INTERNATIONAL FINANCIAL

MAGEMENT

DR. MD. HAMID U BHUIYAN

 Importance to study international financial
management

 We are now living in a world where all the major

economic functions, i.e., consumption, production,
and investment, are highly globalized

Consumption: Jeans, Soft wares, Aircraft, Movies are

exported to other countries from USA. On the other
hand, US consumers routinely purchased Oil
(Middle East & Africa), TV, Camcorders (Japan),
Automobile (Germany).
 Importance to study international
financial management
 Production: Production of goods and services
are highly globalized Which is a result of
Multinational Corporation: (MNCs are
sourcing inputs and locate production
anywhere in the world where costs are lower
and profits are higher)
 Importance to study international financial
management

Investment: Financial market has also become highly integrated.

This development allows investors to diversify their investment

portfolios internationally. In 2009, US investors collectively invest

$549 billion in foreign securities such as stocks and bonds,

whereas, foreigners invested $377 billion in US securities.

 It is thus essential for financial managers to fully understand vital

international dimensions of financial management

 Difference between international financial
management domestic financial management
There are three major dimensions that set apart international
finance from domestic finance

They are:

1. Foreign exchange and political risks: Exchange rate is not

fixed in cross border transaction, changes in government and
changes in rules/laws by the government. For example: an
unexpected devaluation adversely affects your export market,
an unexpected overturn of the government that jeopardizes
existing negotiated contracts
 Difference between international financial
management domestic financial management

2. Market imperfections: Barriers, legal restrictions,

excessive transaction costs. Trade barriers and tax
incentives may affect location of production

3. Expanded opportunity set: Low costs and greater

economies of scale (if firms locate their
production in cross border countries) Raise funds
in global markets, gains from economies of scale
 Theory of Comparative Advantage
The principle argument for international trade is based on the Theory
of Comparative Advantage, which was advanced by David Ricardo
in his seminal book “Principles of Political Economy” (1817).

According to Ricardo: “It is mutually beneficial for countries if they

specialize in the production of those goods they can produce most
efficiently and trade those goods among them”.

For instance, the UK specialize in Textiles, whereas, France produce

Wine most efficiently. Now it makes sense two countries trade their
products between them.
 Globalization of World Economy:
Major Trends and Developments
1. Emergence of Globalized Financial Market

2. Emergence of the EURO as a global currency

3. Trade Liberalization and Economic Integration

4. Privatization

5. Global Financial Crisis (2008-2009)

6. Multinational Corporations
 Globalization of World Economy:
Major Trends and Developments
1. Emergence of Globalised Financial Market: The 1980s and 1990s brought a

rapid integration of international capital and financial markets. Motivation for

globalized financial markets initially came from the governments of major

countries that had begun to deregulate their foreign exchange and capital

markets.

For example,

In 1990 Japan deregulated its foreign exchange market, and 1985 the Tokyo Stock

Exchange admitted as members a limited number of foreign brokerage firms.

The London Stock Exchange (LSE) began admitting foreign firms as full members

in February 1986.
 Globalization of World Economy:
Major Trends and Developments
The most celebrated deregulation occurred in London on October,
1986 (known as BIG BANG) . The US and UK Stock Exchanges
eliminated fixed brokerage commissions. Additionally, the
regulation separating the order-taking function from the market-
making function was eliminated.

In Europe, financial institutions are allowed to perform both

investment-banking and commercial-banking functions.

The LSE affiliates foreign commercial banks as eligible for

membership on the LSE.
 Globalization of World Economy:
Major Trends and Developments

The US cancelled the “Glass - Steagall Act”, which

restricted commercial banks from investment banking
activities, (such as, underwriting corporate securities)
to further promoting competition among financial
institutions.

Developing countries, such as, Chile, Mexico, and Korea

began to liberalize by allowing foreigners to directly
invest in their financial markets
 Globalization of World Economy:
Major Trends and Developments

 Deregulated financial markets and heightened

competition in financial services provided a natural
environment for financial innovations resulted in the
introduction of several financial instruments, for
example: currency futures and options, multicurrency
bonds, international mutual funds, country funds,
Exchange Trade Funds (ETFs), and Foreign Stock
Index Futures and Options.
 Globalization of World Economy:
Major Trends and Developments

Corporations also played an active role in integrating

the world financial markets by listing their shares

across borders. Well known non-US companies

such as, BHP Billiton, Petrobras, China Mobile,

Nokia, Wipro, Honda Motor, Telmex, ING, BP,

Korea Telecom and USB are directly listed and

traded on the New York Stock Exchange.

 Globalization of World Economy:
Major Trends and Developments
At the same time, US firms such as, IBM and GE are listed on

the Frankfurt, London and Paris Stock Exchanges.

Advances in computer and telecommunication industries also

contributed towards the emergence of global financial

markets. Internet based information technology providing

immediate access to most recent news and information to

investors affecting their investment, sharply reduced

information costs.
 Globalization of World Economy:
Major Trends and Developments
2. Emergence of the EURO as a global currency: The advent of the EURO at the

start of 1999 represents a momentous event in the history of world financial

system the has profound ramifications for the world economy.

