المملكة العربية السعودية
وزارة التعليم
الجامعة السعودية اإللكترونية
Kingdom of Saudi Arabia
Ministry of Education
Saudi Electronic University
College of Administrative and Financial Sciences
Assignment 3
FIN 406 (2nd Term 2021-2022)
Deadline: 22/05/2022 @ 23:59
Course Name: International Finance
Student’s Name:
Course Code: FIN 406
Student’s ID Number:
Semester: II
CRN:
Academic Year: 1442/1443 H, 2nd Term
For Instructor’s Use only
Instructor’s Name: Sulaiman Aldhawyan
Students’ Grade:
/ 10
Level of Marks: High/Middle/Low
Instructions – PLEASE READ THEM CAREFULLY
•
•
This assignment is an individual assignment.
The Assignment must be submitted only in WORD format via allocated folder.
•
Assignments submitted through email will not be accepted.
•
Students are advised to make their work clear and well presented, marks may be
reduced for poor presentation. This includes filling your information on the cover
page.
•
Students must mention question number clearly in their answer.
•
Late submission will NOT be accepted.
•
Avoid plagiarism, the work should be in your own words, copying from students
or other resources without proper referencing will result in ZERO marks. No
exceptions.
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All answered must be typed using Times New Roman (size 12, double-spaced)
font. No pictures containing text will be accepted and will be considered
plagiarism).
Submissions without this cover page will NOT be accepted.
Kingdom of Saudi Arabia
Ministry of Education
Saudi Electronic University
المملكة العربية السعودية
وزارة التعليم
الجامعة السعودية اإللكترونية
College of Administrative and Financial Sciences
You are required to provide a critical analysis of the following question in 1000 words.
Use evidence and recent research results to support your answer. You should refer to
the wider literature and real-life examples.
Should companies hedge their exposures to foreign exchange risk? Discuss both views
critically and state your recommendation. Use relevant research results to support your
answer.
In this assessment, the following learning outcomes will be covered:
LO 1. Demonstrate comprehensive knowledge of exchange rate systems and the interaction
between exchange rates, interest rates and inflation
LO 2. Appreciate the types of risks faced by investors and multinational companies
LO 3. Apply and critically evaluate alternative techniques for managing foreign exchange
risks
Answer:
Fundamentals of
MULTINATIONAL
FINANCE
Fifth Edition
The Pearson Series in Finance
Berk/DeMarzo
Corporate Finance*
Corporate Finance: The Core*
Berk/DeMarzo/Harford
Fundamentals of Corporate
Finance*
Brooks
Financial Management:
Core Concepts*
Copeland/Weston/Shastri
Financial Theory and Corporate
Policy
Dorfman/Cather
Introduction to Risk
Management and Insurance
Eakins/McNally
Corporate Finance Online*
Eiteman/Stonehill/Moffett
Multinational Business Finance
Fabozzi
Bond Markets: Analysis
and Strategies
Fabozzi/Modigliani/Jones
Foundations of Financial
Markets and Institutions
Finkler
Financial Management
for Public, Health, and
Not-for-Profit Organizations
Foerster
Financial Management: Concepts
and Applications*
Frasca
Personal Finance
Gitman/Zutter
Principles of Managerial
Finance*
Principles of Managerial
Finance—Brief Edition*
Haugen
The Inefficient Stock Market:
What Pays Off and Why
Modern Investment Theory
Holden
Excel Modeling in Corporate
Finance
Excel Modeling in Investments
Hughes/MacDonald
International Banking: Text
and Cases
Hull
Fundamentals of Futures
and Options Markets
Options, Futures, and Other
Derivatives
Keown
Personal Finance: Turning
Money into Wealth*
Keown/Martin/Petty
Foundations of Finance: The
Logic and Practice of Financial
Management*
Kim/Nofsinger
Corporate Governance
Madura
Personal Finance*
*denotes
Marthinsen
Risk Takers: Uses and Abuses
of Financial Derivatives
McDonald
Derivatives Markets
Fundamentals of Derivatives
Markets
Mishkin/Eakins
Financial Markets
and Institutions
Moffett/Stonehill/Eiteman
Fundamentals of Multinational
Finance
Nofsinger
Psychology of Investing
Pennacchi
Theory of Asset Pricing
Rejda/McNamara
Principles of Risk Management
and Insurance
Smart/Gitman/Joehnk
Fundamentals of Investing*
Solnik/McLeavey
Global Investments
Titman/Keown/Martin
Financial Management:
Principles and Applications*
Titman/Martin
Valuation: The Art and Science
of Corporate Investment
Decisions
Weston/Mitchell/Mulherin
Takeovers, Restructuring, and
Corporate Governance
titles Visit www.myfinancelab.com to learn more.
Fundamentals of
Multinational
Finance
Fifth Edition
Michael H. Moffett
Thunderbird School of Global Management
Arthur I. Stonehill
Oregon State University and University of Hawaii at Manoa
David K. Eiteman
University of California, Los Angeles
Boston Columbus Indianapolis New York San Francisco Hoboken
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Library of Congress Cataloging-in-Publication Data
Moffett, Michael H.
Fundamentals of multinational finance / Michael Moffett, Arthur
Stonehill, David Eiteman.—5th edition.
pages cm
Includes bibliographical references and index.
ISBN 978-0-205-98975-1 (alk. paper)
1. International business enterprises—Finance. 2. International
finance. 3. Foreign exchange. I. Stonehill, Arthur I. II. Eiteman,
David K. III. Title.
HG4027.5.M64 2015
332:042—dc23
2014012796
10 9 8 7 6 5 4 3 2 1
www.pearsonhighered.com
ISBN-10:
0-205-98975-6
ISBN-13: 978-0-205-98975-1
v
Preface
Fundamentals of Multinational Finance, Fifth Edition, reflects the multitude of changes sweeping over global business today. This edition has been revised to reflect a global marketplace
that has moved five years beyond global financial crisis and into an era in which new country
markets and players like that of China, India, and Turkey are altering the global financial
landscape. The book has been focused on the challenges faced by the business leaders of
tomorrow in multinational business—with three points of emphasis.
■
■
■
Organizations. The term multinational enterprise (MNE) applies to organizations of all
kinds—the publicly traded, the privately held, the state-run, the state-owned organizations—
all forms that permeate global business today. Who owns and operates the organization
alters its goals and therefore its management.
Markets. Country markets like that of China and India are no longer the sources of lowcost labor for global manufacturers. They are increasingly the focus for sales and growth
of all firms, manufacturing and services, for earnings and growth. Although they may still
be categorized as “emerging,” they are the economic drivers and primary challenges for
global finance and global financial management.
Leadership. Individuals in positions of leadership within these organizations and markets
are faced with a changing global landscape in which emerging market finance is no longer
on the outer edge of financial management, but moving to its core. These leaders of MNEs
face numerous foreign exchange and political risks, which are actually more volatile, with
global capital moving in and out of countries at an ever-increasing rate. These risks can be
daunting but they also present opportunities for creating value if properly understood. In
the end, the primary question is whether business leaders are able to navigate the strategic
and financial challenges that business faces.
New in the Fifth Edition
The theme for this Fifth Edition could be described as the maturation of the emerging markets.
The cast of characters dominating global finance is changing, with economies and currencies
from Russia, China, India, Brazil, Turkey, to name a few, moving to the forefront of global
business. All companies, from start-ups in Mumbai to mature multinationals in Montreux, are
facing similar currency risks and cross-border business risks as more of global commerce has
moved to a digital interface across a much greater number of countries.
The MNEs in this new world arise from all countries, industrialized and emerging alike,
and are all in search of ever-cheaper labor, raw materials, and outsourced manufacturing,
while all are competing for the same customers across all markets for sales, profits, and cash
flow. These markets—whether they be labeled as BRICs (Brazil, Russia, India, China) or
some other popular label—represent the majority of the earth’s population and therefore its
consumers. We have pursued this theme throughout the book.
v
vi
Preface
The following is a short overview of the features in the Fifth Edition.
■
■
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We have increased the detail on changing currency regimes, theory, and practice, as emerging market currencies become ever-greater contributors to global cash flow.
We have introduced the challenges faced by governments and central banks as cryptocurrencies like Bitcoin have shaken the very foundations of traditional definitions of “currency.”
We have added new content throughout the book on the growing complexity of major
emerging markets which are more open to capital movements, but also subject to sudden
government or central bank intervention in pursuit of sovereign goals and objectives.
We increased our coverage of the multitude of different currency regimes and devices used
by sovereigns over their currencies and markets, currencies like the Chinese yuan, the Russian ruble, the Indian rupee, the Turkish lira, and the South African rand.
We have introduced a number of new Mini-Cases with these currency complexity themes,
while retaining a number of the most popular cases from previous editions.
We have supplemented each chapter with a number of insights into the subtle nuances of
the conduct of financial management with new Global Finance in Practice boxes.
Fundamentals, Fifth Edition, has been restructured to be much shorter and tighter. The
creation of a more intense exploration of global finance without sacrificing depth or detail was
achieved through the integration of a number of concepts and topics.
■
■
■
■
Chapters on the international monetary system cover both the fundamental principles of
defining a currency with the complexities of macroeconomic policy and digital exchange.
Chapters covering the creation and use of currency and interest rate derivatives for hedging
and speculation have been selectively reorganized.
Chapters on raising equity capital and international portfolio theory have been integrated
into one unified exploration of the global cost and availability of capital.
Chapters on the sources of capital and changing financial structures utilized by multinational firms have been reorganized for a more integrated presentation, combining theory
and current practice.
International finance is a subject of sophistication, constant change, yet rich in history.
We have tried to bridge the traditional business practices with digital practices with a mix of
currency notations and symbols throughout the book, using both the common three-letter
currency codes—USD, CNY, EUR—with the traditional currency symbols—$, ¥, £, €—which
are seeing a resurgence as countries like Russia and Turkey have introduced new “currency
identities” of their own.
Audience
Fundamentals of Multinational Finance, Fifth Edition, is aimed at university-level courses in
international financial management, international business finance, international finance, and
similar titles. It can be used at either the undergraduate or graduate level as well as in executive education and corporate learning courses.
A prerequisite course or experience in corporate finance or financial management would
be ideal. However, we review the basic finance concepts before we extend them to the multinational case. We also review the basic concepts of international economics and international
business.
