1. Unit-III
FDI
Why do firm invest abroad:
New source of demand
Economies of scale
For use of foreign raw Mtrl / technology
To exploit cost monopolistic advantage
To diversify inter nationally
To expand in politically safe country
For knowledge
How does FDI flow: Exporting / importing / joint venture / merger
acquisition / licensing?
/ Franchising / turnkey project management contract.
Requirement for bringing FDI: Reliable excess to economic information
Low level of corruption] (Low)
Stable Govt. / stable business environment
Growth potential (More)
Good infrastructure
Ability to meet STD
3500
3000 increasing trend
but
2500 fall in 1999 ~ 2001
2000
1500
1000
500
91-2 2-3 3-4 4-5 5-6 6-7 7-8 8-9 9-0 0-01 0-02
Measure to attract FDI: - 1. Liberal laws
2. Centralize approval
1

2. 3. Liberal rule of business
4. Reduce entry barrier
5. Proper information
6. Policy reform
7. STD guide lines
8. Strong intellectual property right
9. Transparency
10.Dispute resolution
11.EPZ’s creation
12.Formation of council
1998 ~ 89 ~ 2001-02
Fall in FDI
Permission of FDI in India: - Through
Financial collaboration
Joint venture
Technical collaboration
Euro issue
Sectors in which FDI not allowed In India: -
Arm & ammunition
Atomic energy
Railway transport
Coal mining
Reason of FDI growing in India: - big market / skilled manpower
Capability of knowledge management
Properly place-financed system
Democratic politics
Major FDI bringing industry:
Telecom / electrical equipment
Computer software % 50
Transportation industry (excluding railways)
2001- China FDI – 46.8 us $ (in billion)
India FDI – 3.4 us $ (in billion)
Rank wise FDI in India – 1991-2002
1. Mauritius – 38.7 %
2. USA – 17.1 % India’s share in business – 1%
3. Japan – 6.8
4. UK – 5.2
2

3. INTERNATIONAL PORTFOLIO INVESTMENT
- Security are bought & sold in the form of port folio
- It reduces risk :- same risk – high return
Less risk – same return
Comparatively less risk increase for
Comparatively high rate of return
- Gain from stock diversification
- Risk from exchange rate reduced
- Political risk reduced
- Legal / social / country risk reduced
- Standard deviation & variance are used to measure risk
- Two outcomes
1) Dividend 1) interest
2) Capital gain 2) principal
Portfolio
Fix income variable return
Interest rate bond or variable interest
rate bond & security
Debentures
No fix maturity
Fix maturity
3

4. Decision in portfolio investment
- Which type security to select for investment
- Which market that security should be taken / analyses / tax
on security
- International diversification
- Time of diversification
- Compare risk & return, with domestic
- How to reduce risk
Risk in % Total risk of domestic
diversification
25 Total risk of international
diversification
20
15
10
5
5 10 15 20 25 30
No. Of Security New page
4

5. Factors Effecting portfolio investment return: - global economic trends
World business cycle
Trend in word trade world specific
World income
National income
National economic trend nation specific
Business cycle
Cost factor
Out put industry specific
Relative price change for input
Firm specific factor
Currency in which return earnest
Exchange rate behavior currency
factor
Foreign exchange market
5

