© 2018 Cambridge University Press 1-‹#› International Finance •Characteristics of main players • • •Michala Moravcová •Department of Finance, Masaryk University • •International Finance The scope and environment of international finance International Finance © 2018 Cambridge University Press 1-‹#› 1.Growth of International Trade 2.Globalization Process of MNCs 3.Important International Players • 1. 1. 1. •Source: Bekaert, G. J., and Hodrick, R. J. (2012). International Financial Management, 2nd edition. Chapter 1. • • Contents International Finance International Finance © 2018 Cambridge University Press 1-‹#› •We live in a highly globalized and integrated world economy. •Continuous liberalization of international trade and investments and rapid advances in telecommunication and transportation technologies, the world is getting more integrated. •Financial managers of MNCs should learn how to manage foreign exchange and political risk using proper tools and instruments, deal with market imperfections and benefit from the expanded investment and financing opportunities with the aim of contribution to share holder wealth maximization. • International Finance International Finance © 2018 Cambridge University Press 1-‹#› International Finance •Globalization •Increasing connectivity and integration of countries and corporations and the people within them in terms of their economic, political, and social activities •Multinational corporations dominates the corporate landscape •Produce and sell goods or services in more than one nation (e.g. Coca-Cola, IBM, Nestle, ..) •BRIC countries (Brazil, Russia, India and China)/emerging markets offer a lot of opportunities for expansion (Why?) •International scope creates opportunities but also challenges •Recent crisis (others?) 1.1 Introduction “The world economy is becoming increasingly globalized“ International Finance © 2018 Cambridge University Press 1-‹#› International Finance 1.2 Globalization and two main trends: The Growth of International Trade and Capital Flows 1.The growth of international trade •The theory of comparative advantage (advanced by David Ricardo) says: •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. It is not a “zero-sum game” in which one country benefits at the expense of another country. It is “increasing-sum” game at which all players are winners. •Assumptions: •Free trade •Perfect competition •No uncertainty •Costless information •No government interference • •Comparative advantage still explains why some countries are better for export • • International Finance © 2018 Cambridge University Press 1-‹#› International Finance •Trade liberalization so countries can specialize at production of goods for which they have a comparative advantage •1960s only 20% of countries were open •Firms (1980s), the fall of the Iron Curtain in 1990 and subsequent trade liberalizations in many developing countries and privatization •By 2000, over 70% of countries were open •International Efforts to Promote Free Trade (Free trade agreements) •General Agreement on Tariffs and Trade GATT (1947) •World Trade Organization WTO (1986) •Regional Trade agreements (European Union, NAFTA, ASEAN) •More open economies, tend to grow faster (Frankel and Romer (1999), Sachs and Warner (1995), Alcal and Ciccone (2004), and Wacziarg and Welch (2008)). •The examples of protectionist policies: tariffs on imports, subsidies to local producers, quotas on imported products, onerous regulations applying to imported products •Advances in information technology supported Outsourcing of services •Shifting of non-strategic functions to specialist firms to reduce costs (IT, payrolls, logistics, maintenance facilities) •21st century comparative advantage is based on services and supply chain outsourcing • 1.2 Globalization and two main trends: The Growth of International Trade and Capital Flows International Finance © 2018 Cambridge University Press 1-‹#› International Finance 1.2 Globalization and the Growth of International Trade and Capital Flows •The evolution of trade openness dramatically increased trade flows between countries. One measure of trade openness is the sum of exports and imports in a given year divided by a measure of output (GDP) • •The growth in trade (patterns) •Germany is most open, United States is least open •China’s trade jumped due to trade reforms •Countries that border oceans tend to trade more •Large countries tend to trade less than small (USA, China is exception) International Finance © 2018 Cambridge University Press 1-‹#› Exhibit 