Preface
vii
We recognize the fact that a large number of our potential adopters live outside of the
United States and Canada. Therefore, we use a significant number of non-U.S. examples,
Mini-Cases, and Global Finance in Practice examples seen in the business and news press
(anecdotes and illustrations).
Organization
Fundamentals of Multinational Finance, Fifth Edition, has been redesigned and restructured for tightness—critical elements of the field but in a much shorter delivery framework.
This has been accomplished by integrating a number of previous topics along financial
management threads. The book is in five parts unified by the common thread of the globalization process by which a firm moves from a domestic to a multinational business
orientation.
■
■
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■
■
Part 1 introduces the global financial environment
Part 2 explains foreign exchange theory and markets
Part 3 explores foreign exchange rate exposure
Part 4 details the financing of the global firm
Part 5 analyzes international investment decisions
Pedagogical Tools
To make Fundamentals of Multinational Finance, Fifth Edition, as comprehensible as possible,
we use a large number of proven pedagogical tools. Again, our efforts have been informed by
the detailed reviews and suggestions of a panel of professors who are recognized individually
for excellence in the field of international finance, particularly at the undergraduate level.
Among these pedagogical tools are the following:
■
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A student-friendly writing style combined with a structured presentation of material, beginning with learning objectives for each chapter, and ending with a summary of how those
learning objectives were realized.
A wealth of illustrations and exhibits to provide a visual parallel to the concepts and content
presented. The entire book uses a multicolor presentation, which we believe provides a
visual attractiveness that contributes significantly to reader attention and retention.
A running case on a hypothetical U.S.-based firm, Trident Corporation, provides a cohesive
framework for the multifaceted globalization process, and is reinforced in several end-ofchapter problems.
A Mini-Case at the end of each chapter illustrates the chapter content and extends it to the
multinational finance business environment. And, as noted, six of the 17 are new to the
Fifth Edition.
Global Finance in Practice boxes in every chapter illuminate the theory with accounts of
actual business practices. These applications extend the concepts without adding to the
length of the text itself.
Every chapter has a number of end-of-chapter Exercises requiring the use of the Internet,
while a variety of Internet references are dispersed throughout the chapters in text and
exhibits.
viii
Preface
■
A multitude of end-of-chapter Questions and Problems assess the students’ understanding
of the course material. All end-of-chapter Problems are solved using spreadsheet solutions.
Selected end-of-chapter Problem answers, indicated by an asterisk (*), are now included at
the back of the book.
A Rich Array of Support Materials
A robust package of materials for both instructor and student accompanies the text to facilitate learning and to support teaching and testing.
■
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Online Instructor’s Manual. The Online Instructor’s Manual, prepared by William
Chittenden of Texas State University, contains complete answers to all end-of-chapter
Questions, Problems, and chapter Mini-Cases. All quantitative end-of-chapter Problems
are solved using spreadsheets prepared by the authors, which are also available online.
Online Test Item File. The Online Test Item File, prepared by Borijan Borozanov of
the Thunderbird School of Global Management, contains over 1,200 multiple-choice and
short essay questions. The multiple-choice questions are labeled by topic and by category:
recognition, conceptual, and analytical types.
Computerized Test Bank. The Test Item File is also available in Pearson Education’s
TestGen Software. Fully networkable, it is available for Windows and Macintosh.
TestGen’s graphical interface enables instructors to view, edit, and add questions; transfer
questions to tests; and print different forms of tests. Search-and-sort features enable the
instructor to locate questions quickly and arrange them in a preferred order. The TestGen
plug-in automatically grades the exams and allows the instructor to view and print a variety
of reports.
Online Mini-Case PowerPoint® Presentations. Each of the 17 Mini-Cases has a standalone PowerPoint presentation available online.
Online PowerPoint Presentation Slides. The extensive set of PowerPoint slides provides
lecture outlines and selected graphics from the text for each chapter.
Web Site. A dedicated Web site at www.pearsonhighered.com/moffett contains the Web
exercises from the book with wired links, electronic flash cards of glossary terms, and
selected solutions and spreadsheets for end-of-chapter problems.
All of the teaching resources are available online for download at the Instructor Resource
Center at www.pearsonhighered.com/irc.
International Editions
Fundamentals of Multinational Finance and Multinational Business Finance have been used
throughout the world to teach students of international finance. Our books are published in
a number of foreign languages including Chinese, French, Spanish, Indonesian, Portuguese,
and Ukrainian.
Preface
ix
Acknowledgments
We are very thankful for the many detailed reviews of previous editions and suggestions from
a number of colleagues. The final version of Fundamentals, Fifth Edition, reflects most of
the suggestions provided by these reviewers. The survey reviewers were anonymous, but the
detailed reviewers were:
Dev Prasad, University of Massachusetts Lowell
Anand M. Vijh, University of Iowa, Tippie College of Business
Yoon S. Shin, Loyola University Maryland
Raymond M. Johnson, Auburn University Montgomery
Cheryl Riffe, Columbus State Community College
Additionally, we would like to thank Rodrigo Hernandez of Radford University who
meticulously reviewed the Fifth Edition for accuracy.
We would also like to thank all those with Pearson Education who have worked so diligently on this edition: Katie Rowland, Kate Fernandes, Erin McDonagh, and Meredith Gertz.
In addition, Gillian Hall, our outstanding project manager, deserves much gratitude.
Finally, we would like to dedicate this book to our parents, Bennie Ruth and the late Hoy
Moffett, the late Harold and Norma Stonehill, and the late Wilford and Sylvia Eiteman, who
gave us the motivation to become academics and authors. We thank our wives, Megan, Kari,
and Keng-Fong, for their patience while we were preparing Fundamentals of Multinational
Finance.
Glendale, Arizona
Honolulu, Hawaii
Pacific Palisades, California
M.H.M.
A.I.S.
D.K.E.
About the Authors
Michael H. Moffett Michael H. Moffett is Continental Grain Professor in Finance at the
Thunderbird School of Global Management, where he has been since 1994. He has also held
teaching or research appointments at Oregon State University (1985–1993); the University
of Michigan, Ann Arbor (1991–1993); the Brookings Institution, Washington, D.C.; the University of Hawaii at Manoa; the Aarhus School of Business (Denmark); the Helsinki School
of Economics and Business Administration (Finland); the International Centre for Public
Enterprises (Yugoslavia); and the University of Colorado, Boulder.
Professor Moffett received a B.A. (Economics) from the University of Texas at Austin
(1977); an M.S. (Resource Economics) from Colorado State University (1979); an M.A. (Economics) from the University of Colorado, Boulder (1983); and Ph.D. (Economics) from the
University of Colorado, Boulder (1985).
He has authored, co-authored, or contributed to a number of books, articles, and other
publications. He has co-authored two books with Art Stonehill and David Eiteman, Multinational Business Finance, and this book, Fundamentals of Multinational Finance. His articles
have appeared in the Journal of Financial and Quantitative Analysis, Journal of Applied Corporate Finance, Journal of International Money and Finance, Journal of International Financial Management and Accounting, Contemporary Policy Issues, Brookings Discussion Papers
x
Preface
in International Economics, and others. He has contributed to a number of collected works
including the Handbook of Modern Finance, the International Accounting and Finance Handbook, and the Encyclopedia of International Business. He is also co-author of a number of
books in multinational business with Michael Czinkota and Ilkka Ronkainen, International
Business (Seventh Edition) and Global Business (Fourth Edition), and The Global Oil and
Gas Industry: Strategy, Finance, and Management, with Andrew Inkpen.
Arthur I. Stonehill Arthur I. Stonehill is a Professor of Finance and International Business,
Emeritus, at Oregon State University, where he taught for 24 years (1966–1990). During
1991–1997 he held a split appointment at the University of Hawaii at Manoa and Copenhagen
Business School. From 1997 to 2001 he continued as a Visiting Professor at the University
of Hawaii at Manoa. He has also held teaching or research appointments at the University
of California, Berkeley; Cranfield School of Management (U.K.); and the North European
Management Institute (Norway). He was a former president of the Academy of International
Business, and was a western director of the Financial Management Association.
Professor Stonehill received a B.A. (History) from Yale University (1953); an M.B.A.
from Harvard Business School (1957); and a Ph.D. in Business Administration from the University of California, Berkeley (1965). He was awarded honorary doctorates from the Aarhus
School of Business (Denmark, 1989), the Copenhagen Business School (Denmark, 1992), and
Lund University (Sweden, 1998).
He has authored or co-authored nine books and 25 other publications. His articles have
appeared in Financial Management, Journal of International Business Studies, California
Management Review, Journal of Financial and Quantitative Analysis, Journal of International
Financial Management and Accounting, International Business Review, European Management
Journal, The Investment Analyst (U.K.), Nationaløkonomisk Tidskrift (Denmark), Sosialøkonomen (Norway), Journal of Financial Education, and others.
David K. Eiteman David K. Eiteman is Professor Emeritus of Finance at the John E.
Anderson Graduate School of Management at UCLA. He has also held teaching or research
appointments at the Hong Kong University of Science and Technology, Showa Academy
of Music (Japan), the National University of Singapore, Dalian University (China), the
Helsinki School of Economics and Business Administration (Finland), University of Hawaii
at Manoa, University of Bradford (U.K.), Cranfield School of Management (U.K.), and IDEA
(Argentina). He is a former president of the International Trade and Finance Association,
Society for Economics and Management in China, and Western Finance Association.
Professor Eiteman received a B.B.A. (Business Administration) from the University of
Michigan, Ann Arbor (1952); M.A. (Economics) from the University of California, Berkeley
(1956); and a Ph.D. (Finance) from Northwestern University (1959).
