↓ market share, ↓ CFs
Firms do hedge currency risk by using different methods: currency derivative contracts such as forwards,
options, swaps, …
, 1.6.2 POLITICAL RISK
Companies with international activities are exposed to
political risk
Risk of adverse political developments in a
foreign country in which a MNC has operations
Ex. expropriation of foreign assets, unexpected changes in
Page | 3 the tax laws …
Adverse political developments can affect a firm’s cash flows and value
Ex. Suppose that a nationalist party AGAINST foreign investment wins the local election and cancels your company’s project after
investment has begun: loss of the stream of present and future profits associated with the project.
Firms do hedge political risk by using different methods: purchase insurance against political risk, …
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