Once a country adopts the common currency, it is obviously cannot have its own

monetary policy. The common monetary policy for the Euro zone is now

formulated by the European Central Bank (ECB). Considering the sheer size

of the Euro zone, economic output, and world trade share and the prospect of

monetary stability in EU, the EURO has a potential for becoming another

global currency rivaling the US Dollar for dominance in international trade

and finance.
 Globalization of World Economy:
Major Trends and Developments

Since inception, the Euro already brought revolutionary

changes in European Finance. By redominating
corporate and government bonds and stocks from
many different currencies into one common currency,
the Euro has participated the emergence of continent
wide capital market in EUROPE that are comparable
to US markets in depth and liquidity.
 Globalization of World Economy:
Major Trends and Developments
3. Trade Liberalization and Economic Integration:

Beginning with the writings of David Ricardo in the 19th century,

economists have known that countries gain from trade if each nation
specializes in the production of those goods in which it has a
comparative advantage .

Unfortunately, protectionist tendencies have long kept the world

relatively closed, with many countries restricting international trade

through tariffs on imports, non-tariff barriers such as subsidies to

local producers, quotas on imported products, onerous regulations

applying to imported products, and so forth.

 Globalization of World Economy:
Major Trends and Developments

In 1960, only about 20% of countries were open to trade. These countries
included the United Kingdom and the United States, who had a long tradition
of openness to international trade.

Many European countries that liberalized in 1959 or 1960, after the creation of
the European Economic Community (EEC) . The EEC set out to establish free
trade among a number of European countries, later turning into the European
Union

The General Agreement on Tariffs and Trade (GATT) , signed in 1947, was
designed to encourage free trade between member states by regulating
and reducing tariffs on traded goods and by providing a common
mechanism for resolving trade disputes.
 Globalization of World Economy:
Major Trends and Developments
The Tokyo Round in 1979 also reduced non-tariff barriers to trade, and the
Uruguay Round, begun in 1986, established the World Trade Organization
(WTO) in 1995 to replace the GATT Treaty.

GATT succeeded in lowering trade barriers in a multilateral, worldwide way,

however, a number of important regional trade agreements have slashed

trade barriers even more in particular regions. The best known of these

regional agreements are the European Union (EU) , the North America

Free Trade Agreement (NAFTA) , Mercosur in South America, and the

Association of Southeast Asian Nations (ASEAN) .

 Globalization of World Economy:
Major Trends and Developments

The General Agreement on Tariffs and Trade (GATT), a multilateral

agreement among member countries has reduced many barriers to trade.

The World Trade Organization has the power to enforce the rules of

international trade.

International Monetary Fund (IMF) maintains order in the international

monetary system

World Bank (International Bank for Reconstruction and Development)

promote economic development

 Globalization of World Economy:
Major Trends and Developments

4. Privatization: The economic integration and globalization that

began in 1980s picked up speed in 1990s via privatization.

Privatization is a denationalization process. Trough privatization,

a country divest itself of the ownership and operation of a

business venture by turning it over to the free market system.

Privatization has quickly accelerated since the collapse of

communism in the Eastern Bloc countries.

 Globalization of World Economy:
Major Trends and Developments

 Privatization is often seen as a cure of bureaucratic

inefficiency and waste, some economists estimate that

privatization improves efficiency and reduce operating
costs by as much 20%.

 To accomplish privatization in a mass Czech Republic

government essentially gave away its businesses to the

Czech people. From 1991 to 1995, more than 17000
companies were turned over to private hands.
 Globalization of World Economy:
Major Trends and Developments

In Russia, there has been an irreversible shift to

private ownership, according to the World Bank.

More than 80% of the country’s nonfarm workers

are now employed in the private sector. 40 million

Russians now own stock in over 15000 medium-to-

large size corporation the recently became privatized

through mass auctions of state owned industries.

 Globalization of World Economy:
Major Trends and Developments

In China, privatization has proceeded by way of listing State-

Owned Enterprises (SOEs) on the organized exchanges,

making SOEs eligible for private ownership.

The Chinese stock markets (the Shanghai Stock Exchange and

the Shenzhen Stock Exchange) have grown at a phenomenal

pace, becoming some of the largest stock markets in Asia in

terms of capitalization, however, only more than 1500

companies are listed in the China’s Stock Exchanges.

 Globalization of World Economy:
Major Trends and Developments

For some countries privatization has meant

globalization. For example, to achieve fiscal
stability, New Zealand had to open its once-
socialist economy to foreign capital. Australian
investors now control its commercial banks, and
US firms purchased national telephone company
and timber operations.
 Globalization of World Economy:
Major Trends and Developments

5. Global Financial Crisis (2008-2009): The

subprime mortgage crisis in US that began in
2007 led to a severe credit crisis, making
borrowing and refinancing difficult for
households, firms, and banks. The credit crunch,
in turn, escalated to a bull-blown global financial
crisis in 2008-2009.
The working of financial crisis
 Globalization of World Economy:
Major Trends and Developments

6. Multinational Corporations: A multinational corporation

(MNC) consists of a parent company in the firm’s
originating country and the operating subsidiaries,
branches, and affiliates it controls both at home and
abroad.