He has authored or co-authored four books and 29 other publications. His articles have
appeared in The Journal of Finance, The International Trade Journal, Financial Analysts Journal, Journal of World Business, Management International, Business Horizons, MSU Business
Topics, Public Utilities Fortnightly, and others.
xi
Brief Contents
Part 1
Part 2
Part 3
Part 4
Part 5
Global Financial Environment
1
Chapter 1
Multinational Financial Management: Opportunities and Challenges 2
Chapter 2
The International Monetary System 23
Chapter 3
The Balance of Payments 51
Chapter 4
Financial Goals and Corporate Governance 79
Foreign Exchange Theory and Markets
107
Chapter 5
The Foreign Exchange Market
Chapter 6
International Parity Conditions 137
Chapter 7
Foreign Currency Derivatives and Swaps 168
Chapter 8
Foreign Exchange Rate Determination 195
Foreign Exchange Exposure
223
Chapter 9
Transaction Exposure 224
Chapter 10
Translation Exposure 250
Chapter 11
Operating Exposure 267
Financing the Global Firm
108
291
Chapter 12
The Global Cost and Availability of Capital 292
Chapter 13
Raising Equity and Debt Globally 318
Chapter 14
Multinational Tax Management 353
Chapter 15
International Trade Finance 373
Foreign Investment Decisions
399
Chapter 16
Foreign Direct Investment and Political Risk 400
Chapter 17
Multinational Capital Budgeting and Cross-Border Acquisitions 430
Answers A-1
Glossary G-1
Index
I-1
xi
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xiii
Contents
Part 1
Global Financial Environment
1
Chapter 1 Multinational Financial Management: Opportunities and Challenges 2
Financial Globalization and Risk 3
The Global Financial Marketplace 4
Global Finance In Practice The Trouble with Libor 5
The Theory of Comparative Advantage 9
What Is Different about International Financial Management? 11
Global Finance In Practice Corporate Responsibility and Corporate Sustainability 12
Market Imperfections: A Rationale for the Existence of the Multinational Firm 12
The Globalization Process 13
Summary Points 17
Mini-Case Bitcoin—Cryptocurrency or Commodity? 17
Questions 20
Problems 20
Internet Exercises 21
Chapter 2 The International Monetary System
23
History of the International Monetary System 23
Global Finance In Practice Hammering Out an Agreement at Bretton Woods 26
IMF Classification of Currency Regimes 28
Global Finance In Practice Swiss National Bank Sets Minimum Exchange Rate for the Franc 33
Fixed versus Flexible Exchange Rates 34
Global Finance In Practice Who Is Choosing What in the Trinity/Trilemma? 35
A Single Currency for Europe: The Euro 36
Global Finance In Practice The Euro and the Greek/EU Debt Crisis 37
Emerging Markets and Regime Choices 38
Globalizing the Chinese Renminbi 42
Exchange Rate Regimes: What Lies Ahead? 45
Summary Points 46
Mini-Case Russian Ruble Roulette 46
Questions 48
Problems 49
Internet Exercises 50
Chapter 3 The Balance of Payments 51
Typical Balance of Payments Transactions 52
Fundamentals of BOP Accounting 52
The Accounts of the Balance of Payments 54
Global Finance In Practice The Global Current Account Surplus 56
Global Finance In Practice A Country’s Net International Investment Position (NIIP)
BOP Impacts on Key Macroeconomic Rates 62
Trade Balances and Exchange Rates 64
Capital Mobility 67
58
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Contents
Summary Points 72
Mini-Case Global Remittances
Questions 74
Problems 75
Internet Exercises 78
72
Chapter 4 Financial Goals and Corporate Governance 79
Who Owns the Business? 80
The Goal of Management 83
Publicly Traded versus Privately Held: The Global Shift 88
Corporate Governance 90
Global Finance In Practice Italian Cross-Shareholding and the End of the Salatto Buono
Global Finance In Practice Is Good Governance Good Business Globally? 97
Summary Points 98
Mini-Case Luxury Wars—LVMH vs. Hermès 98
Questions 103
Problems 103
Internet Exercises 106
Part 2 Foreign Exchange Theory and Markets
Chapter 5 The Foreign Exchange Market
107
108
Functions of the Foreign Exchange Market 109
Structure of the Foreign Exchange Market 109
Global Finance In Practice FX Market Manipulation: Fixing the Fix 112
Global Finance In Practice My First Day of Foreign Exchange Trading 113
Transactions in the Foreign Exchange Market 114
Size of the Foreign Exchange Market 116
Foreign Exchange Rates and Quotations 119
Global Finance In Practice Russian Symbolism 120
Summary Points 129
Mini-Case The Venezuelan Bolivar Black Market 129
Questions 133
Problems 133
Internet Exercises 136
Chapter 6 International Parity Conditions
Prices and Exchange Rates
137
138
Global Finance In Practice The Immiseration of the North Korean People—The
“Revaluation” of the North Korean Won 140
Interest Rates and Exchange Rates 145
Global Finance In Practice Hungarian Mortgages 152
Forward Rate as an Unbiased Predictor of the Future Spot Rate 153
Prices, Interest Rates, and Exchange Rates in Equilibrium 155
Summary Points 156
Mini-Case Mrs. Watanabe and the Japanese Yen Carry Trade 157
Questions 159
Problems 159
Internet Exercises 163
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Contents
Appendix: An Algebraic Primer to International Parity Conditions 164
The Law of One Price 164
Purchasing Power Parity 164
Forward Rates 165
Covered Interest Arbitrage (CIA) and Interest Rate Parity (IRP) 165
Fisher Effect 166
International Fisher Effect 166
Chapter 7 Foreign Currency Derivatives and Swaps
Foreign Currency Futures
Currency Options 171
168
169
Global Finance In Practice The New Zealand Kiwi, Key, and Krieger
Option Pricing and Valuation 179
Interest Rate Risk 181
Global Finance In Practice A Fixed-Rate or Floating-Rate World?
Interest Rate Derivatives 183
Summary Points 187
Mini-Case McDonald’s Corporation’s British Pound Exposure 188
Questions 189
Problems 190
Internet Exercises 194
Chapter 8 Foreign Exchange Rate Determination
179
182
195
Exchange Rate Determination: The Theoretical Thread 196
Currency Market Intervention 200
Global Finance In Practice Rules of Thumb for Effective Intervention 204
Disequilibrium: Exchange Rates in Emerging Markets 205
Global Finance In Practice Was George Soros to Blame for the Asian Crisis? 207
Forecasting in Practice 212
Global Finance In Practice JPMorgan Chase Forecast of the Dollar/Euro 214
Summary Points 216
Mini-Case The Japanese Yen Intervention of 2010 217
Questions 219
Problems 219
Internet Exercises 222
Part 3
Foreign Exchange Exposure 223
Chapter 9 Transaction Exposure
224
Types of Foreign Exchange Exposure 224
Why Hedge? 225
Transaction Exposure Management: The Case of Trident 230
Risk Management in Practice 238
Global Finance In Practice Hedging and the German Automobile Industry 238
Global Finance In Practice The Credit Crisis and Option Volatilities in 2009 239
Summary Points 239
Mini-Case Banbury Impex (India) 240
Questions 244
Problems 244
Internet Exercises 249
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Contents
Chapter 10 Translation Exposure
250
Overview of Translation 250
Translation Methods 252
Trident Corporation’s Translation Exposure 254
Global Finance In Practice Foreign Subsidiary Valuation 258
Managing Translation Exposure 259
Global Finance In Practice When Business Dictates Hedging Results 260
Summary Points 261
Mini-Case LaJolla Engineering Services 261
Questions 264
Problems 265
Internet Exercises 266
Chapter 11
Operating Exposure
267
A Multinational’s Operating Exposure 267
Global Finance In Practice Expecting the Devaluation—Ford and Venezuela 271
Measuring Operating Exposure: Trident Germany 272
Strategic Management of Operating Exposure 277
Global Finance In Practice Do Fixed Exchange Rates Increase Corporate Currency
Risk in Emerging Markets? 278
Proactive Management of Operating Exposure 279
Summary Points 284
Mini-Case Toyota’s European Operating Exposure 285
Questions 287
Problems 288
Internet Exercises 290
Part 4 Financing the Global Firm 291
Chapter 12 The Global Cost and Availability of Capital 292
Financial Globalization and Strategy 292
International Portfolio Theory and Diversification 295
The Demand for Foreign Securities: The Role of International Portfolio Investors 301
The Cost of Capital for MNEs Compared to Domestic Firms 306
The Riddle: Is the Cost of Capital Higher for MNEs? 307
Summary Points 309
Mini-Case Novo Industri A/S (Novo) 310
Questions 313
Problems 314
Internet Exercises 316
Chapter 13 Raising Equity and Debt Globally 318
Designing a Strategy to Source Capital Globally 319
Optimal Financial Structure 320
Optimal Financial Structure and the MNE 321
Raising Equity Globally 323
Global Finance In Practice The Planned Directed Equity Issue of PA Resources of Sweden
Depositary Receipts 327
Private Placement 333
Foreign Equity Listing and Issuance 334
Raising Debt Globally 337
Global Finance In Practice Islamic Finance 341
Summary Points 342
327
Contents
Mini-Case Petrobrás of Brazil and the Cost of Capital
343
Questions 346
Problems 347
Internet Exercises 349
Appendix: Financial Structure of Foreign Subsidiaries 350
Local Norms 350
Financing the Foreign Subsidiary 351
Chapter 14
Multinational Tax Management
353
Tax Principles 354
Transfer Pricing 361
Global Finance In Practice Offshore Profits and Dividend Repatriation
361
Tax Management at Trident 364
Tax-Haven Subsidiaries and International Offshore Financial Centers 365
Summary Points 367
Mini-Case Google, Taxes, and “Do No Evil” 368
Questions 370
Problems 370
Internet Exercises 372
Chapter 15 International Trade Finance
373
The Trade Relationship 373
Benefits of the System 376
Key Documents 378
Global Finance In Practice Florence—The Birthplace of Trade Financing
Documentation in a Typical Trade Transaction 383
Government Programs to Help Finance Exports 385
Trade Financing Alternatives 386
Global Finance In Practice Factoring in Practice 388
Forfaiting: Medium- and Long-Term Financing 389
Summary Points 391
Mini-Case Crosswell International and Brazil 392
Questions 395
Problems 395
Internet Exercises 398
Part 5
381
Foreign Investment Decisions 399
Chapter 16
Foreign Direct Investment and Political Risk
400
Sustaining and Transferring Competitive Advantage 400
The OLI Paradigm and Internationalization 403
Deciding Where to Invest 404
Modes of Foreign Investment 406
Predicting Political Risk 410
Global Finance In Practice Apache Takes a Hit from Egyptian Protests 412
Firm-Specific Political Risk: Governance Risk 412
Country-Specific Risk: Transfer Risk 416
Country-Specific Risk: Cultural and Institutional Risk 419
Global-Specific Risk 421
Global Finance In Practice Drugs, Public Policy, and the Death Penalty in 2011
Summary Points 425
Mini-Case Corporate Competition from the Emerging Markets 426
Questions 428
Internet Exercises 429
422
xvii
xviii
Contents
Chapter 17
Multinational Capital Budgeting and Cross-Border Acquisitions
Complexities of Budgeting for a Foreign Project 431
Project versus Parent Valuation 432
Illustrative Case: Cemex Enters Indonesia 433
Project Financing 446
Cross-Border Mergers and Acquisitions 448
Global Finance In Practice Statoil of Norway’s Acquisition of Esso of Sweden
Summary Points 453
Mini-Case Elan and Royalty Pharma 454
Questions 458
Problems 459
Internet Exercises 462
Answers A-1
Glossary G-1
Index
I-1
453
430
PART
1
Global
Financial
Environment
Chapter 1
Multinational Financial Management:
Opportunities and Challenges
Chapter 2
The International Monetary System
Chapter 3
The Balance of Payments
Chapter 4
Financial Goals and Corporate
Governance
CHAPTER
1
Multinational
Financial
Management:
Opportunities and
Challenges
I define globalization as producing where it is most costeffective, selling where it is most profitable, and sourcing
capital where it is cheapest, without worrying about
national boundaries.
