International Financial Management

Oleh : Dr. Heri Ispriyahadi SE MBA

Buku Wajib
◻ International Financial Management Jeff
Madura
◻ Multinational Business Finance, 2013 David K
Eitemen, Arthur I Stonehill dan Michael H.
Moffet
◻ Foundations of Multinational Financial
Management , 7th Edition Allan Shapiro
◻ Fundamentals of Multinational Finance Moffet
, Stonehill, Eitemen.
◻ International Finance ---> eun, Resnick and
Sabherwal
 Metode Penilaian

◻ Absensi 10%
◻ Tugas Individual & diskusi
kelompok 20%
◻ Ujian Tengah Semester (UTS)
30%
◻ Ujian Akhir Semester (UAS)
40%
Total 100 %
Ouline
◻ Overview
◻ The Definition of Multinational
Companies (MNCs)
◻ The Goal of MNC
◻ Theories of International Business
◻ International Business Methods
◻ The Globalization Process
 The International Financial Environment

Multinational Corporation (MNC)

Foreign Exchange Markets

Dividend
Remittance
& Financing Investing
Exporting & Financing
& Importing

Product Markets Subsidiaries International

Financial
Markets
 overview
Firms Strategies to improve their cash flows
❑ Expansion within local areas
❑ The penetrations of foreign markets
Recently, many barriers to entry into foreign
markets have been removed, thereby
encouraging firms to pursue international
business (producing and/or selling goods in
foreign countries.
Many firms involved into Multinational Companies
 overview
◻ An Understanding of international financial
management is crucial to not only the large MNCs
with large numerous foreign subsidiaries, but also
to the small firms that conduct international
business.
◻ Several factors affected MNCs are movement in
exchange rates, foreign interest rates, labor cost
and competitors’ cost of production and pricing
policy.
◻ Japanese firms have international business as
means of growth. Japan based MNCs such as
Theories of International Business

Why are firms motivated to expand

their business internationally?

❶ Theory of Comparative Advantage

Specialization by countries can increase production
efficiency.
❷ Imperfect Markets Theory
The markets for the various resources used in
production are “imperfect.”
Theories of International Business

Why are firms motivated to expand

their business internationally?

❸ Product Cycle Theory

As a firm matures, it may recognize additional
opportunities outside its home country.
The Definition of MNCs
◻ A corporation that
operates in two or more
countries.
◻ Decision making within
the corporation may be
centralized in the home
country, or may be
decentralized across the
countries the
corporation does
business in.
 The Definition of MNCs
8/23

◻ Initially, firms may merely attempt to export

products to particular country or import supplies
from a foreign manufacturer. Overtime, however,
many of them recognized additional foreign
opportunities and eventually established
subsidiaries in foreign countries,
◻ Annually 80% of its annual operating income is
typically generated outside of US.
Why do firms expand into other countries?
1. To seek new markets.
2. To seek raw materials.
3. To seek new technology.
4. To seek production efficiency.
5. To avoid political and regulatory hurdles.
6. To diversify.
 The Goal of MNCs
◻ The Goal of MNCs is to maximize
shareholder wealth.

◻ Constraints interfering with the MNC

Objective

Environmental constraints
Regulatory constraint
Ethical constraint
 Theories of International Business

◻ Theory of comparative advantage

◻ Imperfect Market Theory
◻ Product life Cycle
 International Busines Methods
◻ International trade
◻ Licensing
◻ Franchising
◻ Joint ventures
◻ Acquisitions of existing operations
◻ Establishing new foreign subsidiaries
 International
Business Methods
◻ International trade is a relatively conservative
approach involving exporting and/or importing.
The internet facilitates international trade by
enabling firms to advertise and manage orders
through their websites.
 International
Business Methods
◻ Licensing allows a firm to provide its technology in
exchange for fees or some other benefits.
◻ Franchising obligates a firm to provide a
specialized sales or service strategy, support
assistance, and possibly an initial investment in the
franchise in exchange for periodic fees.
 International
Business Methods
◻ Firms may also penetrate foreign markets by
engaging in a joint venture (joint ownership and
operation) with firms that reside in those markets.
◻ Acquisitions of existing operations in foreign
countries allow firms to quickly gain control over
foreign operations as well as a share of the foreign
market.
 International
Business Methods

