International Financial Management
Chapter one: Globalization and the Multinational Firm (MF)
A. Why study International Finance
International Finance is important because the world economy is highly globalized and
increasingly integrated in the markets for goods and services, but also in the financial markets.
Today consumption, production and investment are globalized.
B. There are 4 things that make International Finance special:
1. Foreign exchange risk = change in value of different currencies
2. Political risks
3. Market imperfections
4. Expanded opportunity set
These specialties are the consequence of sovereign nations that have the right to implement
what they want.
Foreign exchange risk:
Due to uncertain future exchange rates. It’s possible that the exchange rate changes. A currency
can appreciate and depreciate. Exchange rate uncertainty influence all major economic
functions, so also consumption, production and investment!!!
Example:
NOW: $1 = ¥100 ➔ you invest $1.000 to buy 50 shares at ¥2,000 per share. ➔ initial investment
= $1.000 or ¥100.000
1 YEAR LATER:
- Share price has increased by 10% ➔ worth of your investment = ¥110.000
- Exchange rate: $1 = ¥120 ➔ so yen has depreciated and USD is appreciating
➔ your investment is worth in $: ¥110.000/(120¥/$) = $916,67
WHAT is your investment return after 1 year? = % difference between value in period t and value
in period t-1
USD is the most important currency in the world. (60% reserve) . 2nd most important currency is
€ (20% reserves). 3rd most important is Chinese yuan.
Reserves = currencies that are held by a country
, Yen is depreciating against the
USD. The USD is appreciating.
Reference currency here is USD. If
the curve is going down, the YEN
depreciates against the USD.
➔ Makes you get less USD for 1
YEN. Or with base = 100, you
need more YEN for 100 USD
What is a carry trade
= an investment strategy where an investor borrows money in a currency with a low interest rate
and invests it in a currency with a higher interest rate.
➔ The goal is to make profit on the the interest rate differential (the “carry”). So between
the low interest rate on the loan and the higher interest rate on the investment.
Example:
Suppose in Japan interest rates are near 0% (you can borrow yen cheaply). In Australia interest
rates are 5%. You borrow yen, convert them into Australian dollars, and invest in Australian
bonds yielding 5%.
➔ Profit = roughly the difference between the two rates, as long as exchange rates remain
stable
!!! RISK !!!: If the exchange rate changes (e.g. YEN starts to appreciate. If it appreciates by 5% or
more, there is no advantage anymore for borrowing in YEN instead of Australian dollar)
Political risk:
= a sovereign country can change the “rules of the game” and the affected parties may not have
the possibility to fight back.
Political risk refers to the possibility that a government changes policies or regulations in a
way that can harm businesses or investors, without them being able to effectively protect
themselves against it.
Market imperfections:
= barriers that hinder the free movement of people, goods, services, and capital across
national borders. Because of that markets function imperfectly.
Examples of market imperfections:
• Legal restrictions
• Transaction and transportation costs
, • Information assymetry ➔ where one party has more or better information than the other.
• Discriminatory taxation ➔ whereby foreign parties are taxed more heavily than local
parties
Because of the highly imperfect world markets, MNCs are motivated to locate production
overseas. It also restricts the extent to which investors can diversify their portfolios. (Het
beperkt beleggers in de mate waarin zij hun portefeuilles internationaal kunnen diversifiëren.)
(Example: Nestlé used to issue 2 types of common shares: 1) bearer shares and 2) registered
shares. Swiss residents could buy both types, but foreigners could only buy bearer shares.
The bearer shares were more expensive than the registered shares. On a certain moment, Nestlé
made it also possible for foreigners to hold registered shares
➔ Because of that the price spread between those two type of shares narrowed drastically
In this graph you see the that the spread
gets narrowed drastically. The price of
bearer stocks decreased and the price of
registered stocks increased (reason: offer
& demand)
Other, more recent examples of companies from which the stock prices of local shares and
stock prices of international shares is significantly different and fluctuates a lot:
Aramco (2019) = world's largest oil company. During the IPO of this firm, there was a significant
difference between local and international investors. The shares were primarily offered to Saudi
investors and some others in the region, while foreign investors had limited access due to listing
constraints and local restrictions. This difference in market access led to a disparity in the
perceived valuation of the company between local and international markets.