—Narayana Murthy, Founder and Executive Chairman of the Board,
Infosys.
Learning Objectives
■
Examine the requirements for the creation of value
■
Consider the basic theory, comparative advantage, and its requirements for the explanation and justification for international trade and commerce
■
Discover what is different about international financial management
■
Detail which market imperfections give rise to the multinational enterprise
■
Consider how the globalization process moves a business from a purely domestic focus
in its financial relationships and composition to one truly global in scope
■
Examine possible causes of the limitations to globalization in finance
The subject of this book is the financial management of multinational enterprises (MNEs)—
multinational financial management. MNEs are firms—both for-profit companies and notfor-profit organizations—that have operations in more than one country, and conduct their
business through branches, foreign subsidiaries, or joint ventures with host country firms.
New MNEs are appearing all over the world today, while many of the older and established ones are struggling to survive. Businesses of all kinds are seeing a very different world
than in the past. Today’s MNEs depend not only on the emerging markets for cheaper labor,
raw materials, and outsourced manufacturing, but also increasingly on those same emerging
markets for sales and profits. These markets—whether they are emerging, less developed, or
developing, or are BRIC (Brazil, Russia, India, and China), BIITS (Brazil, India, Indonesia,
Turkey, South Africa, which are also termed the Fragile Five), or MINTs (Mexico, Indonesia,
Nigeria, Turkey)—represent the majority of the earth’s population and, therefore, potential
2
Chapter 1 Multinational Financial Management: Opportunities and Challenges
3
customers. And adding market complexity to this changing global landscape is the risky andchallenging international macroeconomic environment, both from a long-term and short-term
perspective. The global financial crisis of 2008–2009 is already well into the business past,
and capital is flowing again—although in and out of economies—at an ever-increasing pace.
How to identify and navigate these risks is the focus of this book. These risks may all
occur on the playing field of the global financial marketplace, but they are still a question of
management—of navigating that complexity in pursuit of the goals of the firm.
Financial Globalization and Risk
Back in the halcyon pre-crisis days of the late 20th and early 21st centuries, it was taken
as self evident that financial globalisation was a good thing. But the subprime crisis and
eurozone dramas are shaking that belief. . . . what is the bigger risk now—particularly in
the eurozone—is that financial globalisation has created a system that is interconnected
in some dangerous ways.
—“Crisis Fears Fuel Debate on Capital Controls,”
Gillian Tett, Financial Times, December 15, 2011.
The theme dominating global financial markets today is the complexity of risks associated
with financial globalization—far beyond whether it is simply good or bad, but how to lead and
manage multinational firms in the rapidly moving marketplace.
■
The international monetary system, an eclectic mix of floating and managed fixed exchange
rates, is under constant scrutiny. The rise of the Chinese renminbi is changing much of the
world’s outlook on currency exchange, reserve currencies, and the roles of the dollar and
the euro (see Chapter 2).
■
Large fiscal deficits, including the current eurozone crisis, plague most of the major trading
countries of the world, complicating fiscal and monetary policies, and ultimately, interest
rates and exchange rates (see Chapter 3).
■
Many countries experience continuing balance of payments imbalances, and in some
cases, dangerously large deficits and surpluses—whether it be the twin surpluses enjoyed
by China, the current account surplus of Germany amidst a sea of eurozone deficits, or the
continuing current account deficit of the United States, all will inevitably move exchange
rates (see Chapter 3).
■
Ownership, control, and governance vary radically across the world. The publicly traded
company is not the dominant global business organization—the privately held or familyowned business is the prevalent structure—and their goals and measures of performance
vary dramatically (see Chapter 4).
■
Global capital markets that normally provide the means to lower a firm’s cost of capital,
and even more critically, increase the availability of capital, have in many ways shrunk in
size and have become less open and accessible to many of the world’s organizations (see
Chapter 1).
■
Today’s emerging markets are confronted with a new dilemma: the problem of first being
the recipients of capital inflows, and then of experiencing rapid and massive capital outflows.
Financial globalization has resulted in the ebb and flow of capital in and out of both industrial
and emerging markets, greatly complicating financial management (Chapter 5 and 8).
4
PART 1 Global Financial Environment
These are but a sampling of the complexity of risks. This first chapter is meant only
as an introduction and a taste. The Mini-Case at the end of this first chapter, Bitcoin—
Cryptocurrency or Commodity?, is intended to push you in your thinking about how and why
money moves across the globe today.
The Global Financial Marketplace
Business—domestic, international, global—involves the interaction of individuals and individual organizations for the exchange of products, services, and capital through markets. The
global capital markets are critical for the conduct of this exchange. The global financial crisis
of 2008–2009 served as an illustration and a warning of how tightly integrated and fragile this
marketplace can be.
Assets, Institutions, and Linkages
Exhibit 1.1 provides a map of the global capital markets. One way to characterize the global
financial marketplace is through its assets, institutions, and linkages.
Assets. The assets—financial assets—at the heart of the global capital markets are the debt
securities issued by governments (e.g., U.S. Treasury Bonds). These low-risk or risk-free assets
form the foundation for the creation, trading, and pricing of other financial assets like bank
loans, corporate bonds, and equities (stock). In recent years, a number of additional securities
have been created from existing securities—derivatives, whose value is based on market value
changes of the underlying securities. The health and security of the global financial system
relies on the quality of these assets.
Exhibit 1.1 Global Capital Markets
The global capital market is a collection of institutions (central banks, commercial banks, investment banks, not-forprofit financial institutions like the IMF and World Bank) and securities (bonds, mortgages, derivatives, loans, etc.),
which are all linked via a global network—the Interbank Market. This interbank market, in which securities of all
kinds are traded, is the critical pipeline system for the movement of capital.
Public Debt
Mortgage Loan
Corporate Loan
Corporate Bond
Bank
Interbank
Market
(LIBOR )
Bank
Currency
Currency
Currency
Private Debt
Private Equity
Bank
Central Banks
Institutions
The exchange of securities—the movement of capital in the global financial system—must all take place through
a vehicle—currency. The exchange of currencies is itself the largest of the financial markets. The interbank market,
which must pass-through and exchange securities using currencies, bases all of its pricing through the single most
widely quoted interest rate in the world—LIBOR (the London Interbank Offered Rate).
Chapter 1 Multinational Financial Management: Opportunities and Challenges
5
Institutions. The institutions of global finance are the central banks, which create and control
each country’s money supply; the commercial banks, which take deposits and extend loans to
businesses, both local and global; and the multitude of other financial institutions created to
trade securities and derivatives. These institutions take many shapes and are subject to many
different regulatory frameworks. The health and security of the global financial system relies
on the stability of these financial institutions.
Linkages. The links between the financial institutions, the actual fluid or medium for
exchange, are the interbank networks using currency. The ready exchange of currencies in
the global marketplace is the first and foremost necessary element for the conduct of financial
trading, and the global currency markets are the largest markets in the world. The exchange
of currencies, and the subsequent exchange of all other securities globally via currency, is the
international interbank network. This network, whose primary price is the London Interbank
Offered Rate (LIBOR), is the core component of the global financial system.
The movement of capital across currencies and continents for the conduct of business has
existed in many different forms for thousands of years. Yet, it is only within the past 50 years
that these capital movements have started to move at the pace of an electron in the digital
marketplace. And it is only within the past 20 years that this market has been able to reach
the most distant corners of the earth at any moment of the day. The result has been an explosion of innovative products and services—some for better, some for worse, and as described
in Global Finance in Practice 1.1, not always without challenges.
Global Finance in Practice
1.1
The Trouble with LIBOR
“The idea that my word is my Libor is dead.”
— Mervyn King, Bank of England Governor.
No single interest rate is more fundamental to the operation
of the global financial markets than the London Interbank
Offered Rate (LIBOR). LIBOR is used in loan agreements,
financial derivatives, swap agreements, in different maturities and different currencies, every day—globally. But
beginning as early as 2007, a number of participants in the
interbank market on both sides of the Atlantic suspected
that there was trouble with LIBOR.
LIBOR is published under the auspices of the British
Bankers Association (BBA). Each day, a panel of 16 major
multinational banks are requested to submit their estimated
borrowing rates in the unsecured interbank market which
are then collected, massaged, and published in three steps.
Step 1. The banks on the LIBOR panels must submit their estimated borrowing rates by 11:10 a.m. London time.
The submissions are directly to Thomson Reuters,
which executes the process on behalf of the BBA.
Step 2. Thomson Reuters discards the lowest 25% and
highest 25% of interest rates submitted. It then calculates an average rate by maturity and currency
using the remaining 50% of borrowing rate quotes.
Step 3. The BBA publishes the day’s LIBOR rates 20
minutes later, by 11:30 a.m. London time.
This process is used to publish LIBOR for 10 different
currencies across 15 different maturities. The three-month
and six-month maturities are the most significant maturities
due to their widespread use in various loan and derivative
agreements, with the dollar and the euro being the most
widely used currencies.
The Trouble
One problem with LIBOR is the origin of the rates submitted
by banks. First, rates are not limited to those at which actual
borrowing occurred, meaning they are not market transaction rates. The logic behind including “estimated borrowing rates” was to avoid reporting only actual transactions,
as many banks may not conduct actual transactions in all
maturities and currencies each day. As a result, the origin of
the rate submitted by each bank becomes, to some degree,
discretionary.