◻ Firms can also penetrate foreign markets by

establishing new foreign subsidiaries.
◻ In general, any method of conducting business
that requires a direct investment in foreign
operations is referred to as a direct foreign
investment (DFI).
◻ The optimal international business method may
depend on the characteristics of the MNC.
Increased Globalization

◻ Growth in international trade

◻ Growth in Direct Foreign Investment
◻ Relationship between globalization and
Profitability
◻ International Opportunities and Risk.
What factors distinguish multinational financial
management from domestic financial management?

1. Different currency denominations.

2. Economic and legal ramifications.
3. Language differences.
4. Cultural differences.
5. Role of governments.
6. Political risk.
Moment in Time When Exchange Rate Changes

Translatio
Operating
n
Exposure
Exposure
Transactio
n
Exposure
Consider the following exchange
rates
US $ to buy 1 unit
Japanese yen 0.009
Australian dollar 0.650

◻ Are these currency prices direct or indirect

quotations?
Since they are prices of foreign currencies
expressed in dollars, they are direct quotations.
What is an indirect quotation?

◻ The number of units of a foreign

currency needed to purchase one U.S.
dollar, or the reciprocal of a direct
quotation.
◻ Are you more likely to observe direct or
indirect quotations?
Most exchange rates are stated in terms of
an indirect quotation.
Except the British pound, which is usually
in terms of a direct quotation.
Calculate the indirect quotations for yen
and Australian dollar
# of units of foreign
currency per US $
Japanese yen 111.11
Australian dollar 1.5385

◻ Simply find the inverse of the direct

quotations.
What is a cross rate?

◻ The exchange rate between any two

currencies. Cross rates are actually calculated
on the basis of various currencies relative to
the U.S. dollar.
◻ Cross rate between Australian dollar and the
Japanese yen.
Cross rate = (Yen / US Dollar) x (US Dollar / A. Dollar)
= 111.11 x 0.650
= 72.22 Yen / A. Dollar
The inverse of this cross rate yields:
0.0138 A. Dollars / Yen
Orange juice project:
Setting the appropriate price
◻ A firm can produce a liter of orange juice and ship
it to Japan for $1.75 per unit. If the firm wants a
50% markup on the project, what should the juice
sell for in Japan?

Price = (1.75)(1.50)(111.11)
= 291.66 yen
Orange juice project:
Determining profitability
◻ The product will cost 250 yen to produce and
ship to Australia, where it can be sold for 6
Australian dollars. What is the U.S. dollar
profit on the sale?
Cost in A. dollars = 250 yen (0.0138)
= 3.45 A. dollars
A. dollar profit = 6 – 3.45 = 2.55 A. dollars
U.S. dollar profit = 2.55 / 1.5385 = $1.66
What is exchange rate risk?

◻ The risk that the value of a cash flow in one

currency translated to another currency will
decline due to a change in exchange rates.
◻ For example, in the last slide, a weakening
Australian dollar (strengthening dollar) would
lower the dollar profit.
◻ The current international monetary system is a
floating rate system.
European Monetary Union

◻ In 2002, the full implementation of the

“euro” was completed. The national
currencies of the 12 participating countries
were phased out in favor of the “euro.” The
newly formed European Central Bank
controls the monetary policy of the EMU.
 Member nations of the EMU

◻ Austria ■ Ireland
◻ Belgium■ Italy
◻ Finland ■ Luxembourg
◻ France ■ Netherlands
◻ Germany■ Portugal
◻ Greece ■ Spain
■ Notable European Union
countries not in the EMU:
■ Britain, Sweden, and
Denmark
What is a convertible currency?

◻ A currency is convertible when the

issuing country promises to redeem the
currency at current market rates.
◻ Convertible currencies are traded in
world currency markets.
What problems may arise when a firm operates
in a country whose currency is not convertible?