1.1 (Panel A) International Trade as a Percentage of GDP C:\Users\is5985\Desktop\New folder\GEERT BEKAERT_Chapter1\GEERT BEKAERT_fig. 1.1a.jpg International Finance International Finance © 2018 Cambridge University Press 1-‹#› Exhibit 1.1 (Panel B) International Trade as a Percentage of GDP (BRIC countries) C:\Users\is5985\Desktop\New folder\GEERT BEKAERT_Chapter1\GEERT BEKAERT_fig. 1.1b.jpg International Finance International Finance © 2018 Cambridge University Press 1-‹#› 1.2 Globalization and the Growth of International Trade and Capital Flows •Incredible growth in MNCs after WWII boosted international trade •37,000 MNCs in 1990 •82,053 in 2010 •More than 50% of international trade occurs within MNCs •Globalization of financial markets improved MNCs access to foreign capital, and enhanced their ability to reduce financing costs •Trends in financial openness •Countries open financially and allow foreigners to invest in their markets (1980s) and vice versa (= free flow of capital across borders) •Creation of new asset class – emerging markets •New financial landscape – derivatives (← deregulation, advance in technology) •An investment whose payoff over time is derived from the performance of underlying assets (futures, forwards, …) •Securitization – repackaging of “pools” of loans or other receivables to create a new financial instrument •Derivatives and securitization improved the ability of banks and corporations to manage financial risk • • International Finance International Finance © 2018 Cambridge University Press 1-‹#› International Finance 1.2 Globalization and the Growth of International Trade and Capital Flows •Globalization of financial markets •Pros and cons of development •Pro – banks (and companies) could hedge against risk •Cons – smart financiers exploit differences in country-specific regulations and complexity of instruments created opaqueness in the financial system •Global Financial Crisis – 2008 – 2010 •Started in U.S. •Longest and deepest in the postwar era •Scale and depth of crisis raises deep issues about the functioning of the global financial system International Finance © 2018 Cambridge University Press 1-‹#› International Finance •A parent company in the firm’s originating country and operating subsidiaries, branches, and affiliates abroad •UN calls these “transnational corporations” •How they enter foreign markets •Exporting / Importing •Licensing – gives local firms right to manufacture their products in exchange for a fee (royalties) (difficult to maintain quality standards) •Franchising – the firm provides sales or service strategies in exchange for fees •Joint venture – two or more firms form a new legal entity, jointly owned by all of the firms •Buying foreign company •Greenfield investments – starting company from scratch (part of FDI) 1.3 Multinational Corporations International Finance © 2018 Cambridge University Press 1-‹#› International Finance •Goals of an MNC •Maximize shareholder wealth •Australia, Canada, U.K. and U.S. •Appropriate time horizon is long •Maximize stakeholder wealth •Europe and Asia •Agency Theory – stockholders hire managers who make decisions about production and marketing. How can the ultimate owners of the assets motivate the managers to act in the owners’ interest? • The studies problems that arise from the separation of ownership and control •Corporate governance – legal/financial structure controlling relationship the relationship between a company’s shareholders and its management. Establish the framework within which the managers operate and to mitigate the principal–agent problem. •Corporate fraud •Enron, WorldCom, Tyco, Parmalat 1.3 Multinational Corporations International Finance © 2018 Cambridge University Press 1-‹#› Exhibit 1.4 Methods of Overcoming Agency Problems Due to the Separation of Ownership and Control C:\Users\is5985\Desktop\New folder\Final\GEERT BEKAERT_Chapter1\GEERT BEKAERT_fig. 1.4.jpg International Finance International Finance © 2018 Cambridge University Press 1-‹#› International Finance •Foreign Direct Investment (FDI) •When a company from one country buys at least 10% of a company in another country •Has grown from $7.5 trillion in 2000 to $25.0 trillion in 2015 •Mergers and acquisitions (M&A) play a huge role in this trend 1.3 Multinational Corporations International Finance © 2018 Cambridge University Press 1-‹#› Exhibit 1.6 Cross-Border Mergers and Acquisitions, 2000–2015 (in millions of dollars) C:\Users\is5985\Desktop\New folder\Final\GEERT BEKAERT_Chapter1\GEERT BEKAERT_fig. 1.6.jpg