INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT

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INBU 4200INTERNATIONALFINANCIAL MANAGEMENT

• Professor Michael Palmer
• Professor of Finance
• University of Colorado at Boulder
• Fall Semester 2005
• Lecture 1 Introduction and Globalization

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What is your current understanding of
international finance?

• Foreign exchange symbols on previous slide?
• What is the current exchange rate for the
• Yen, Pound, Euro?
• Which of the following currencies is NOT pegged
  to the U.S. dollar?
• Malaysian ringlet, Hong Kong dollar, Argentina
  Peso
• What country currently has the lowest (highest)
  interest rates?
• United States, Japan, U.K., Germany
• What has the U.S. dollar done since the beginning
  of the year against a basket of major currencies?
• Strengthened or weakened?
• What is the approximate current account balance
  of the United States?
• Which country is Japans major trading partner?
• Which country is the largest acquirer of U.S.
  businesses?

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INBU 4200 Course Objectives

• To introduce you to the unique financial
  environments, issues, and challenges
• Business firms face when they enter the global
  financial environment
• Both non-financial and financial enterprises
• Focus on FOREIGN EXCHANGE MARKETS
• To examine the forces of globalization which are
  affecting these financial environments.
• And to discuss strategies for dealing with these
  environments, issues, and challenges

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Course Learning Objectives

• By the end of this semester, I would like you to
  be
• Knowledgeable with regard to the workings of
  international financial markets.
• Understand foreign exchange markets
• Knowledgeable with regard to the impact of global
  financial markets on businesses.
• The risks they face
• Methods for managing these risks.

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Course Topics

• Globalization and International Finance
• Impact on business firms?
• Impact on financial markets?
• International Financial Markets
• Banking, bond and equity markets
• Foreign exchange market
• Offshore and domestic (national markets)
• International Monetary System
• Foreign exchange regimes

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Course Topics

• Foreign Exchange Exposure
• Risk, Measurement, Management
• Forecasting Foreign Exchange Rates
• Short term and longer term models
• Foreign market entry modes
• Financing impacts
• Licensing arrangements to FDI
• Cost of capital impacts.
• Working Capital (Short-term) Issues

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What is GLOBALIZATION?

• What do you think of????

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Globalization Defined

• The act of becoming world wide in scope or
  application
• Thus, it can be viewed as an increasingly freer
  flow of
• money,
• goods,
• services,
• companies,
• Ideas (technology), and
• people
• across national borders.

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Globalizations Potential Impact on Business
Firms

• Impacts on the current and potential target
  markets where companies sell and buy
• consumer goods and
• industrial goods.
• Impacts on where companies source the factors of
  production for their enterprises
• capital (financial markets),
• technology,
• labor

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Globalizations Potential Impact on Business
Firms

• Global acquisition impacts.
• Firms can now be the target of or acquirer of
  foreign firms.
• Buying other firms technology, market share,
  patents, etc.
• Expands the opportunity set for acquiring
  firms.
• Risk impacts associated with increasingly global
  enterprises.
• Global competition, understanding different
  markets, and the unique financial risks that
  confront these firms.

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History of Globalization

• Review of the Globalization Process
• 150 years ago Free Trade Era
• Second British Empire and Industrial Revolution
• Last half of the 18th Century.
• Economic Thought of the Time
• Adam Smith and David Ricardo
• WW I (1914-1918) 1940s Abandonment of Free
  Trade
• High protectionism especially during Great
  Depression (1929 early 1940s)
• Hawley-Smoot Tariff Act in U.S. (1930) imposed
  the highest duties on agricultural products and
  manufactured goods in U.S. history

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History of Globalization

• Period Immediately After WWII (1939 1945) Slow
  Return to Globalization Process
• Formation of GATT in 1948
• Reduced tariffs and grew world trade
• Bretton Woods Agreements in 1944
• Return to fixed exchange rates promoting world
  trade. (Bretton Woods International Monetary
  System)
• International Monetary Fund established in 1944
• Promoted international monetary cooperation in
  the area of exchange rates to encourage world
  trade.
• World Bank established in 1944
• Initially loans to Europe for the reconstruction
  of damaged industries.

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History of Globalization

• 1970s Accelerating goods trade linkages among
  worlds industrial countries
• Accelerating role of GATT
• Impact of negotiated trade agreements and
  regional trading blocs (EU)
• 1980s Expansion of goods trade liberalization
  among developing countries.
• Mid-1980s Trade liberalization spreads to
  capital flows.
• Reduced restrictions on cross border financial
  flows.
• 1994 Establishment of WTO
• Replacing GATT

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Measuring Globalization

• Study by Kose (Dec. 2004, Finance and
  Development) looked at 85 countries over the last
  20 years.
• 21 industrial countries
• 64 developing countries
• Findings
• Financial liberalization rose from 20 to 55
• Trade liberalization rose from 30 to 85

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Economic Volatility and Growth

• Kose (2004) looked at the relationship between
  volatility (of GDP growth) and growth (GDP).
• 1960-2000
• For all counties there was a negative
  correlation.
• Greater volatility is associated with lower
  growth!

