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Mf0006 I


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Mf0006 I

  1. 1. MF0006 INTERNATIONAL FINANCIAL MANAGEMENT 1. Why do companies expand into other countries and become multinationals? Give suitable examples. (5 Marks) Answer: Intense global competition has resulted in relentless cost-cutting measures – finding cheapest cost of production by relocating production to the cheapest country, outsourcing purchase of parts, etc. Many multinationals obtain raw materials from one nation, financial capital from another, produce goods with labour and capital equipment in a third country and sell their output in various other national markets. As an example of a multinational company, General Motors produces cars in 50 countries, and sells them in almost 200 countries. There are only a few products that are made exclusively in one country now. Thus, IBM computers may be assembled in Malaysia, with Taiwanese monitors, Korean keyboards, US made microchips, with software developed by US and Indian engineers, advertising services of a UK company, and financing from banks in Holland and Germany. Financial markets are highly and increasingly integrated. Capital flows instantly around the world, seeking the highest return, staying where it is well-treated, leaving when it is not well-treated. Multinationals have their shares cross-listed on foreign stock exchanges. There is an enormous influence of global brands like Coca Cola, Canon, or BMW across the world. These are multinational brands. A Multinational Corporation (MNC) is a company that has been incorporated in one country and has production and sales operations in other countries. Often 30% or more of sales and profits of multinationals are generated outside national borders. A typical multinational company consists of a parent company located in the home country and at least five or six foreign subsidiaries, with a high degree of strategic interaction among them. Some of the possible reasons for the companies expand into other countries and become multinationals: Page 1 of 9
  2. 2. MF0006 INTERNATIONAL FINANCIAL MANAGEMENT • To broaden markets: Saturated home markets ask for market development abroad. For example Coca Cola, MacDonald’s, etc. Multinationals seek new markets to fill product gaps in foreign markets where excess returns can be earned. • To seek raw materials: Multinationals secure the necessary raw materials required to sustain primary business line. Multinationals also seek to obtain easy access to oil exploration, mining, and manufacturing in many developing nations. • To seek new technologies: Multinationals seek leading scientific and design ideas. • To seek production efficiencies by shifting to low cost regions. • To avoid political hurdles such as import quota, regulatory measures of governments, trade barriers, etc. • To diversify i.e. to cushion the impact of adverse economic events. • To postpone payment of domestic taxes. • To counter foreign investment by competitors. Page 2 of 9
  3. 3. MF0006 INTERNATIONAL FINANCIAL MANAGEMENT 2. Explain different methods of entering foreign markets with examples. (5 Marks) Answer: The methods for entering foreign markets are exporting, turnkey projects, licensing, franchising, joint ventures and wholly owned subsidiaries. Exporting: Exporting uses domestic plants as a production base for exporting to foreign markets. It is a conservative way to test international waters and therefore can be an excellent initial strategy to pursue international sales. Exporting minimizes direct investments in foreign countries, avoids, the cost of establishing manufacturing operations overseas, helps to achieve experience curve and location economies and minimizes both risk and capital requirements. An export strategy is vulnerable when manufacturing costs in home country are higher than in those countries where rivals have plants or when high shipping costs are involved. Also tariff barriers may exist for the exporter. There is also a possible lack of control over marketing representatives. Turnkey projects: In a turnkey project, the client (from the host country) buys a complete project from the outside source (the contractor from the foreign country) and the project is designed, implemented, and delivered ready to operate. In a turnkey project, the contractor agrees to handle every detail of project for the foreign client. Advantages are that a company can earn a return on a knowledge asset. It is also less risky than the conventional foreign direct investment. The disadvantages of turnkey projects as an entry mode are that there is no long- term interest in the foreign country, and it may create a competitor; selling process technology may be selling competitive advantage as well. Page 3 of 9