6. Aspect of portfolio investment
Fix income security variable return security
Fix income security : - invest in appreciating country /- (foreign investment
to bond is better than home )
- calculate after tax return
International equity investment : - Compare tax on dividend
- Compare return of home with return from
foreign by
Adjusting currency exchange rate
- Measurement of stock return
- Select of indent portfolio return
Factors of portfolio investment
- Foreign exchange rate – appreciating / depreciating
- Profitability
- Tax factor: - high / low – profit after tax
- Risk factor : economic/ political / legal / social / country /
natural factor
- Foreign exchange risk : economic/ transaction / translation
risk & exposure
- Management
- Market segmented or integrated
- Availability of information (speed / reliability / on time )
- Laws / policy govt
- STD guideline
- Return
- To invest in fix income bond / variable return security
- Which market to invest
- Which currency to invest
- At what time to invest
- How many no’s of stock
- How much qty of money to invest
- Time of maturity required
- Global economic trends
- World business cycle
- Trend in world trade
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7. - World income
- National income
- National economic trend
- Domestic business cycle
- Output how much increase or decrease (relative price
change of output)
- Relative price change in input
- Currency in which return required
- Invest in bond or security
- Compare home return it international portfolio in vestment
BENIFIT OF INTERNATIONAL PORTFOLIO INVESTMENT
1. Same risk – high return
2. Less risk – same return
3. International portfolio investment is better than
domestic
4. Less cost of capital – high return
5. Better opportunity
6. Knowledge increase
7. Domestic threat can be removed
8. Economics of scale
9. Better use of recourse.
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8. INTERNATIONAL CAPM .
r
j = r
f + Bw (r
w – r
f)
Bw
= Cov (r
j
r
w)
Var (r
w)
r
w = world market expected return
r
j = required expected return on security / portfolio
Var r
w = variance of world market portfolio
Cov (r
j
r
w) = covariance between security or portfolio and world market w
Segmented market gives better return than integrated market
If unsystematic risk is removed (overcome cause of segmentation &
diversify internationally
Return
15
10
5
5 10 15
Risk
Reason of market segmentation
- Legal barrier
- tax rates
- Information
- Exchange rate risk
- Expected return depend on domestic factor
- Listing costs variation
- Reduce systematic risk of domestic market
-
- DETERMINANTS OF VOLUME
Volume means how much flow of FDI
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9. Determinants of volume: -
- If profitability is high in another country then high FDI
- Govt policy if favorable then high volume of FDI
- If country risk less than FI flow will be high
- If good infrastructure the high volume of FDI
- Labour problem less – high FDI flow
- If legislation favorable to FDI – them high FDI
- Political stability effects volume favorable for FDI
- Finance market effects FDI
- Economic policy if favorable for FDI, then high FDI
- Price stability effect FDI
- Exchange rate flexibility effect volume of FDI ]
- If return on investment is high then high volume of FDI
- Social environment
- Cultural environment
- Availability of skilled labour
- Tax factor
- Availability of information / accurately and timely
- Relative price change in inputs
- Attitude of Govt toward home industry
- Cost factor
- National income
- National business cycle
- Availability of technology at home
- Registration & approval procedure
- Entry barrier
Infrastructure: / rail / road / electricity
Remittance restriction
Business norms & tradition
Inflation / interest rate
Market size /skilled manpower / financial system
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10. COMPOSITION OF FDI
- Formula
- Machine
- Drawing
- Software
- License franchising
- Technology
- Turnkey projects
- Management
- Idea
- Finance
- Joint venture
- Merger & acquisition
- Through euro issue
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11. DIRECTION OF FDI
Year- 2001
From : (1) Mauritius : 38.7%
(2) USA : 17.1%
(3) Japan : 6.8% To India
(4) UK : 5.2%
(5) Germany : 5.0%
FDI Inflow 2001
(1) China :6.4%
(2) Hongkong :3.1% Of world FDI
(3) India : .5%
(4) Korea : .4%
FDI – from developed country to least developed country
From developed country to developing country
From business saturated country to expanding country
From high technology country to low technology country
From US/ UK /Europe – to –Asian countries
- African countries
High tax country to – low tax countries
Developed countries to – highly populated countries
FDI is coming through MNC’s
From economically unstable countries to economically stable countries
U-3
PROCESS OF CAPITAL BODGETING
- Search project
- Assess political climate of that country
- Check strategy
- Cash flow analysis
11

12. - Required rate of return
- Economic evaluation
- Select
- Risk analysis
- Implement
- Execute control
- Post audit
MULTINATIONAL CAPITAL BUDGETING
APPLICATION & INTER PRETATION
Application
APV is best method (adjusted present value)
- Parent & project cash flow
- Problem in foreign investment analysis
- Issue in foreign investment analysis
- Adjustment of risk
Out of prospective investment – select a combination of these project
which maximize the company value to its share holder in it
discounting of project flow is done
Unique complexities of foreign project evaluation: -
- Parent cash flow are different from project cash flow
- Conversion of currency into parent’s currency
- Two tax : parent & host country
- Inflation effect cash flow of parent
- Forex variation effect parents cash flow
- Most country can impose restriction political risk
Problem & issue in foreign investment analysis
- Cost of equity
- Foreign exchange risk
- Remit hence restriction
- - Profit transfer problem
- - Fee / royalty
- - Deprecation
- - Concessionary loan
- Tax issue
- Risk free rate
Requirement
- Sales creation
- Opportunity cost
- Transfer pricing
12

13. - Fee/ royalty
- Cost of capital
- Segmented capital market
- Types of financing debt / equity
- Life of project
- Price of product
- Demand
Project Vs parent cash flow
- - Tax
- - Exchange control Deferens in parent Vs
project
- Management fee / royalty
- Evaluation project cash flow
- Cash flow to parent
- Both (cost & benefit (indirect)
METHOUED OF CAPITAL BUDGETING
1) No discounted method :- payback
2) Discounted cash flow method
- NPV
- IRR
- ARR
3) ADJESTED PRESENT VALUE
- It is used to evaluation of unique aspect of foreign project
- Different component discounted separately
- There is same flexibility to accommodate various things
- Different rate for different segment
- Testing of variability can be done
- If project is not acceptable than additional evaluation can be
done
(According to complexities)
- Rimetence
- Exchange control
- Last export
- Blocked found
Criteria of selection - accept / reject criteria
Mutually exclusive
Capital rations
APV
13

14. APV = present value + Pv of side effects associated with project
Political Risk
U-3
FM INDICATOR: -
- Stability of Govt
- Inflation
- Priorities of Govt / Govt control
- Attitude of Govt
- Low return
- War
- Tax
- Direction of polices
- Debt
- BOP
RISK: -
- Expropriation: - forced dis investment
- Confiscation – without compensation
- Nationalization – package given
- Unwelcome regulation
- Interface with operation
- Goal conflict
- Capital flight
- Exchange rate
- Govt regulation & control
- Price control
- Tax risk / legal
- Low return
- High inflation
Country factor - fiscal / exchange control / over expenditure / capacity of
country
Geographic –dispute bourder
Social factor – religion /language
Company factor – nature of industry / technology / competition
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