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Differences Within Sample of Countries

• Koses (2004) study showed that industrial and
  emerging market countries showed a positive
  relationship of volatility to growth.
• Even through these countries may have experienced
  greater volatility, that did not adversely affect
  growth rates.

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But for Developing Countries

• For the sample of developing countries, however,
  the correlation was negative.
• Thus, greater volatility is associated with lower
  growth for these developing countries.

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Issues Surrounding the Globalization Process

• Has the globalization process has been uneven for
  sets of countries?
• Claim that rich countries have benefited at the
  expense of poorer countries.
• Claim that rich countries continue to protect
  their key sectors (especially agriculture now
  textiles).
• Has globalization has resulted in unstable
  economic situations and lower growth?
• Wider economic swings and greater financial
  instability.
• Currency/economic crises of the 1990s on.
• Is there an impact volatility on economic growth?

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Issues Surrounding the Globalization Process

• Has globalization resulted in a disruptive level
  of outsourcing?
• A political issue in many developed
  (industrial) countries.
• United States, Western Europe, Japan
• Country outsourcing sites
• Production China
• Services India
• Has globalizations opening of markets resulted
  in disruptions to specific sectors of national
  economies?
• Dumping or comparative advantage?

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Globalization by Functions

• Selling Function
• McDonalds Corporation
• Starbucks
• Production Function
• Nike Corporation
• Financial Services (banking, insurance,
  investments) Function
• Citigroup

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Selling Function

• McDonalds operates in 120
• Countries.
• - 66 of 2004 sales were from international
  operations.
• Starbucks has 2,840 international
• retail coffee stores operating
• in 34 countries.
• - International stores accounted for about 20
  of Starbucks 2004 earnings.

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Production Function

• About 99 of all Nike brand apparel is produced
  outside the United States in 35 different
  countries.
• Country Percent
• China 38
• Indonesia 27
• Vietnam 18
• Thailand 16

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Financial Services Function

• Citigroup operates in over
• 100 countries in
• banking, insurance,
• and investment services.
• In 2003, 46 of its revenues from operations
  resulted from activities outside of North
  America!

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Globalization Summary

• As a result of globalization, business firms are
  discovering new opportunities
• New markets for their products.
• New sources for their inputs
• Globalization, however, introduces new and more
  complex sources of risk.
• Need to be managed.
• Governments are also involved in this globalized
  world.
• Their involvement can hurt or help companies.

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Globalization of Financial Markets

• Resulted from financial market deregulations over
  the last 25 years.
• Has encouraged financial innovation, foreign
  entry, and competition.
• United States 1979 Monetary Control and
  Deregulations Act.
• Followed by a series of deregulations, including
  the lifting of the Glass Steagall Act in 1999
• London Big Bang in 1986 (stock market)
• Japan phasing in of universal financial
  institutions legislation (2005)

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Globalization of Financial Markets

• Developing nations have also opened their
  financial markets to non-resident investors.
• Need to attract external capital.
• Especially after Third World Debt Crisis
  (1980s)
• Attracting capital and financial institutions.
• Emergence of tax and regulatory attractive
  offshore financial centers.
• Governments providing tax and regulatory
  incentives to attract financial service
  providers.
• Threat to traditional financial centers?
• Threat to global financial stability?

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The Globalization of Financial Markets Summary

• Financial markets now function in many ways as
  one integral whole covering the globe.
• Large volumes trading across borders.
• Securities of many different nations trading in
  each major financial market center.
• Events in one market affecting other markets
  around the world.
• Today, companies look at funding possibilities in
  capital markets around the world.
• Today, investors can select from opportunities
  offered by a vast array of countries.

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Why is International Finance Difference
from Domestic Finance?

• Foreign Exchange Risk
• Risks associated with doing business in different
  currencies.
• Political Risk
• Policies of different national governments will
  affect performance.
• Expanded Opportunity Set
• Activities beyond the home market create both
  opportunities and challenges.
• Cultural Differences
• Differences in equity cultures and corporate
  cultures complicate global business
• Corporate Governance Issues
• Differences in the relationship between managers
  and investors (owners).

