INTERNATIONAL

FINANCE
Lecturer: DAO MAI HUONG
SUBJECT OVERVIEW: Textbook

CORE: Eiteman, D. K., Stonehill, A. I. and

Moffett, M. H. (2021). Multinational Business
Finance (15th Global Edition). Pearson.

FOR REFERENCE: Jeff Madura (2021).

International Financial Management (14th
edition). Cengage Learning.
What the subject is about
 The environment and key variables affecting
international firms
❖ Interest rates
❖ Inflation rates
❖ Foreign exchange rates
❖ ……
 Financing decisions and investment decisions of
international firms
❖ Costs of capital
❖ Risks
❖ Returns
 Risk management techniques
Lecture 1

Business and financial backgrounds

Chapter 1: Globalization and the

MNEs

Chapter 2: The international

monetary system
Business and Financial
backgrounds
 Business:
❖ Strategic decisions
❖ Key financial decisions
 Financing (sources and costs of fund)
 Investing
 Dividends
 Investors
 Risk and return concepts
 Perceived risk and required return
 Financial instruments
 Time value of money
 Present value vs. Future value
 Valuation
 Chapter 1

Current Multinational
Financial Challenges
 1. The Global Financial Marketplace:
The Multinational Enterprise (MNE)
 I define globalization as producing where it is most cost-
effective, selling where it is most profitable, and sourcing
capital where it is cheapest, without worrying about national
boundaries.
—Narayana Murthy, President and CEO, Infosys.
 MNEs are firms, both for-profit companies and not-for-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.
1. The Global Financial Marketplace:
The Multinational Enterprise (MNE)

Source: Madura, Jeff (2021)

1. The Global Financial Marketplace:
structure
1. The Global Financial Marketplace:
The Market for Currencies

 Foreign currency exchange rate: price of any one

country’s currency in terms of another country’s currency
 Most currencies are quoted against the dollar as in “so
many units per dollar”
 A few are quoted as “dollars per unit” due to custom e.g.,
$/£ and $/€.
 Several symbols that can be used to write the quotations
(E.g. £/GBP/STG/UKL)
Exhibit 1.2 Selected Global Currency Exchange
Rates
Exhibit 1.2 Selected Global Currency Exchange
Rates (cont.)
1. The Global Financial Marketplace:
The Market for Currencies

 Eurocurrencies: domestic currencies of one country on

deposit in a second country.
 Example: a U.S. dollar deposit in a British bank, called eurodollar
deposit. There are also eurosterling (British pounds deposited
outside the United Kingdom); euroeuros (euros on deposit outside
the eurozone); euroyen (Japanese yen deposited outside Japan).
 Eurobanks are major world banks that conduct a
eurocurrency business in addition to all other banking
functions. They simultaneously bids for time deposits and
makes loans in a currency other than that of its home
currency.
1. The Global Financial Marketplace:
The Market for Currencies

 Eurocurrency interest rates: interests paid on eurocurrency deposits

 Before January 2022, LIBOR (London interbank offer rate) is widely
used as the reference rate of interest in standardized quotations, loan
agreements, or financial derivatives valuations in the eurocurrency
market.
 LIBOR is replaced by the Secured Overnight Financing Rate (SOFR),
which is based on the rates U.S. financial institutions pay each other
for overnight loans.
 Most major domestic financial centers construct their own interbank
offered rates for local loan agreements: PIPOR, SIBOR, FIBOR,
VNIBOR,…
2. What Is Different About International Financial
Management?
 3. The Theory of Comparative Advantage

 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.
 Origin: Adam Smith, developed by Ricardo (absolute advantage
vs comparative advantage)
3. The Theory of Comparative Advantage

Absolute advantage: is when a producer can provide a good or service

in greater quantity for the same cost, or the same quantity at a lower
cost, than its competitors.

Comparative advantage: an economy's ability to produce a particular

good or service at a lower opportunity cost than its trading partners.
3. The Theory of Comparative Advantage

1. What are

absolute advantages
of US and Brazil?
2. What are
comparative
advantages of US
and Brazil?
3. The Theory of
Comparative Advantage
 Even if a country possessed absolute advantage in
the production of two products, it might still be
relatively more efficient than the other country in
one product than the other
 Each country would possess comparative advantage
in the production of one product, and benefit by
specializing completely in one product and trading
for the other.
 Factors of production cannot be moved freely from
one country to the other, the benefits of
specialization are realized through international
trade.
3. The Theory of
Comparative Advantage
 Limitation of the classical theory:
 Existence of government interference (Tariff, quotas…)
 At least two factors of production (capital and
technology) now flow directly and easily between
countries
 Modern factors of production are more numerous than in
this simple model (E.g. local and managerial skills, legal
structure, supporting infrastructure…)
→ Comparative advantage shifts over time
 Certain issues are not addressed: the effect of
uncertainty and information costs, economies of scale…
Exhibit 1.3 Global Outsourcing of
Comparative Advantage
4. Market Imperfections: A Rationale
for the Existence of the Multinational
Firm
 MNEs take advantage of imperfections in national
markets for products, factors of production, and
financial assets → market opportunities
 Large international firms are better able to exploit such
competitive factors as:
 economies of scale
 managerial and technological expertise
 product differentiation
 financial strength…
than their local competitors.
4. Market Imperfections: A Rationale
for the Existence of the Multinational
Firm

