Anupama Chowdhary 08-MBA-11

Portfolio investments represent passive holdings of securities such as foreign stocks, bonds, or other financial assets, none of which entail active management or control of the securities issuer by the investor. Foreign direct investment (FDI) acquisition of foreign assets for the purpose of controlling them. U.S. government statisticians define FDI as ownership or control of 10 percent or more of an enterprises voting securitiesor the equivalent interest in an unincorporated U.S. business.

 Ownership

Advantage Theory. Capital Arbitrage Theory. Market Imperfection Theory. International Product Life Cycle Theory. Internalization Theory. Dunnings Eclectic Theory.

The ownership advantage theory suggests that a firm owning a valuable asset that creates a competitive advantage domestically can use that advantage to penetrate foreign markets through FDI.

The Theory of capital arbitrage is suitable for foreign portfolio investments where the returns on capital are crucial in the short term. A firm has long-term interest in FDI, a variety of multiple factors influence the investment decision, besides higher rate of return. Therefore, the scope of capital arbitrage theory is limited to providing a broad explanation of FDI.

Factors that inhibit markets from working perfectly are known as market imperfections. Govt. policies, including import restrictions and quotas, incentives on exports and FDI are some of the examples of government intervention that create market imperfections. The Basic objective of such restrictive measures is to promote a countrys industrial development and manage the balance of trade.

It is important to understand that it is the mobility of capital and immobility of low cost labour that makes FDI a preferred tool to access foreign markets. Firms often take advantage of market imperfections, such as economies of scale and scope, product differentiations, financial strengths, etc., by way of investing abroad.

International Product life cycle theory developed by Raymond Vernon provides an explanation as to why production locations are shifted across countries. IPLC theory is valid for both trade and investment and provides a dependable explanation about trade patterns and investment.

The theory explains why firms undertake FDI in countries with low production costs and considerable demand to support local production. The theory applies mainly to industrial FDI in manufacturing sector. It is generally relevant to large firms with innovating capabilities. The IPLC theory ignores revenue as it is too cost-oriented.

Transaction costs are the costs of entering into a transaction; that is, those connected to negotiating, monitoring, and enforcing a contract.

Internalization theory suggests that FDI is more likely to occurthat is, international production will be internalized within the firmwhen the costs of negotiating, monitoring, and enforcing a contract with a second firm are high.

This theory recognizes that FDI reflects both international business activity and business activity internal to the firm. According to Dunning, FDI will occur when three conditions are met: Ownership advantage Location advantage Internalization advantage

Numerous factors may influence a firms decision to undertake FDI. These can be classified as supply factors, demand factors, and political factors. Supply factors Production costs Logistics Availability of natural resources Access to key technology

Demand factors Customer access Marketing advantages Exploitation of competitive advantages Customer mobility Political factors Avoidance of trade barriers Economic development incentives