Secondly, banks—specifically money-market and
derivative traders within the banks—have a number of interests that may be impacted by borrowing costs reported
by the bank that day. One such example can be found in
the concerns of banks in the interbank market in September 2008, when the credit crisis was in full-bloom. A bank
reporting that other banks were demanding it pay a higher
rate that day would, in effect, be self-reporting the market’s
6
PART 1 Global Financial Environment
assessment that it was increasingly risky. In the words of
one analyst, akin “to hanging a sign around one’s neck that
I am carrying a contagious disease.” Market analysts are
now estimating that many of the banks in the LIBOR panel
were reporting borrowing rates which were anywhere from
30 to 40 basis points lower than actual rates throughout the
financial crisis. As one financial reform advocate so sharply
stated it, “the issue is Lie More, not Libor.”
Court documents continue to shed light on the depth
of the market’s manipulation, although it is not really
known to what degree attempts at manipulation have been
successful.
Hi Guys, We got a big position in 3m libor for the next
3 days. Can we please keep the libor fixing at 5.39 for
the next few days. It would really help.
—Barclays New York trader email, September 13, 2006, as
reported in Barclays PLC, Barclays Bank PLC, and Barclays
Capital Inc., CFTC Docket No. 12-25, CFTC, p.10.
In December 2013, a collection of banks in London
and New York agreed to pay $2.3 billion in fines to the
European Commission for LIBOR manipulation. And more
lawsuits, accusations, and regulations are sure to come.
The Market for Currencies
The price of any one country’s currency in terms of another country’s currency is called a
foreign currency exchange rate. For example, the exchange rate between the U.S. dollar ($
or USD) and the European euro (€ or EUR) may be stated as “1.3654 dollar per euro” or
simply abbreviated as $1.3654/€. This is the same exchange rate as when stated “EUR1.00 =
USD1.3654.” Since most international business activities require at least one of the two parties
in a business transaction to either pay or receive payment in a currency that is different from
their own, an understanding of exchange rates is critical to the conduct of global business.
Currency Symbols. As noted, USD and EUR are often used as the symbols for the U.S. dollar
and the European Union’s euro. These are the computer symbols (ISO-4217 codes) used today
on the world’s digital networks. The field of international finance, however, has a rich history of
using a variety of different symbols in the financial press, and a variety of different abbreviations
are commonly used. For example, the British pound sterling may be £ (the pound symbol), GBP
(Great Britain pound), STG (British pound sterling), ST£ (pound sterling), or UKL (United
Kingdom pound). This book uses the simpler common symbols—the $ (dollar), the € (euro), the
¥ (yen), the £ (pound)—but be warned and watchful when reading the business press!
Exchange Rate Quotations and Terminology. Exhibit 1.2 lists currency exchange rates
for January 13, 2014, as would be quoted in New York or London. The exchange rate listed is
for a specific country’s currency—for example, the Argentina peso against the U.S. dollar
is Peso 6.6580/$, against the European euro is Peso 9.0905/€, and against the British pound
is Peso 10.9078/£. The rate listed is termed a “mid-rate” because it is the middle or average
of the rates at which currency traders buy currency (bid rate) and sell currency (offer rate).
The U.S. dollar has been the focal point of most currency trading since the 1940s. As a
result, most of the world’s currencies have been quoted against the dollar—Mexican pesos per
dollar, Brazilian real per dollar, Hong Kong dollars per dollar, etc. This quotation convention
is also followed against the world’s major currencies, as listed in Exhibit 1.2. For example, the
Japanese yen is commonly quoted as ¥103.365/$, ¥141.129/€, and 169.343/£.
Quotation Conventions. Several of the world’s major currency exchange rates, however,
follow a specific quotation convention that is the result of tradition and history. The exchange
rate between the U.S. dollar and the euro is always quoted as “dollars per euro” or $/€. For
example, $1.3654 listed in Exhibit 1.2 under “United States.” Similarly, the exchange rate
between the U.S. dollar and the British pound is always quoted as “dollars per pound” or $/£.
For example, $1.6383 listed under “United States” in Exhibit 1.2. In addition, countries that
were formerly members of the British Commonwealth will often be quoted against the U.S.
dollar, as in U.S. dollars per Australian dollar or U.S. dollars per Canadian dollar.
Exhibit 1.2
January 13, 2014
Country
Selected Global Currency Exchange Rates
Currency
Symbol
Code
Currency to Equal
1 U.S. Dollar
Currency to Equal
1 Euro
Currency to Equal
1 Pound
10.9078
Argentina
peso
Ps
ARS
6.6580
9.0905
Australia
dollar
A$
AUD
1.1043
1.5078
1.8092
Bahrain
dinar
—
BHD
0.3770
0.5148
0.6177
Bolivia
boliviano
Bs
BOB
6.9100
9.4346
11.3207
Brazil
real
R$
BRL
2.3446
3.2012
3.8411
Canada
dollar
C$
CAD
1.0866
1.4836
1.7801
863.351
Chile
peso
$
CLP
526.980
719.512
China
yuan
¥
CNY
6.0434
8.2514
9.9009
Colombia
peso
Col$
COP
1,924.70
2,627.89
3,153.24
colon
499.475
681.959
818.291
koruna
//
C
Kc
CRC
Czech Republic
Costa Rica
CZK
20.0425
27.3650
32.8356
Denmark
krone
Dkr
DKK
5.4656
7.4624
8.9542
Egypt
pound
£
EGP
6.9562
9.4977
11.3964
12.7045
Hong Kong
dollar
HK$
HKD
7.7547
10.5878
Hungary
forint
Ft
HUF
218.680
298.575
358.264
India
rupee
INR
61.5750
84.0715
100.8780
Indonesia
rupiah
Rp
IDR
12,050.0
16,452.5
19,741.5
rial
—
IRR
12,395.5
16,924.2
20,307.5
Israel
shekel
Shk
ILS
3.4882
4.7627
5.7148
Japan
yen
¥
JPY
103.365
141.129
169.343
141.303
Iran
Kenya
shilling
KSh
KES
86.250
117.761
Kuwait
dinar
—
KWD
0.2824
0.3856
0.4627
Malaysia
ringgit
RM
MYR
3.2635
4.4559
5.3466
21.2561
Mexico
new peso
$
MXN
12.9745
17.7148
New Zealand
dollar
NZD
1.1957
1.6326
1.9590
Nigeria
naira
NZ$
=
N
NGN
159.750
218.115
261.718
Norway
krone
NKr
NOK
6.1216
8.3581
10.0290
Pakistan
rupee
Rs.
PKR
105.535
144.092
172.898
new sol
S/.
=
P
PEN
2.7965
3.8182
4.5816
peso
PHP
44.5950
60.8878
73.0600
zloty
—
PLN
3.0421
4.1535
4.9839
new leu
L
RON
3.3133
4.5238
5.4281
54.4997
Peru
Phillippines
Poland
Romania
Russia
ruble
RUB
33.2660
45.4198
Saudi Arabia
riyal
SR
SAR
3.7505
5.1207
6.1444
Singapore
dollar
S$
SGD
1.2650
1.7272
2.0725
South Africa
rand
R
ZAR
10.7750
14.7117
17.6527
South Korea
won
W
KRW
1,056.65
1,442.70
1,731.11
Sweden
krona
SKr
SEK
6.4986
8.8728
10.6466
Switzerland
franc
Fr.
CHF
0.9026
1.2324
1.4788
Taiwan
dollar
T$
TWD
30.0060
40.9687
49.1588
Thailand
baht
B
THB
32.9750
45.0224
54.0230
Tunisia
dinar
DT
TND
1.6548
2.2593
2.7110
Turkey
lira
TRY
2.1773
2.9728
3.5671
Ukraine
hrywnja
—
UAH
8.3125
11.3495
13.6184
United Arab Emirates
dirham
—
AED
3.6730
5.0149
6.0175
United Kingdom
pound
£
GBP
0.6104
0.8334
—
United States
dollar
$
USD
—
1.3654
1.6383
peso
$U
UYU
21.6050
29.4984
35.3955
bolivar fuerte
Bs
d
–
€
VEB
6.2921
8.5910
10.3084
VND
21,090.0
28,795.2
34,551.8
EUR
0.7324
—
1.1999
—
SDR
0.6509
0.8887
1.0663
Uruguay
Venezuela
Vietnam
dong
Euro
euro
Special Drawing Right
—
Notes: A number of different currencies use the same symbol (for example both China and Japan have traditionally used the ¥ symbol, yen or yuan,
meaning round or circle). That is one of the reasons why most of the world’s currency markets today use the three-digit currency code for clarity of
quotation. All quotes are mid-rates, and are drawn from the Financial Times, January 14, 2014. The British pound and euro are quoted here in the
identical terms — per dollar, per euro, per pound — as are all other country currencies. However, the Financial Times, which is the original source for
these currency quotations, will quote the pound and euro in the reciprocal form as is industry practice for these currencies.
7
8
PART 1 Global Financial Environment
Eurocurrencies and LIBOR
One of the major linkages of global money and capital markets is the eurocurrency market
and its interest rate, which is LIBOR. Eurocurrencies are domestic currencies of one country
on deposit in a second country for a period ranging from overnight to more than a year or
longer. Certificates of deposit are usually for three months or more and in million-dollar
increments. A eurodollar deposit is not a demand deposit—it is not created on the bank’s
books by writing loans against required fractional reserves, and it cannot be transferred by
a check drawn on the bank having the deposit. Eurodollar deposits are transferred by wire
or cable transfer of an underlying balance held in a correspondent bank located within the
United States. In most countries, a domestic analogy would be the transfer of deposits held
in nonbank savings associations. These are transferred when the association writes its own
check on a commercial bank.
Any convertible currency can exist in “euro-” form. Note that this use of “euro-” should
not be confused with the new common European currency called the euro. The eurocurrency
market includes eurosterling (British pounds deposited outside the United Kingdom); euroeuros (euros on deposit outside the eurozone); euroyen (Japanese yen deposited outside Japan)
and eurodollars (U.S. dollars deposited outside the U.S.).
Eurocurrency markets serve two valuable purposes: 1) eurocurrency deposits are an efficient and convenient money market device for holding excess corporate liquidity; and 2) the
eurocurrency market is a major source of short-term bank loans to finance corporate working
capital needs, including the financing of imports and exports. Banks in which eurocurrencies
are deposited are called eurobanks. A eurobank is a financial intermediary that simultaneously
bids for time deposits and makes loans in a currency other than that of its home currency.