 Strategic motives drive the decision to invest

abroad and become a MNE:
 Market seekers
 Raw material seekers
 Production efficiency seekers
 Knowledge seekers
 Political safety seekers
 These categories are not mutually exclusive.
Exhibit 1.5 Trident Corp: Initiation of the
Globalization Process
5. The Globalization Process

Stage II: A successful firm

will continue to grow from
Stage I: early domestic phase
simple international trade to
growing into the
the multinational phase
international trade phase
characterized by production
(Exhibit 1.5)
and investment both at home
and abroad (Exhibit 1.6)
Exhibit 1.6 Trident’s Foreign Direct
Investment Sequence
 Chapter 2

The International
Monetary System
The Evolution of global monetary system
History of the International Monetary
System
 The Gold Standard (1876 – 1913)
 Gold has been a medium of exchange since 3000
BC
 Each country set the rate at which its currency
unit could be converted to a weight of gold
→ “fixed” exchange rates
 In effect until the outbreak of WWI when the
free movement of gold was interrupted
 Example: If an ounce of gold is worth 30$ in the
USA, and £6 in the UK:
$30 = 1 ounce of gold = £6
$30 = £6
→$5 = £1
History of the International Monetary
System
 The Inter-War Years & WWII (1914-1944)
 Currencies were allowed to fluctuate over a fairly wide range in
terms of gold and each other
 The U.S. adopted a modified gold standard in 1934, the U.S. dollar
was devalued to $35 per ounce of gold from the $20.67 per ounce
price in effect prior to World War I.
 During WWII and its chaotic aftermath the U.S. dollar was the only
major trading currency that continued to be convertible, many of
the main trading currencies lost their convertibility into other
currencies.
History of the International Monetary
System  Bretton Woods and the International
Monetary Fund (IMF) (1944)
 The Bretton Woods Agreement established
a U.S. dollar based international monetary
system and created two new institutions
the International Monetary Fund (IMF) and
the World Bank
 All countries fixed the value of their
currencies in terms of gold but were not
required to exchange their currencies for
gold. Only the dollar remained convertible
into gold (at $35 per ounce)
History of the International Monetary
System
 Fixed Exchange Rates (1945-1973)
 The currency arrangement negotiated at Bretton Woods and
monitored by the IMF worked fairly well during the post-World War
II period of reconstruction and rapid growth in world trade.
 Widely diverging monetary and fiscal policies, differential rates of
inflation and various currency shocks resulted in the Bretton
Woods system’s demise
 Most currencies were allowed to float to levels determined by
market forces as of March 1973.
The IMF’s Exchange Rate
Regime Classifications
In effect since January 2009
 Category 1: Hard Pegs
 Countries that have given up their own sovereignty over monetary policy
 E.g., dollarization or currency boards
 Category 2: Soft Pegs
 AKA fixed exchange rates, with five subcategories of classification:
 Conventional pegged arrangement
 Stabilized arrangement
 Crawling peg
 Crawl-like arrangement
 Pegged exchange rate within horizontal bands
The IMF’s Exchange Rate
Regime Classifications
The IMF’s Exchange Rate
Regime Classifications
 Category 3: Floating Arrangements
 Mostly market driven, these may be free floating or floating with occasional
government intervention
 Category 4: Residual
 The remains of currency arrangements

 Vietnam: since 2016, the rate is pegged to three benchmarks: demand and supply
of the Vietnam dong (VND), the exchange rates for a basket of eight strong foreign
currencies, and for any change to balance macro-economic needs.
→ setting the official central rate of the Vietnamese dong against the U.S. dollar on
a daily basis.
→ According to IMF classification (2020): stabilized arrangement
Fixed Versus Flexible
Exchange Rates
 A nation’s choice as to which currency regime to follow
reflects national priorities about all facets of the
economy, including:
 inflation,
 unemployment,
 interest rate levels,
 trade balances, and
 economic growth.

 The choice between fixed and flexible rates may change

over time as priorities change.
Fixed Versus Flexible
Exchange Rates
 Countries would prefer a fixed rate regime for the following
reasons:
 Stability in international prices --> growth of international trade and
lessen business risks
 Inherent anti-inflationary nature of fixed prices
→ Restrictive monetary and fiscal policy
 However, a fixed rate regime has the following problems:
 Need for central banks to maintain large quantities of hard currencies
and gold to defend the fixed rate
 Fixed rates can be maintained at rates that are inconsistent with
economic fundamentals
Attributes of the “Ideal”
Currency
 Possesses three attributes, often referred
to as the Impossible Trinity:
 Exchange rate stability
 Full financial integration
 Monetary independence

 The forces of economics do not allow the

simultaneous achievement of all three
Exhibit 3.5 The Impossible Trinity
 The impossible trinity

Choice #1 Choice #2 Therefore,

United Independent Free movement of Currency value

States monetary policy capital floats

Independent Restricted movement

China Fixed value of currency
monetary policy of capital

Fixed rate of currency

Europe Free movement of Integrated monetary
exchange between
(EU) capital policy
countries

Global finance in practice 3.3

Summary

 Global financial markets and MNEs

 Theory of comparative advantage
 History of international monetary system
 The current exchange rate regimes
 The impossible trinity