Introduction to international finance
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The document provides an introduction to international finance. It discusses that international finance is different than domestic finance due to foreign exchange and political risks, market imperfections, and expanded opportunity sets when operating globally. Effective international financial management requires controlling risks, managing imperfections, and maximizing opportunities while pursuing the goal of shareholder wealth maximization. Globalization trends like increased trade liberalization, financial market integration, and the emergence of the Euro as a global currency have further integrated the world economy.
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Introduction to international finance
- 1. Topic 1 :: Introduction Dr. Md Mohan Uddin
- 2. Introduction to International Finance Finance in an international context… Why do we need to study international finance? We are living in a highly globalized and integrated world economy Continued liberalization of international trade further internationalizes the consumption pattern Globalized production: MNCs source inputs and locate productions anywhere in the world Integrated financial markets: internationally diversified investment, internationally tradable financial securities Dr. Md Mohan Uddin 2/24/2014 2
- 3. What makes international finance special? Three major dimensions make international finance different from purely domestic finance: Foreign exchange and political risks Market imperfections Expanded opportunity sets Dr. Md Mohan Uddin 2/24/2014 3
- 4. What makes international finance special? Foreign exchange and political risks Unexpected fluctuations of the exchange rates may adversely affect the MNCs as well as individuals who are engaged in cross border transactions Exchange rate uncertainty may affect all the major economic functions including consumption, production, and investment. Sovereign country can change the rules, e.g., Tax rules Expropriation of assets In some countries, there is a lack of tradition of the rule of law. Dr. Md Mohan Uddin 2/24/2014 4
- 5. What makes international finance special? Market imperfections Market imperfections represent various frictions and impediments preventing markets from functioning perfectly. Such frictions/ impediments/ barriers include Legal restrictions Excessive transportation and transaction costs Information asymmetry Discriminatory taxation Dr. Md Mohan Uddin 2/24/2014 5
- 6. What makes international finance special? Market imperfections Often, MNCs are motivated to locate production overseas due to such market imperfections Imperfection in the international financial market often restrict the extent to which investors can diversify their portfolios. Dr. Md Mohan Uddin 2/24/2014 6
- 7. What makes international finance special? Expanded opportunity set If firms venture into the arena of global markets, they can benefit from an expanded opportunity set by: locating production in any country/region of the world to maximize performance raising fund in any capital market where the cost capital is the lowest. deploying assets on a global basis to gain from greater economies of scale. Dr. Md Mohan Uddin 2/24/2014 7
- 8. What makes international finance special? International finance is different from domestic finance and to be benefitted from it, maximize the benefits from the global opportunity set control exchange rate and political risks manage various market imperfections Dr. Md Mohan Uddin 2/24/2014 8
- 9. Effective international financial management Effective financial management requires an underlying goal. Shareholder wealth maximization is considered as the fundamental goal of sound financial management. Shareholder wealth maximization is long accepted as a goal in the AngloSaxon countries like Australia, Canada, UK, and USA. Dr. Md Mohan Uddin 2/24/2014 9
- 10. Effective international financial management In other countries like France or Germany, shareholders are viewed as merely one among many “stakeholders” of the firm including: Suppliers Employees Customers In Japan, managers have typically sought to maximize the value of the keiretsu—a family of firms to which the individual firms belongs. Dr. Md Mohan Uddin 2/24/2014 10
- 11. Effective international financial management As a result of recent liberalization and international integration of capital markets even the managers in France, Germany, Japan, and other non-AngloSaxon countries are beginning to pay serious attention to shareholder wealth maximization. Shareholder wealth maximization does not imply that the firm would not pursue other goals. Rather, shareholder wealth maximization also helps accomplishing other legitimate goals. Dr. Md Mohan Uddin 2/24/2014 11
- 12. Effective international financial management As shown by a series of recent corporate scandals at companies like Enron, WorldCom, and Global Crossing, managers may pursue their own private interests at the expense of shareholders when they are not closely monitored. These calamities have painfully reinforced the importance of corporate governance, i.e., the financial and legal framework for regulating the relationship between a firm’s management and its shareholders. Dr. Md Mohan Uddin 2/24/2014 12
- 13. Effective international financial management These types of issues can be much more serious in many other parts of the world, especially emerging and transitional economies, such as Indonesia, Korea, and Russia, where legal protection of shareholders is weak or virtually non-existing. Dr. Md Mohan Uddin 2/24/2014 13