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Foreign Exchange Risk

• Global companies take positions in foreign
  currencies as a result of their global
  activities.
• Foreign currency denominated assets
• Resulting from accounts receivable and owned
  overseas financial assets
• Foreign currency denominated liabilities
• Results from accounts payable and overseas
  financial liabilities
• Critical questions for global company
• How will changes in these foreign currencies
  affect their consolidated financial performance?
• How volatile are the currencies it is dealing in?
• What are the appropriate techniques for managing
  this risk?

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Trend Changes U.S. Dollar
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Sudden Short Term Moves, Yen March 23, 2005
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Tracking Short Term Currency Volatility Web
Source

• FX Street provides real time quotes for trading
  currencies.
• http//www.fxstreet.com/nou/graph/streamingchart.a
  sp
• Lets look at some major currencies
• Euro, pound and yen.

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Currency Volatility Summary

• Major currencies appear to be potentially
  volatile.
• Susceptible to longer term trend moves
• Susceptible to (sudden) short term movements
• Why?
• Governments are less (or no longer) involved in
  managing (supporting) these major currencies.
• Market forces, therefore, determine these rates.
• As a result Rates become more volatile during
  periods of uncertainty.

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Political Risk

• Involves the role of the host (foreign)
  government in
• Foreign exchange controls and government
  intervention in market itself.
• Profit repatriation process
• How easy is it to remove profits from foreign
  operations
• Taxation policies (including withholding taxes on
  dividends and tax treaties)
• Contract enforcement protection of private
  property (legal systems important here also
  enforcement of current laws and enactment of new
  laws)

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Expanded Opportunities

• Possibility for activities in many markets allows
  for
• Rapid growth in scale of business enterprise.
• Especially when domestic market has become
  saturated.
• May be done with little financial commitment.
• Licensing, franchising, joint ventures.
• Expansion of scope of business enterprises
• Acquisition of foreign firms in new business
  areas.
• Economies of scale in operations.
• Can only be achieved if product or service
  offering can be standardized!
• Case study Kelloggs cereals.
• Case study U.S. drug sales in Japan require
  additional trials.

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Standardized Global Product Example Kelloggs
Corn Flakes

• United States

• Japan (Koon fure-ku)

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Corporate Structural Differences

• Shareholder Wealth Structure (Anglo-American or
  Anglo-Saxon)
• Believe that a firms objective should be to
  maximize shareholder wealth
• These countries include the US, Canada,
  Australia, United Kingdom.
• Corporate Wealth Structure (Non-Anglo-American)
• Believe that a firms objective should be to
  maximize corporate wealth (which includes all
  stakeholders)
• These countries include the EU, Japan and Latin
  American countries

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Shareholder Wealth Structure

• Focuses on the importance of shareholder
  relationships to corporate structure.
• Wealth is strictly financial.
• Management tools measure impact of decisions on
  equity (common stock) values.
• Acceptance of hostile takeovers.
• Capital budgeting techniques
• Net Present Value
• Internal Rates of Return
• Aimed at securing returns greater than the firms
  cost of capital and thereby increasing returns to
  shareholders.

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Corporate Wealth Structure

• Came about because of
• Distrust of Anglo-American capitalism especially
  in Europe (search for the Third-Way).
• Definition of corporate wealth is broader than
  Anglo-American viewpoint
• Consideration given to the implications of
  strategic moves affecting all parties such as
  human resources, community, state, etc.
• Advisory Committees in Europe
• Strict labor laws (e.g., firing) in Europe.
• Life time employment concept in Japan
• Weakened in the 1990s
• Friendly takeovers are the rule.

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Equity Cultural Differences

• Anglo Saxon countries (U.S., U.K., Canada)
• Generally a well developed equity culture
• Understanding and acceptance of ownership and
  equity risk.
• Important source of funds for corporate financing
• Affects corporate goals.
• Management tends to focus on shareholders.
• Non-Anglo Saxon Countries (Continental Europe and
  many Asian countries)
• Relatively poorly developed equity culture
• Risk not as well tolerated.
• Reliance on debt and bank financing in these
  cultures.
• Corporate goals become more diverse.

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Corporate Governance

• Defined The financial and legal framework for
  regulating the relationship between managers and
  owners.
• Important to shareholders (as owners).
• Historically important in Anglo-American markets.
• Issue of market transparency (information
  available to all at the same time).
• (Relatively) well defined in the United States.
• Although we have had our abuses!
• Sabanes-Oxley Act

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Corporate Governance

• Concept not as well developed in other parts of
  the world.
• No independent boards of directors in China!
• Who are the owners in China?
• State historically.
• Germany, since 2002, has a voluntary corporate
  governance code.
• The German code suggests that companies disclose
  top management salaries (including bonuses).
• Thus far few Germany firms have reported this
  information to shareholders. (only 9 of the top
  30 companies 2004 data).