International Finance International Finance © 2018 Cambridge University Press 1-‹#› International Finance •International banks (CitiBank, HSBC, Global Asset management firms for M&As) •International institutions •International Monetary Funds (IMF) •Member organization whose goal is to ensure the stability of the international monetary and financial system through surveillance and technical assistance. IMF helps to resolve crises when they occur, and to promote growth and alleviate poverty. •The World Bank •The World Bank also provides advisory services to developing countries and is actively involved with efforts to reduce and cancel the international debt of the poorest countries • 1.4 Other Important International Players International Finance © 2018 Cambridge University Press 1-‹#› International Finance •Multilateral development banks •Provide financial support and professional advice for economic and social development activities in developing countries •Regional development banks (including World Bank and regional banks in Africa, Asia and Europe) who provide financing and grants •World Trade organization (WTO) •Mediates trade disputes •Organization for Economic Cooperation and Development (OECD) •Examines, devises and coordinates policies across 34 relatively wealthy nations to foster sustainable economic growth and employment, rising standards of living and financial stability •Bank for International Settlements (BIS) •Fosters international monetary and financial cooperation – central banks’ central bank 1.4 Other Important International Players International Finance © 2018 Cambridge University Press 1-‹#› International Finance •European Union (EU) •Cooperation among countries in this region and (in most cases) the adoption of the same currency to promote international business •Economic and monetary union (EMU) •Governments •Individual investors •Institutional investors •Sovereign wealth funds •Government-run investment pools •Hedge funds •Private equity funds 1.4 Other Important International Players International Finance © 2018 Cambridge University Press 1-‹#› International Finance •Countries who had opened their markets to foreigners subsequently fell into crisis •Benefits of openness •Channels savings to most productive uses •Sharing of risk beyond what is possible domestically •Domestic recessions can be buffered through borrowing •Cost of capital decreases, leading firms to invest more, which increases growth •Costs of openness •Sometimes capital is not used wisely (price boom) •Foreign capital can leave quickly causing financial volatility •Difficulty in taxing profits – MNCs shift to avoid •Capital control effectiveness decreases 1.5 Globalization and the MNC: Benefactor or Menace? International Finance © 2018 Cambridge University Press 1-‹#› International Finance •Anti-globalist movement and MNCs •Movement opposing globalization •Identifies MNCs as a main “villain” of globalization •Criticize global financial institutions such as the World Bank, IMF and WTO •They fear that MNC activities will harm the environment •They argue that globalization is seen as a threat to employment in their own country 1.5 Globalization and the MNC: Benefactor or Menace? International Finance © 2018 Cambridge University Press 1-‹#› International Finance •Final thoughts on globalization •Can be valuable •Some evidence that workers in developed countries have not benefited •Globalization destroys some jobs and creates others •Some believe that government must intervene to better spread the newly created wealth by helping those that have been displaced by globalization •Retraining •Benefits of openness should be fairly shared among countries. 1.5 Globalization and the MNC: Benefactor or Menace? International Finance © 2018 Cambridge University Press 1-‹#› International Finance 1.What is agency theory? How does corporate governance the issues raised by agency theory? 2.Why is ownership more concentrated in developing countries than in developed countries? 3.Go to the Web site of your favorite multinational firm and determine where it operates thoughout the world. How many employees does it have worldwide? Has it done any interesting cross-border mergers and acquisitions during the last year? 4.Go to UNCTADstat at http://unctadstat.unctad.org. Update the data in Exhibit 1.6 on cross-border mergers and acquisitions for the most recent years. •(country profile for the Czech Rep. http://unctadstat.unctad.org/CountryProfile/GeneralProfile/en-GB/203/index.html). • • • Questions International Finance