- 14. Globalization of the World Economy: Major Trends and Developments Key trends and developments include: Emergence of Globalized Financial Markets Emergence of the Euro as a Global Currency Europe’s Sovereign Debt Crisis of 2010 Trade Liberalization and Economic Integration Privatization Global Financial Crisis of 2008-2009 Dr. Md Mohan Uddin 2/24/2014 14
- 15. Globalization of the World Economy: Emergence of globalized financial markets Deregulation of Financial Markets Advances in Technology have greatly reduced information and transaction costs, which has led to: Financial Innovations, such as Currency futures and options Multi-currency bonds Cross-border stock listings International mutual funds Dr. Md Mohan Uddin 2/24/2014 15
- 16. Globalization of the World Economy: Emergence of the euro as a global currency The advent of the euro in 1999 represents a momentous event in the history of world financial system Many new members of the EU would like to adopt the euro Dr. Md Mohan Uddin More than 300 million Europeans are using the common currency The transaction domain of the euro may become larger than the USD in near future 2/24/2014 16
- 17. Globalization of the World Economy: Europe’s sovereign-debt crisis of 2010 All EU member states are automatically members of both the Economic and Monetary Union (EMU) and the Stability and Growth Pact (SGP) SGP is an agreement, among the member states of the European Union, to facilitate and maintain the stability of the EMU The SGP requires each Member State to implement a fiscal policy aiming for the country to stay within the limits on government deficit (3% of GDP) Dr. Md Mohan Uddin 2/24/2014 17
- 18. Globalization of the World Economy: Europe’s sovereign-debt crisis of 2010 In December 2009, the new Greek government revealed that the actual budget deficit was 12.7 percent compared to the previously forecasted 3.7 percent based on falsified national account data Therefore, Greece actually was in a serious violation of the SGP. This situation was a result of excessive borrowing and spending, with wages and prices rising faster than productivity Dr. Md Mohan Uddin 2/24/2014 18
- 19. Globalization of the World Economy: Europe’s sovereign-debt crisis of 2010 Greece could not use the traditional means of depreciating national currency as the country had adopted the euro. Investors became worried about sovereign default They started to sell off Greek government bonds The panic spread to other weak European countries, especially Ireland, Portugal, and Spain Dr. Md Mohan Uddin 2/24/2014 19
- 20. Globalization of the World Economy: Europe’s sovereign-debt crisis of 2010 In 2010, credit rating agencies downgraded the government bonds of the affected countries Borrowing and refinancing became more costly Although the debt crisis in Greece accounted for only about 2.5% of Eurozone GDP, it quickly escalated to a Europe-wide debt crisis Dr. Md Mohan Uddin 2/24/2014 20
- 21. Globalization of the World Economy: Europe’s sovereign-debt crisis of 2010 Dr. Md Mohan Uddin 2/24/2014 21
- 22. Globalization of the World Economy: Europe’s sovereign-debt crisis of 2010 On May 9, 2010, EU countries led by France and Germany, jointly with IMF, put together a massive Euro 750 billion package to bail out Greece and other weak countries. The agreement on the bailout plan was slow and thus became expensive due to Europe’s lack of political union Fragmented decision making structure Dr. Md Mohan Uddin 2/24/2014 22
- 23. Globalization of the World Economy: Trade liberalization and economic integration Over the past 50 years, international trade increased about twice as fast as world GDP. There has been a change in the attitudes of many of the world’s governments, who have abandoned mercantilist views and embraced free trade as the surest route to prosperity for their citizenry. Dr. Md Mohan Uddin 2/24/2014 23
- 24. Globalization of the World Economy: Trade liberalization and economic integration The General Agreement on Tariffs and Trade (GATT) is a multilateral agreement among member countries that has reduced many barriers to trade. The World Trade Organization (WTO) has the power to enforce the rules of international trade. Dr. Md Mohan Uddin 2/24/2014 24
- 25. Globalization of the World Economy: Trade liberalization and economic integration The European Union (EU) was established to foster economic integration among the countries of Western Europe. The North American Free Trade Agreement (NAFTA) calls for phasing out impediments to trade between Canada, Mexico, and the United States over a 15-year period beginning in 1994. Dr. Md Mohan Uddin 2/24/2014 25
- 26. Globalization of the World Economy: Privatization The selling of state-run enterprises to investors is also known as “denationalization.” Privatization is often seen as socialist economies in transition to market economies. By most estimates, this increases the efficiency of the enterprise. It also often spurs a tremendous increase in cross-border investment. Dr. Md Mohan Uddin 2/24/2014 26
- 27. Globalization of the World Economy: Global financial crisis of 2008—2009 The “Great Recession” was the most serious, synchronized economic downturn since the Great Depression of the 1930s. Factors included: Households and financial institutions borrowed too much and took too much risk. This risk was repackaged with securitization. Dr. Md Mohan Uddin 2/24/2014 27
- 28. Multinational Corporations There are about 60,000 MNCs in the world. Dr. Md Mohan Uddin A multinational corporation (MNC) is a firm that has been incorporated in one country and has production and sales operations in other countries. Many MNCs obtain raw materials from one nation, financial capital from another, produce goods with labor and capital equipment in a third country, and sell their output in various other national markets. 2/24/2014 28
- 29. Dr. Md Mohan Uddin 2/24/2014 29