Alibaba (2020): After its IPO in Hong Kong, there were significant differences in the prices of
Alibaba shares listed in Hong Kong and New York (ADR)
Tencent (2020), Baidu (2021), Adani Group (2022)
Identifying the sources of market imperfections. Different types of market imperfections:
- Geopolitical impact = political shifts or trade restrictions ➔ can lead to disparities in
asset prices between regions
- Cross-Listing Arbitrage = Companies that are listed on multiple exchanges can have
price disparities due to different liquidity levels, investor bases and local market
regulations
- Emerging Market Barriers = In some markets the foreign investor access is restricted or
limited
, - Exchange Rate Fluctuations = Companies with a lot of foreign operations may
experience valuation differences due to volatile exchange rate
- New Regulations = New laws and rules can affect companies uneven
Expanded Opportunity Set:
Firms and investors may benefit from an expanded opportunity set when they venture into global
markets
(= Bedrijven en investeerders kunnen profiteren van een groter aanbod aan kansen wanneer ze
zich op de wereldwijde markten begeven.)
➔ Firms can locate them anywhere in the world to maximize their performance
➔ Investors can benefit from diversifying internationally by getting a lower risk/higher
reward/both from international portfolios compared to domestic portfolios
“It just doesn’t make sense to play in only one corner of the sandbox.”
C. Goals for International Financial Management
➔ Try to maximize the benefits from the global opportunity set, while controlling the
political risks, the exchange rate risks and managing various market imperfections.
US, UK, Australia and Canada:
Fundamental goal of financial management = shareholder wealth maximalization ➔ every
decision made by the firm is made with an eye toward making the owners of the firm better
financially.
Continental Europe:
Shareholders are one of many stakeholders of the firm
Japan:
In Japan it’s not about the individual, it’s about the cooperation between multiple companies
➔ Keiretsu = a family of firms to which individual firms belong.
➔ GOAL: maximize the value and growth of the keiretsu. = Maximize profit of a group of
firms not just 1 company. Keiretsu is a sharing of losses and gains between companies.
Managers can pursue their own private interests, at the expense of shareholders when they
are not closely monitored
(= Managers kunnen echter hun eigen privébelangen nastreven ten koste van aandeelhouders
wanneer zij niet nauwlettend worden gecontroleerd.)
= agency problem ➔ major weakness of the public corporation
Corporate governance = the financial and legal framework for regulation between a firm’s
management and the shareholders
Chapter one: Globalization and the Multinational Firm (MF)
A. Why study International Finance
International Finance is important because the world economy is highly globalized and
increasingly integrated in the markets for goods and services, but also in the financial markets.
Today consumption, production and investment are globalized.
B. There are 4 things that make International Finance special:
1. Foreign exchange risk = change in value of different currencies
2. Political risks
3. Market imperfections
4. Expanded opportunity set
These specialties are the consequence of sovereign nations that have the right to implement
what they want.
Foreign exchange risk:
Due to uncertain future exchange rates. It’s possible that the exchange rate changes. A currency
can appreciate and depreciate. Exchange rate uncertainty influence all major economic
functions, so also consumption, production and investment!!!
Example:
NOW: $1 = ¥100 ➔ you invest $1.000 to buy 50 shares at ¥2,000 per share. ➔ initial investment
= $1.000 or ¥100.000
1 YEAR LATER:
- Share price has increased by 10% ➔ worth of your investment = ¥110.000
- Exchange rate: $1 = ¥120 ➔ so yen has depreciated and USD is appreciating
➔ your investment is worth in $: ¥110.000/(120¥/$) = $916,67
WHAT is your investment return after 1 year? = % difference between value in period t and value
in period t-1
USD is the most important currency in the world. (60% reserve) . 2nd most important currency is
€ (20% reserves). 3rd most important is Chinese yuan.
Reserves = currencies that are held by a country
, Yen is depreciating against the
USD. The USD is appreciating.
Reference currency here is USD. If
the curve is going down, the YEN
depreciates against the USD.
➔ Makes you get less USD for 1
YEN. Or with base = 100, you
need more YEN for 100 USD
What is a carry trade
= an investment strategy where an investor borrows money in a currency with a low interest rate
and invests it in a currency with a higher interest rate.
➔ The goal is to make profit on the the interest rate differential (the “carry”). So between
the low interest rate on the loan and the higher interest rate on the investment.
Example:
Suppose in Japan interest rates are near 0% (you can borrow yen cheaply). In Australia interest
rates are 5%. You borrow yen, convert them into Australian dollars, and invest in Australian
bonds yielding 5%.