Eurobanks are major world banks that conduct a eurocurrency business in addition to all
other banking functions. Thus, the eurocurrency operation that qualifies a bank for the name
eurobank is, in fact, a department of a large commercial bank, and the name springs from the
performance of this function.
The modern eurocurrency market was born shortly after World War II. Eastern European
holders of dollars, including the various state trading banks of the Soviet Union, were afraid
to deposit their dollar holdings in the United States because those deposits might be attached
by U.S. residents with claims against communist governments. Therefore, Eastern European
holders deposited their dollars in Western Europe, particularly with two Soviet banks: the
Moscow Narodny Bank in London, and the Banque Commerciale pour l’Europe du Nord
in Paris. These banks redeposited the funds in other Western banks, especially in London.
Additional dollar deposits were received from various central banks in Western Europe, which
elected to hold part of their dollar reserves in this form to obtain a higher yield. Commercial
banks also placed their dollar balances in the market because specific maturities could be
negotiated in the eurodollar market. Such companies found it financially advantageous to
keep their dollar reserves in the higher-yielding eurodollar market. Various holders of international refugee funds also supplied funds.
Although the basic causes of the growth of the eurocurrency market are economic efficiencies, many unique institutional events during the 1950s and 1960s contributed to its growth.
■
■
In 1957, British monetary authorities responded to a weakening of the pound by imposing
tight controls on U.K. bank lending in sterling to nonresidents of the United Kingdom.
Encouraged by the Bank of England, U.K. banks turned to dollar lending as the only
alternative that would allow them to maintain their leading position in world finance. For
this they needed dollar deposits.
Although New York was “home base” for the dollar and had a large domestic money and
capital market, international trading in the dollar centered in London because of that city’s
Chapter 1 Multinational Financial Management: Opportunities and Challenges
■
9
expertise in international monetary matters and its proximity in time and distance to major
customers.
Additional support for a European-based dollar market came from the balance of payments
difficulties of the U.S. during the 1960s, which temporarily segmented the U.S. domestic
capital market.
Ultimately, however, the eurocurrency market continues to thrive because it is a large
international money market relatively free from governmental regulation and interference.
Eurocurrency Interest Rates. The reference rate of interest in the eurocurrency market is
the London Interbank Offered Rate, or LIBOR. LIBOR is the most widely accepted rate of
interest used in standardized quotations, loan agreements or financial derivatives valuations.
The use of interbank offered rates, however, is not confined to London. Most major domestic financial centers construct their own interbank offered rates for local loan agreements.
Examples of such rates include PIBOR (Paris Interbank Offered Rate), MIBOR (Madrid
Interbank Offered Rate), SIBOR (Singapore Interbank Offered Rate), and FIBOR (Frankfurt Interbank Offered Rate), to name but a few.
The key factor attracting both depositors and borrowers to the eurocurrency loan market
is the narrow interest rate spread within that market. The difference between deposit and loan
rates is often less than 1%. Interest spreads in the eurocurrency market are small for many reasons. Low lending rates exist because the eurocurrency market is a wholesale market, where
deposits and loans are made in amounts of $500,000 or more on an unsecured basis. Borrowers are usually large corporations or government entities that qualify for low rates because of
their credit standing and because the transaction size is large. In addition, overhead assigned
to the eurocurrency operation by participating banks is small.
Deposit rates are higher in the eurocurrency markets than in most domestic currency
markets because the financial institutions offering eurocurrency activities are not subject to
many of the regulations and reserve requirements imposed on traditional domestic banks and
banking activities. With these costs removed, rates are subject to more competitive pressures,
deposit rates are higher, and loan rates are lower. A second major area of cost avoided in the
eurocurrency markets is the payment of deposit insurance fees (such as the Federal Deposit
Insurance Corporation, FDIC) and assessments paid on deposits in the United States.
The Theory of Comparative Advantage
The theory of comparative advantage provides a basis for explaining and justifying international trade in a model world assumed to enjoy free trade, perfect competition, no uncertainty,
costless information, and no government interference. The theory’s origins lie in the work
of Adam Smith, and particularly with his seminal book, The Wealth of Nations, published in
1776. Smith sought to explain why the division of labor in productive activities, and subsequently international trade of those goods, increased the quality of life for all citizens. Smith
based his work on the concept of absolute advantage, with every country specializing in the
production of those goods for which it was uniquely suited. More would be produced for less.
Thus, with each country specializing in products for which it possessed absolute advantage,
countries could produce more in total and trade for goods that were cheaper in price than
those produced at home.
In his work, On the Principles of Political Economy and Taxation, published in 1817,
David Ricardo sought to take the basic ideas set down by Adam Smith a few logical steps
further. Ricardo noted that even if a country possessed absolute advantage in the production
of two goods, it might still be relatively more efficient than the other country in one good’s
10
PART 1 Global Financial Environment
production than the production of the other good. Ricardo termed this comparative advantage.
Each country would then possess comparative advantage in the production of one of the two
products, and both countries would then benefit by specializing completely in one product and
trading for the other.
Although international trade might have approached the comparative advantage model
during the nineteenth century, it certainly does not today, for a variety of reasons. Countries
do not appear to specialize only in those products that could be most efficiently produced
by that country’s particular factors of production. Instead, governments interfere with comparative advantage for a variety of economic and political reasons, such as to achieve full
employment, economic development, national self-sufficiency in defense-related industries,
and protection of an agricultural sector’s way of life. Government interference takes the form
of tariffs, quotas, and other non-tariff restrictions.
At least two of the factors of production—capital and technology—now flow directly and
easily between countries, rather than only indirectly through traded goods and services. This
direct flow occurs between related subsidiaries and affiliates of multinational firms, as well as
between unrelated firms via loans and license and management contracts. Even labor flows
between countries, such as immigrants into the United States (legal and illegal), immigrants
within the European Union, and other unions.
Modern factors of production are more numerous than in this simple model. Factors
considered in the location of production facilities worldwide include local and managerial
skills, a dependable legal structure for settling contract disputes, research and development
competence, educational levels of available workers, energy resources, consumer demand for
brand name goods, mineral and raw material availability, access to capital, tax differentials,
supporting infrastructure (roads, ports, and communication facilities), and possibly others.
Although the terms of trade are ultimately determined by supply and demand, the process
by which the terms are set is different from that visualized in traditional trade theory. They
are determined partly by administered pricing in oligopolistic markets.
Comparative advantage shifts over time as less-developed countries become more developed and realize their latent opportunities. For example, over the past 150 years comparative
advantage in producing cotton textiles has shifted from the United Kingdom to the United
States, to Japan, to Hong Kong, to Taiwan, and to China. The classical model of comparative
advantage also did not really address certain other issues such as the effect of uncertainty and
information costs, the role of differentiated products in imperfectly competitive markets, and
economies of scale.
Nevertheless, although the world is a long way from the classical trade model, the general
principle of comparative advantage is still valid. The closer the world gets to true international specialization, the more world production and consumption can be increased, provided
that the problem of equitable distribution of the benefits can be solved to the satisfaction
of consumers, producers, and political leaders. Complete specialization, however, remains
an unrealistic limiting case, just as perfect competition is a limiting case in microeconomic
theory.
Global Outsourcing of Comparative Advantage
Comparative advantage is still a relevant theory to explain why particular countries are most
suitable for exports of goods and services that support the global supply chain of both MNEs
and domestic firms. The comparative advantage of the twenty-first century, however, is one
that is based more on services, and their cross-border facilitation by telecommunications and
the Internet. The source of a nation’s comparative advantage, however, still is created from
the mixture of its own labor skills, access to capital, and technology.
Chapter 1 Multinational Financial Management: Opportunities and Challenges
11
For example, India has developed a highly efficient and low-cost software industry. This
industry supplies not only the creation of custom software, but also call centers for customer
support, and other information technology services. The Indian software industry is composed of subsidiaries of MNEs and independent companies. If you own a Hewlett-Packard
computer and call the customer support center number for help, you are likely to reach a
call center in India. Answering your call will be a knowledgeable Indian software engineer
or programmer who will “walk you through” your problem. India has a large number of
well-educated, English-speaking technical experts who are paid only a fraction of the salary
and overhead earned by their U.S. counterparts. The overcapacity and low cost of international telecommunication networks today further enhances the comparative advantage of
an Indian location.
The extent of global outsourcing is already reaching out to every corner of the globe. From
financial back-offices in Manila, to information technology engineers in Hungary, modern
telecommunications now take business activities to labor rather than moving labor to the
places of business.
What Is Different about International
Financial Management?
Exhibit 1.3 details some of the main differences between international and domestic financial
management. These component differences include institutions, foreign exchange and political
risks, and the modifications required of financial theory and financial instruments.
Multinational financial management requires an understanding of cultural, historical, and
institutional differences such as those affecting corporate governance. Although both domestic
firms and MNEs are exposed to foreign exchange risks, MNEs alone face certain unique risks,
such as political risks, that are not normally a threat to domestic operations.
MNEs also face other risks that can be classified as extensions of domestic finance theory.
For example, the normal domestic approach to the cost of capital, sourcing debt and equity,
Exhibit 1.3
What Is Different about International Financial Management?
Concept
International
Domestic
Culture, history, and institutions
Each foreign country is unique and not
always understood by MNE management
Each country has a known base case
Corporate governance
Foreign countries’ regulations and institutional practices are all uniquely different
Regulations and institutions are well
known
Foreign exchange risk
MNEs face foreign exchange risks due
to their subsidiaries, as well as import/
export and foreign competitors
Foreign exchange risks from import/
export and foreign competition (no
subsidiaries)
Political risk
MNEs face political risk because of their
foreign subsidiaries and high profile
Negligible political risks
Modification of domestic finance
theories
MNEs must modify finance theories like
capital budgeting and the cost of capital
because of foreign complexities
Traditional financial theory applies
Modification of domestic financial
instruments
MNEs utilize modified financial instruments such as options, forwards, swaps,
and letters of credit
Limited use of financial instruments
and derivatives because of few foreign
exchange and political risks
12
PART 1 Global Financial Environment
Global Finance in Practice
1.2
Corporate Responsibility
and Corporate Sustainability
Sustainable development is development that meets
the needs of the present without compromising the
ability of future generations to meet their own needs.
—Brundtland Report, 1987, p. 54.