The United Nations refers to such firms as transnational

corporations to emphasize that the operation and ownership
of these enterprises is spread throughout the world.
 Globalization of World Economy:
Major Trends and Developments

In addition to the international trade , foreign direct

investment by MNCs is a major force driving
globalization of the world economy. According to UN
report, there are about 60000 MNCs in the world with
over 500000 foreign affiliates.

Since 1990s, foreign direct investment by MNCs grew at the

annual rate of about 10%. In comparison, international
trade grew at the rate of 3.5% during the same period.
The worlds top 20 Nonfinancial MNCs Ranked by
Foreign Assets
Gain from Trade – The Theory of Comparative Advantage

The Theory of Comparative Advantage: Originally advanced by the 19 th –

century economist David Ricardo.

The theory claims that economic well being is enhanced if each country’s

citizens produce that which they have a comparative advantage in

producing relative to the citizens of other countries and then trade

products.

Assumptions underlying the theory:

a. Free Trade Agreement between Nations

b. The factors of production (Land, Labor, Technology, and Capital) are

relatively immobile (immovable).

 The Theory of Comparative Advantage - Illustration
Country Total
A B
1. Units of Input (in Million)
Food 40 40
Textiles 20 20
2. Output per Unit of Input (lbs. or yards)
Food 5 15
Textiles 3 4
3. Total Output (lbs. or yards) - (in Million)
Food 200 600 800
Textiles 60 80 140
4. Consumptions (lbs. or yards) - (in Million)
Food 200 600 800
Textiles 60 80 140
 The Theory of Comparative Advantage - Illustration

Illustration assumes that two countries A & B, which only produce Food

& Textiles, but they do not trade with one another.

Each country presently allocates 40 million units to the production of

Food & 20 million units to the production of Textiles.

Examination of information shows that country A produce 5 lbs. of Food

& 3 yards of Textile with one unit of production.

Country B produce 15 lbs. of Food & 4 yards of Textile with one unit of

production.
The Theory of Comparative Advantage - Illustration

When all units are employed:

Country A can produce 200 million lbs. of Food & 60 million
yards of Textiles.
Country B can produce 600 million lbs. of Food & 80 million
yards of Textiles.

It is clear that Country B has an absolute advantage over country

A in production of both Food & Textiles.

Total output is 800 million lbs. of Food & 140 million yards of
Textile.
Without Trade, each nations citizens can consume what they
produce.
The Theory of Comparative Advantage - Illustration

While it is clear that from the information that Country B has

an absolute advantage in the production of Food & Textile.

However, it is not clear that Country A (B) has a relative

advantage over Country B (A) in producing Textile (Food)

Note that, in using units of production Country A can

“TRADE OFF” one unit of production needed to produce
5 lbs of Food for 3 yards of Textiles.
The Theory of Comparative Advantage - Illustration

Thus a yard of Textile has an opportunity cost of 5/3 = 1.67 lbs. of

Food, or

One lbs. of Food has an opportunity cost of 3/5 = 0.60 yards of

Textile.

Analogously, Country B, a yard of Textile has an opportunity cost

of 15/4 = 3.75 lbs. of Food, or

One lbs. of Food has an opportunity cost of 4/15 = 0.27 yards of

Textile.

A relative efficiency that shows up via a lower opportunity cost is

referred to as a competitive advantage.
The Theory of Comparative Advantage - Illustration

In terms of opportunity cost it is clear that Country A is

relatively more efficient in producing Textiles and
Country B is relatively more efficient in producing Food.

Country A’s opportunity cost of producing Textiles is less

than Country B’s &

Country B’s opportunity cost of producing Food is less

than Country A’s.
The Theory of Comparative Advantage - Illustration

The following Table shows that when there are no restrictions or

impediments to Free Trade, such as Import Quotas, Import Tariffs, or

Costly Transportation, the economic well-being of the citizen of both

countries is enhanced through Trade.

Assume that,

Country A has shifted 20 million units from the production of Food to the

production of Textiles where it has comparative advantage, &

Country B has shifted 10 million units from the production of Textiles to

the production of Food where it has comparative advantage.

The Theory of Comparative Advantage - Illustration

Assume that,

Country A & B agree on a price of 2.5 lbs. of Food for 1

yard of Textiles, &

Country A sells to Country B 50 million yards of Textiles

for 125 million lbs. of Food

With Free Trade the following Table makes it clear that

the consumption of each countries citizens has
increased
The Theory of Comparative Advantage - Illustration
COUNTRY Total
A B
1. Units of Input (in Million)
Food 20 50
Textiles 40 10
2. Output per Unit of Input (lbs. or yards)
Food 5 15
Textiles 3 4
3. Total Output (lbs. or yards) - (in Million)
Food 100 750 850
Textiles 120 40 160
4. Consumptions (lbs. or yards) - (in Million)
Food 225 625 850
Textiles 70 90 160