➔ Profit = roughly the difference between the two rates, as long as exchange rates remain
stable
!!! RISK !!!: If the exchange rate changes (e.g. YEN starts to appreciate. If it appreciates by 5% or
more, there is no advantage anymore for borrowing in YEN instead of Australian dollar)
Political risk:
= a sovereign country can change the “rules of the game” and the affected parties may not have
the possibility to fight back.
Political risk refers to the possibility that a government changes policies or regulations in a
way that can harm businesses or investors, without them being able to effectively protect
themselves against it.
Market imperfections:
= barriers that hinder the free movement of people, goods, services, and capital across
national borders. Because of that markets function imperfectly.
Examples of market imperfections:
• Legal restrictions
• Transaction and transportation costs
, • Information assymetry ➔ where one party has more or better information than the other.
• Discriminatory taxation ➔ whereby foreign parties are taxed more heavily than local
parties
Because of the highly imperfect world markets, MNCs are motivated to locate production
overseas. It also restricts the extent to which investors can diversify their portfolios. (Het
beperkt beleggers in de mate waarin zij hun portefeuilles internationaal kunnen diversifiëren.)
(Example: Nestlé used to issue 2 types of common shares: 1) bearer shares and 2) registered
shares. Swiss residents could buy both types, but foreigners could only buy bearer shares.
The bearer shares were more expensive than the registered shares. On a certain moment, Nestlé
made it also possible for foreigners to hold registered shares
➔ Because of that the price spread between those two type of shares narrowed drastically
In this graph you see the that the spread
gets narrowed drastically. The price of
bearer stocks decreased and the price of
registered stocks increased (reason: offer
& demand)
Other, more recent examples of companies from which the stock prices of local shares and
stock prices of international shares is significantly different and fluctuates a lot:
Aramco (2019) = world's largest oil company. During the IPO of this firm, there was a significant
difference between local and international investors. The shares were primarily offered to Saudi
investors and some others in the region, while foreign investors had limited access due to listing
constraints and local restrictions. This difference in market access led to a disparity in the
perceived valuation of the company between local and international markets.
Alibaba (2020): After its IPO in Hong Kong, there were significant differences in the prices of
Alibaba shares listed in Hong Kong and New York (ADR)
Tencent (2020), Baidu (2021), Adani Group (2022)
Identifying the sources of market imperfections. Different types of market imperfections:
- Geopolitical impact = political shifts or trade restrictions ➔ can lead to disparities in
asset prices between regions
- Cross-Listing Arbitrage = Companies that are listed on multiple exchanges can have
price disparities due to different liquidity levels, investor bases and local market
regulations
- Emerging Market Barriers = In some markets the foreign investor access is restricted or
limited
, - Exchange Rate Fluctuations = Companies with a lot of foreign operations may
experience valuation differences due to volatile exchange rate
- New Regulations = New laws and rules can affect companies uneven
Expanded Opportunity Set:
Firms and investors may benefit from an expanded opportunity set when they venture into global
markets
(= Bedrijven en investeerders kunnen profiteren van een groter aanbod aan kansen wanneer ze
zich op de wereldwijde markten begeven.)
➔ Firms can locate them anywhere in the world to maximize their performance
➔ Investors can benefit from diversifying internationally by getting a lower risk/higher
reward/both from international portfolios compared to domestic portfolios
“It just doesn’t make sense to play in only one corner of the sandbox.”
C. Goals for International Financial Management
➔ Try to maximize the benefits from the global opportunity set, while controlling the
political risks, the exchange rate risks and managing various market imperfections.
US, UK, Australia and Canada:
Fundamental goal of financial management = shareholder wealth maximalization ➔ every
decision made by the firm is made with an eye toward making the owners of the firm better
financially.
Continental Europe:
Shareholders are one of many stakeholders of the firm
Japan:
In Japan it’s not about the individual, it’s about the cooperation between multiple companies
➔ Keiretsu = a family of firms to which individual firms belong.
➔ GOAL: maximize the value and growth of the keiretsu. = Maximize profit of a group of
firms not just 1 company. Keiretsu is a sharing of losses and gains between companies.
Managers can pursue their own private interests, at the expense of shareholders when they
are not closely monitored
(= Managers kunnen echter hun eigen privébelangen nastreven ten koste van aandeelhouders
wanneer zij niet nauwlettend worden gecontroleerd.)
= agency problem ➔ major weakness of the public corporation
Corporate governance = the financial and legal framework for regulation between a firm’s
management and the shareholders