  4. 4. MF0006 INTERNATIONAL FINANCIAL MANAGEMENT Licensing: A license is an agreement where licensor grants rights to intangible property to another entity for a specified period of time in return for royalties. Licensing allows a firm to provide its technology in exchange for fees or some other benefits. Licensing reduces development costs and risks of establishing foreign enterprise. It is suitable when a company lacks capital for venture or when it is entering an unfamiliar or politically volatile market. Licensing can also overcome restrictive investment barriers that are sometimes put in place by host country governments. Licensing carries the risk of providing valuable technical know-how to foreign firms and losing some control over its use. Franchising: Franchising obliges a company (franchiser) to provide a specialized sale or service strategy, support assistance, and possibly an initial investment to the franchisee, in exchange for periodic fees. This method is most suited to global expansion efforts of service and retailing enterprise. The advantage of franchising for the franchiser is that the franchisee bears most of the costs and risks of establishing foreign locations. The franchiser only has to expend the resources to recruit, train, and support franchisees. The disadvantage is that the responsibility for maintaining cross-country quality control is with the franchiser. Joint Venture: Firms may also penetrate foreign markets by engaging in a joint venture with firms that reside in those markets. » Acquisitions of existing operations in foreign countries allow firms to quickly gain control over foreign operations as well as a share of the foreign market. » Firms can also penetrate foreign markets by establishing new foreign subsidiaries. Page 4 of 9
  5. 5. MF0006 INTERNATIONAL FINANCIAL MANAGEMENT 3. What is Balance of Payment? Explain the sub-accounts of the balance of payment. (10 Marks) Answer: Balance of Payments (BOP) of a country is a systematic record of all economic transactions between the residents of a country and the rest of the world. It presents a classified record of all receipts on account of goods exported, services rendered and capital received by residents and payments made by them on account of goods imported and services received from the capital transferred to non-residents or foreigners. Importance: • It is a summary of a nation’s economic transactions with the outside world. • An international trade account. • A key Macro-economic Parameter-Determine external balance. Sub-accounts of the balance of payment: 1. Current Account: The current account is that balance of payments account in which all short term flows of payments are listed. Current account consists of, receipts of merchandise Exports and spending on merchandise Imports of goods and services- Difference Trade Balance-Surplus or Deficit; net exports a part of GDP. Invisibles -services, remittances, investment income, Debt Servicing and unilateral transfers- Current Account Balance: Surplus or Deficit. Current account represents improvement or decline in net worth of a nation. Page 5 of 9
  6. 6. MF0006 INTERNATIONAL FINANCIAL MANAGEMENT 2. Capital Account: The capital account is that balance of payments account in which all cross border transactions involving financial assets are listed. Represents purchase or sale of assets; Foreign Direct Investment, Foreign Loans, Increase or decrease of foreign assets and liabilities- Capital Account Balance. Current Account Balance + Capital Account Balance = 0. Capital Account represents how you finance current account deficit or invest current account surplus. Surplus invested in foreign currency, gold deposit with IMF or in Foreign Govt. Securities as Reserve. 3. Official Reserves Account: The official reserve account records the total reserves held by the official monetary authorities within the country. These reserves are normally composed of the major currencies used in international trade and financial transactions. The reserves consist of “hard” currencies (such as, US Dollar, Pound, Euro, and Yen), official gold reserve and IMF Special Drawing Rights. Page 6 of 9
  7. 7. MF0006 INTERNATIONAL FINANCIAL MANAGEMENT CASE STUDY (10 MARKS) 4. a). Money and foreign exchange markets in New York and London are very efficient. You have the following information: London New York Spot Exchange Rate USD 1.850/GBP GBP: 0.590/USD 1 year T-bill rate 4% 4.5% The expected inflation rate in the U.S is 2.5% p.a. If the PPP holds, what is the expected inflation rate in London? Answer: The equation for finding out the inflation rate in the foreign country is as follows: Where, et = expected future spot rate [i.e., 1.850 + (1.850 X 4%) = 1.924] eo = spot rate [i.e., 1.850] ih = home inflation [i.e., 2.5% or 0.025] if = foreign inflation Page 7 of 9
  8. 8. MF0006 INTERNATIONAL FINANCIAL MANAGEMENT This equation can be approximated by the following equation: = 1.924 – 1.850 / 1.850 = 0.025 – if = 0.04 = 0.025 – if = 0.04 - 0.025 = if if = 0.015 Therefore, expected inflation rate in London is 1.5%. ============================ ================================ Page 8 of 9
  9. 9. MF0006 INTERNATIONAL FINANCIAL MANAGEMENT 4. b). A dealer in London quotes: GBP/USD Spot: 1.7580/90 GBP/JPY Spot: 190.70/85 Calculate the Cross Rate between USD/JPY in New York. Answer: The Cross Rate between USD/JPY in New York is to be calculated as follows: British Pound/ Japanese Yen 190.70/85 British Pound/ US Dollar 1.7580/90 = 108.476/99 GBP Page 9 of 9