What is the purpose of the corporation? It is accepted
that the purpose of the corporation is to certainly create
profits and value for its stakeholders, but the responsibility of the corporation is to do so in a way that inflicts
no costs on society, including the environment. As a
result of globalization, this growing responsibility and
role of the corporation in society has added a level of
complexity to the leadership challenges faced by the
multinational firm.
This developing controversy has been somewhat hampered to date by conflicting terms and labels—corporate
goodness, corporate responsibility, corporate social
responsibility (CSR), corporate philanthropy, and corporate
sustainability, to list but a few. Confusion can be reduced
by using a guiding principle—that sustainability is a goal,
while responsibility is an obligation. It follows that the obligation of leadership in the modern multinational is to pursue
profit, social development, and the environment, all along
sustainable principles.
The term sustainability has evolved greatly within the
context of global business in the past decade. A traditional
primary objective of the family-owned business has been
the “sustainability of the organization”—the long-term ability
of the company to remain commercially viable and provide
security and income for future generations. Although narrower in scope, the concept of environmental sustainability
shares a common core thread—the ability of a company, a
culture, or even the earth, to survive and renew over time.
capital budgeting, working capital management, taxation, and credit analysis needs to be
modified to accommodate foreign complexities. Moreover, a number of financial instruments
that are used in domestic financial management have been modified for use in international
financial management. Examples are foreign currency options and futures, interest rate and
currency swaps, and letters of credit.
The main theme of this book is to analyze how an MNE’s financial management evolves
as it pursues global strategic opportunities and new constraints emerge. In this chapter, we will
take a brief look at the challenges and risks associated with Trident Corporation (Trident), a
company evolving from domestic in scope to becoming truly multinational. The discussion will
include constraints that a company will face in terms of managerial goals and governance as
it becomes increasingly involved in multinational operations. But first we need to clarify the
unique value proposition and advantages that the MNE was created to exploit. And as noted
by Global Finance in Practice 1.2, the objectives and responsibilities of the modern multinational have grown significantly more complex in the twenty-first century.
Market Imperfections: A Rationale for the Existence
of the Multinational Firm
MNEs strive to take advantage of imperfections in national markets for products, factors
of production, and financial assets. Imperfections in the market for products translate into
market opportunities for MNEs. Large international firms are better able to exploit such
competitive factors as economies of scale, managerial and technological expertise, product
differentiation, and financial strength than are their local competitors. In fact, MNEs thrive
best in markets characterized by international oligopolistic competition, where these factors
are particularly critical. In addition, once MNEs have established a physical presence abroad,
they are in a better position than purely domestic firms to identify and implement market
opportunities through their own internal information network.
Chapter 1 Multinational Financial Management: Opportunities and Challenges
13
Why Do Firms Become Multinational?
Strategic motives drive the decision to invest abroad and become an MNE. These motives can
be summarized under the following categories:
1. Market seekers produce in foreign markets either to satisfy local demand or to export to
markets other than their home market. U.S. automobile firms manufacturing in Europe
for local consumption are an example of market-seeking motivation.
2. Raw material seekers extract raw materials wherever they can be found, either for export or
for further processing and sale in the country in which they are found—the host country.
Firms in the oil, mining, plantation, and forest industries fall into this category.
3. Production efficiency seekers produce in countries where one or more of the factors of
production are underpriced relative to their productivity. Labor-intensive production of
electronic components in Taiwan, Malaysia, and Mexico is an example of this motivation.
4. Knowledge seekers operate in foreign countries to gain access to technology or managerial
expertise. For example, German, Dutch, and Japanese firms have purchased U.S.-located
electronics firms for their technology.
5. Political safety seekers acquire or establish new operations in countries that are considered
unlikely to expropriate or interfere with private enterprise. For example, Hong Kong
firms invested heavily in the United States, United Kingdom, Canada, and Australia in
anticipation of the consequences of China’s 1997 takeover of the British colony.
These five types of strategic considerations are not mutually exclusive. Forest products firms
seeking wood fiber in Brazil, for example, may also find a large Brazilian market for a portion
of their output.
In industries characterized by worldwide oligopolistic competition, each of the above
strategic motives should be subdivided into proactive and defensive investments. Proactive
investments are designed to enhance the growth and profitability of the firm itself. Defensive
investments are designed to deny growth and profitability to the firm’s competitors. Examples
of the latter are investments that try to preempt a market before competitors can get established in it, or capture raw material sources and deny them to competitors.
The Globalization Process
Trident is a hypothetical U.S.-based firm that will be used as an illustrative example throughout the book to demonstrate the globalization process—the structural and managerial changes
and challenges experienced by a firm as it moves its operations from domestic to global.
Global Transition I: Trident Moves from the Domestic Phase
to the International Trade Phase
Trident is a young firm that manufactures and distributes an array of telecommunication
devices. Its initial strategy is to develop a sustainable competitive advantage in the U.S. market. Like many other young firms, it is constrained by its small size, competitors, and lack of
access to cheap and plentiful sources of capital. The top half of Exhibit 1.4 shows Trident in
its early domestic phase.
Trident sells its products in U.S. dollars to U.S. customers and buys its manufacturing
and service inputs from U.S. suppliers, paying U.S. dollars. The creditworth of all suppliers and buyers is established under domestic U.S. practices and procedures. A potential
14
PART 1 Global Financial Environment
Exhibit 1.4
Trident Corp: Initiation of the Globalization Process
Phase One: Domestic Operations
U.S. Suppliers
(domestic)
U.S. Buyers
(domestic)
All payments in U.S. dollars.
All credit risk under U.S. law.
Trident Corporation
(Los Angeles, USA)
Mexican Suppliers
Canadian Buyers
Are Mexican suppliers dependable?
Will Trident pay US$ or Mexican pesos?
Are Canadian buyers creditworthy?
Will payment be made in US$ or C$?
Phase Two: Expansion into International Trade
issue for Trident at this time is that although Trident is not international or global in its
operations, some of its competitors, suppliers, or buyers may be. This is often the impetus
to push a firm like Trident into the first phase of the globalization process—into international trade. Trident was founded by James Winston in Los Angeles in 1948 to make
telecommunications equipment. The family-owned business expanded slowly but steadily
over the following 40 years. The demands of continual technological investment in the
1980s, however, required that the firm raise additional equity capital in order to compete.
This need led to its initial public offering (IPO) in 1988. As a U.S.-based publicly traded
company on the New York Stock Exchange, Trident’s management sought to create value
for its shareholders.
As Trident became a visible and viable competitor in the U.S. market, strategic opportunities arose to expand the firm’s market reach by exporting product and services to one or more
foreign markets. The North American Free Trade Area (NAFTA) made trade with Mexico
and Canada attractive. This second phase of the globalization process is shown in the lower
half of Exhibit 1.4. Trident responded to these globalization forces by importing inputs from
Mexican suppliers and making export sales to Canadian buyers. We define this phase of the
globalization process as the International Trade Phase.
Exporting and importing products and services increases the demands of financial management over and above the traditional requirements of the domestic-only business in two
ways. First, direct foreign exchange risks are now borne by the firm. Trident may now need
to quote prices in foreign currencies, accept payment in foreign currencies, or pay suppliers
in foreign currencies. As the values of currencies change from minute to minute in the global
marketplace, Trident will increasingly experience significant risks from the changing values
associated with these foreign currency payments and receipts.
Second, the evaluation of the credit quality of foreign buyers and sellers is now more
important than ever. Reducing the possibility of non-payment for exports and non-delivery
of imports becomes a key financial management task during the international trade phase.
This credit risk management task is much more difficult in international business, as buyers
and suppliers are new, subject to differing business practices and legal systems, and generally
more challenging to assess.
Chapter 1 Multinational Financial Management: Opportunities and Challenges
15
Global Transition II: The International Trade Phase
to the Multinational Phase
If Trident is successful in its international trade activities, the time will come when the globalization process will progress to the next phase. Trident will soon need to establish foreign sales and
service affiliates. This step is often followed by establishing manufacturing operations abroad
or by licensing foreign firms to produce and service Trident’s products. The multitude of issues
and activities associated with this second larger global transition is the real focus of this book.
Trident’s continued globalization will require it to identify the sources of its competitive
advantage, and with that knowledge, expand its intellectual capital and physical presence
globally. A variety of strategic alternatives are available to Trident—the foreign direct investment sequence—as shown in Exhibit 1.5. These alternatives include the creation of foreign
sales offices, the licensing of the company name and everything associated with it, and the
manufacturing and distribution of its products to other firms in foreign markets.
As Trident moves farther down and to the right in Exhibit 1.5, the degree of its physical
presence in foreign markets increases. It may now own its own distribution and production
facilities, and ultimately, may want to acquire other companies. Once Trident owns assets
and enterprises in foreign countries it has entered the multinational phase of its globalization.
The Limits to Financial Globalization
The theories of international business and international finance introduced in this chapter
have long argued that with an increasingly open and transparent global marketplace in which
capital may flow freely, capital will increasingly flow and support countries and companies
Exhibit 1.5
Trident’s Foreign Direct Investment Sequence
Trident and Its
Competitive Advantage
Change
Competitive Advantage
Greater
Foreign
Presence
Exploit Existing Competitive
Advantage Abroad
Production at Home:
Exporting
Production Abroad
Licensing
Management Contract
Control Assets
Abroad
Wholly Owned
Subsidiary
Joint Venture
Greater
Foreign
Investment
Greenfield
Investment
Acquisition of
of aa
Acquisition
Foreign Enterprise
Enterprise
Foreign
16
PART 1 Global Financial Environment
based on the theory of comparative advantage. Since the mid-twentieth century, this has
indeed been the case as more and more countries have pursued more open and competitive markets. But the past decade has seen the growth of a new kind of limit or impediment
to financial globalization: the growth in the influence and self-enrichment of organizational
insiders.
One possible representation of this process can be seen in Exhibit 1.6. If influential insiders in corporations and sovereign states continue to pursue the increase in firm value, there
will be a definite and continuing growth in financial globalization. But, if these same influential
insiders pursue their own personal agendas, which may increase their personal power and
influence or personal wealth, or both, then capital will not flow into these sovereign states
and corporations. The result is the growth of financial inefficiency and the segmentation of
globalization outcomes—creating winners and losers. As we will see throughout this book,
this barrier to international finance may indeed be increasingly troublesome.