◻ It becomes very difficult for

multi-national companies to conduct
business because there is no easy way to
take profits out of the country.
◻ Often, firms will barter for goods to
export to their home countries.
What is difference between spot
rates and forward rates?

◻ Spot rates are the rates to buy currency

for immediate delivery.
◻ Forward rates are the rates to buy
currency at some agreed-upon date in
the future.
When is the forward rate at a
premium to the spot rate?

◻ If the U.S. dollar buys fewer units of a

foreign currency in the forward than in
the spot market, the foreign currency is
selling at a premium.
◻ In the opposite situation, the foreign
currency is selling at a discount.
◻ The primary determinant of the
spot/forward rate relationship is relative
interest rates.
What is interest rate parity?

◻ Interest rate parity holds that investors should

expect to earn the same return in all countries after
adjusting for risk.
Evaluating interest rate parity

◻ Suppose one yen buys $0.0095 in the

30-day forward exchange market and kNOM
for a 30-day risk-free security in Japan and
in the U.S. is 4%.
ft = 0.0095
kh = 4% / 12 = 0.333%
kf = 4% / 12 = 0.333%
Does interest rate parity hold?

◻ Therefore, for interest rate parity to hold, e0

must equal $0.0095, but we were given earlier
that e0 = $0.0090.
Which security offers the highest
return?
◻ The Japanese security.
Convert $1,000 to yen in the spot market.
$1,000 x 111.111 = 111,111 yen.
Invest 111,111 yen in 30-day Japanese security. In 30
days receive 111,111 yen x 1.00333 = 111,481 yen.
Agree today to exchange 111,481 yen 30 days from now
at forward rate, 111,481/105.2632 = $1,059.07.
30-day return = $59.07/$1,000 = 5.907%, nominal
annual return = 12 x 5.907% = 70.88%.
What is purchasing power parity
(PPP)?
◻ Purchasing power parity implies that the level of
exchange rates adjusts so that identical goods cost
the same amount in different countries.
Ph = Pf(e0)
-OR-
e0 = Ph/Pf
If grapefruit juice costs $2.00 per liter in the U.S. and PPP
holds, what is the price of grapefruit juice in Australia?

e0 = Ph/Pf
$0.6500 = $2.00/Pf
Pf = $2.00/$0.6500
= 3.0769 Australian dollars.
What impact does relative inflation have
on interest rates and exchange rates?

◻ Lower inflation leads to lower interest rates, so

borrowing in low-interest countries may appear
attractive to multinational firms.
◻ However, currencies in low-inflation countries
tend to appreciate against those in high-inflation
rate countries, so the effective interest cost
increases over the life of the loan.
International money and
capital markets
◻ Eurodollar markets
a source of dollars outside the U.S.
◻ International bonds
Foreign bonds – sold by foreign borrower,
but denominated in the currency of the
country of issue.
Eurobonds – sold in country other than the
one in whose currency the bonds are
denominated.
To what extent do average capital structures
vary across different countries?

◻ Previous studies suggested that average

capital structures vary among the large
industrial countries.
◻ However, a recent study, which controlled
for differences in accounting practices,
suggests that capital structures are more
similar across different countries than
previously thought.
Impact of multinational operations

◻ Cash management
Distances are greater.
Access to more markets for loans and for
temporary investments.
Cash is often denominated in different
currencies.
Impact of multinational operations

◻ Capital budgeting decisions

Foreign operations are taxed locally, and
then funds repatriated may be subject to U.S.
taxes.
Foreign projects are subject to political risk.
Funds repatriated must be converted to U.S.
dollars, so exchange rate risk must be taken
into account.
Impact of multinational operations

◻ Credit management
Credit is more important, because commerce to
lesser-developed countries often relies on
credit.
Credit for future payment may be subject to
exchange rate risk.
◻ Inventory management
Inventory decisions can be more complex,
especially when inventory can be stored in
locations in different countries.
Some factors to consider are shipping times,
carrying costs, taxes, import duties, and
exchange rates.