This growing dilemma is also something of a composite of what this book is about. The
three fundamental elements—financial theory, global business, and management beliefs and
actions—combine to present either the problem or the solution to the growing debate over
the benefits of globalization to countries and cultures worldwide. The Mini-Case sets the stage
for our debate and discussion. Are the controlling family members of this company creating
value for themselves or for their shareholders?
We close this chapter—and open this book—with the simple words of one of our colleagues
in a recent conference on the outlook for global finance and global financial management.
Welcome to the future. This will be a constant struggle. We need leadership, citizenship,
and dialogue.
—Donald Lessard, in Global Risk, New Perspectives and Opportunities, 2011, p. 33.
Exhibit 1.6
The Limits of Financial Globalization
There is a growing debate over whether many of the insiders and rulers of organizations with enterprises
globally are taking actions consistent with creating firm value or consistent with increasing their own
personal stakes and power.
Actions of Rulers
of Sovereign States
Higher Firm Value
(possibly lower
insider value)
The Twin Agency
Problems Limiting
Financial Globalization
Lower Firm Value
(possibly higher
insider value)
Actions of
Corporate Insiders
If these influential insiders are building personal wealth over that of the firm, it will indeed result in preventing
the flow of capital across borders, currencies, and institutions to create a more open and integrated global
financial community.
Source: Constructed by authors based on “The Limits of Financial Globalization,” Rene M. Stulz, Journal of Applied Corporate
Finance, Vol. 19, No. 1, Winter 2007, pp. 8–15.
Chapter 1 Multinational Financial Management: Opportunities and Challenges
17
Summary Points
■
The creation of value requires combining three critical elements: 1) an open marketplace; 2) high-quality
strategic management; and 3) access to capital.
■
The theory of comparative advantage provides a basis
for explaining and justifying international trade in a
model world assumed to enjoy free trade, perfect competition, no uncertainty, costless information, and no
government interference.
■
■
■
International financial management requires an
understanding of cultural, historical, and institutional differences, such as those affecting corporate
governance.
Although both domestic firms and MNEs are exposed
to foreign exchange risks, MNEs alone face certain
unique risks, such as political risks, that are not normally a threat to domestic operations.
MNEs strive to take advantage of imperfections in
national markets for products, factors of production,
and financial assets.
Mini-Case
Bitcoin—Cryptocurrency
or Commodity?1
The difference is that established fiat currencies—ones
where the bills and coins, or their digital versions, get
their value by dint of regulation or law—are underwritten
by the state which is, in principle at least, answerable to its
citizens. Bitcoin, on the other hand, is a community currency. It requires self-policing on the part of its users. To
some, this is a feature, not a bug. But, in the grand scheme
of things, the necessary open-source engagement remains
a niche pursuit. Most people would rather devolve this
sort of responsibility to the authorities. Until this mindset
changes, Bitcoin will be no rival to real-world dosh.
—“Bits and bob,” The Economist, June 13, 2011.
Bitcoin is an open-source, peer-to-peer, digital currency. It is a cryptocurrency, a digital currency that
is created and managed using advanced encryption
techniques known as cryptography. And it may be
the world’s first completely decentralized digital-payments
system. The unofficial three letter currency code for Bitcoin
is BTC, and its singular currency symbol is shown above.
■
Large international firms are better able to exploit such
competitive factors as economies of scale, managerial
and technological expertise, product differentiation,
and financial strength than are their local competitors.
■
A firm may first enter into international trade transactions, then international contractual arrangements,
such as sales offices and franchising, and ultimately the
acquisition of foreign subsidiaries. At this final stage it
truly becomes a multinational enterprise (MNE).
■
The decision whether or not to invest abroad is driven
by strategic motives and may require the MNE to enter
into global licensing agreements, joint ventures, crossborder acquisitions, or greenfield investments.
■
If influential insiders in corporations and sovereign
states pursue their own personal agendas, which may
increase their personal power, influence, or wealth,
then capital will not flow into these sovereign states
and corporations. This will, in turn, create limitations
to globalization in finance.
But is Bitcoin a true currency? Is it, or can it become,
money? In January 2014 a number of major regulatory bodies across the world—the U.S. Federal Reserve, the European Central Bank, the People’s Bank of China—were
all trying to decide whether Bitcoin was something to be
prohibited, regulated, or simply left alone. Perspectives on
Bitcoin use varied dramatically, and in many cases, unexpectedly so. But the regulators were only one stakeholder
interest; users and producers had their own perspectives on
the potential of Bitcoin.
Producing and Using Bitcoins
Bitcoin was invented in 2009 by a man claiming to be
Satoshi Nakamoto. Nakamoto published, via the Internet,
a nine-page paper outlining how the Bitcoin system would
work. He also provided the open-source code needed to
both produce the digital coins (mine in Bitcoin terminology) and trade Bitcoins digitally as money. (Nakamoto is
not thought to be a real person, likely being a nome de
plume for some relatively small working group. Nakamoto
disappeared from the Internet in 2012.)
Mining. The actual mining of Bitcoins is a mathematical
process. The miner must find a sequence of data (called a
block) that produces a particular pattern when the Bitcoin
Copyright © 2014 Thunderbird School of Global Management. All rights reserved. This case was prepared by Professor Michael H.
Moffett for the purpose of classroom discussion only and not to indicate either effective or ineffective management.
1
18
PART 1 Global Financial Environment
hash algorithm is applied to it. When a match is found, the
miner obtains a bounty—an allocation—of Bitcoins. This
repetitive guessing, conducted by increasingly complex
computers, is called hashing. The motivation for mining is
clear: to make and earn money.
The Bitcoin software system is designed to release a
25-coin reward to the miner in the worldwide network (anyone, anywhere, can theoretically be a part of the network)
who succeeds in solving the mathematical problem. Once
solved, the solution is broadcast network-wide, and competition for the next 25-coin reward begins. The system’s
protocol is designed to release a new block of Bitcoins every
10 minutes until all 21 million are released, with the blocks
getting smaller as time goes on. If the miners in the network take more than 10 minutes to find the correct code, the
Bitcoin program adapts to make the mathematics easier. If
the miners solve the problems in less than 10 minutes, the
mathematical code becomes harder.
The difficulty of the search continually increases over
time with mining. This creates an ever-increasing scarcity
over time, similar to what many believe about gold when
gold was the basis of currency values. But ultimately the
Bitcoin system is limited in both time (every 10 minutes)
and total issuance (21 million). Theoretically the last of the
21 million Bitcoins would be mined in 2140.
Within a few short years Bitcoin mining has become a big
business of its own. Whereas in the early stages an individual
could have theoretically mined Bitcoins on a laptop, or theoretically without a computer at all, that is no longer the case.
By 2014, Bitcoin mining had become the object of multimillion dollar investments in computer systems by business startups from Iceland to Austin in what one journalist
described as a “computational arms race.” Eleven million of
the total potential 21 million coins had been mined.
Users. Once mined, Bitcoins are considered a
pseudonymous—nearly anonymous—cryptocurrency.2 Bitcoins are initially issued to the successful miners, who are
then able to buy things with them or sell them to non-miners
who wish to use digital currency for purchases or speculate
on its future value.
Ownership of each and every coin is verified and registered through a digital chain timestamp across the thousands
of network nodes. Like cash, this prevents double spending, since every Bitcoin exchange is authenticated across
the decentralized Bitcoin network (currently estimated at
20,000 nodes). Unlike cash, every transaction that has ever
occurred in the Bitcoin system is recorded in terms of the
two public keys (the transactors, the Bitcoin addresses) in
the system. This record, called the block chain, includes the
time, amount, and the two near-anonymous IP addresses
(public keys are not tied to any person’s identity). And
unlike credit cards or PayPal, there is no third-party facilitator. It is true peer-to-peer.
The Bitcoin Foundation, a nonprofit organization, runs
the global system. The current Bitcoin Foundation chief
scientist is Gavin Andresen, who is paid a salary. The Foundation is funded mainly through grants made by for-profit
companies (like the Linux Foundation) who either mine or
use the Bitcoin system.
Value Drivers and Concerns
Traditional currencies are issued by governments through
central banks. They regulate the growth of the currency, its
supply, and they also implicitly guarantee its value in some
way. Bitcoin has no such guarantor, no insurer, no lenderof-last-resort. If a Bitcoin user were to lose or erase their
records of ownership, there would be no support or
insurer—no one to sue, no institution to apply to for
recourse.3 The value of a Bitcoin is completely dependent
on what users and investors are willing to pay for it at any
point in time. This makes it similar in nature to both a currency and a commodity.
Bitcoin is a rather complex composite of currency systems. A gold standard like that used in the first part of the
twentieth century, is a system based on specie; it has some
fixed link to a scarce metal of some intrinsic value. Bitcoin
does have digital scarcity, and ultimately a fixed limit on its
availability. But Bitcoins have no intrinsic value; they are not
composed of a precious metal; they are nothing more than
digital code. Their value reflects the supply and demand by
those in the marketplace who believe in its value—a fiat
currency—similar to the world’s major currencies today. As
illustrated in Exhibit A, that value has been very volatile.
After spending several years trading at less than $10 per
Bitcoin (using U.S. dollar values, like an exchange rate), its
price skyrocketed to $1238 per coin in December 2013—and
then plummeted.
The reasons behind Bitcoin’s price volatility in 2013 provide some insight into its potential uses. A bank crisis in
November 2013 in Cyprus resulted in many Cypriot citizens
putting their money into Bitcoins (bidding the price up)
in an effort to keep their money out of the hands of government. Similarly, in late 2013 Bitcoins surged in interest
and use in China. Chinese residents, in search of a way to
invest their money outside of China despite Chinese capital
controls (restrictions on taking money out of the country),
purchased Bitcoins through a number of different Bitcoin
exchanges in China, using Chinese renminbi, and then used
the Bitcoins to invest abroad. Chinese authorities moved
Bitcoin is not the only cryptocurrency or altcoin. Competitors include Litecoin, Ripple, MintChip, Anoncoin, Peercoin, and Zerocoin.
Physical bitcoins, called Casascius coins, can be purchased from casascius.com. These coins contain a private key on a card embedded
in the coin and sealed with a tamper-evident hologram.
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Chapter 1 Multinational Financial Management: Opportunities and Challenges
Exhibit A
Bitcoin Price in U.S. Dollars
Daily close: January 1, 2013 – January 19, 2014
$1,4...
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