International Financial Management
1. INTRODUCTION
1.1 WHAT DOES INTERNATIONAL FINANCIAL MANAGEMENT REFER TO?
3 sets of decisions:
1. Investment decisions: In what does a firm invest?
2. Financing decisions: How does a firm finances its operations?
3. Risk management decisions: How to hedge risks that affect profitability?
One predefined objective: shareholders’ wealth maximization
• Anglo-Saxon countries: most important corporate objective
• This does not have to be the case (see Loderer et al. 2010, ’Shareholder value: principles,
declarations, and actions’)
Role of the finance director in a company with international activities
Same decisions BUT…
• Considers more opportunities: can invest in many countries, can raise funds in many capital
markets, can choose other securities (i.e., securities available on the international bond market)
• Takes into account additional market imperfections: legal restrictions, transportation and
transaction costs, taxes, ... are different from country to country
• Assesses and hedges additional risks: currency risk, political risk
1.2 MOTIVATIONS
GLOBALIZATION
Fact 1: We are living in a highly globalized world
→ Gygli et al. 2019, ’The KOF Globalisation Index - revisited’:
compute the KOF globalization index: measures globalization for
every country in the world distinguish between:
• Economic globalization: "long distance flows of goods,
capital and services [...]"
• Social globalization: "spread of ideas, information, images
and people"
• Political globalization: "diffusion of government policies";
"ability to engage in international political cooperation"
1
,INTERNATIONAL NANCIAL OPENESS
Index based on both the number and the severity of restrictions on capital flows (source: Quinn et al.
2008, ’Does Capital Account Liberalization Lead to Growth?’)
BUSINESS INTERNALIZATION
Fact 2: for a large number of companies, international activities have become an important part of their
total activity.
→ case of multinational corporations (MNCs)
- MNC: undertakes foreign direct investments (FDIs)
- FDI: investment involving a certain measure of control of a foreign business.
"The term MNC suggests a firm obtaining raw materials from one national market and financial capital
from another, producing goods with labor and capital equipment in a third country, and selling the
finished product in yet other national markets. Indeed, some MNCs have operations in dozens of
different countries. MNCs obtain financing from major money centers around the world in many different
currencies to finance their operations. [...]"
Airbus: more than 20 manufacturing sites and 12 final assembly lines spread across multiple countries
2
,1.3 THE INVESTMENT DECISION
How does the international dimension affect the investment decision?
National markets are more and more but not perfectly integrated
⇒ the same investment in different countries does not have the same value: taking the best investment
decisions involves to take into account cross-country differences
Level of cash flows:
Taxes (imports, exports, profit, ...); Cost
of labor; Legal restrictions (quotas, ...);
Exchange rates; ...
Risk:
Currency risk; political risk; ...
1.4 THE FINANCING DECISION
How does the international dimension
affect the financing decision?
National capital markets are more and
more but not perfectly integrated
⇒ the same security issued to obtain
funds does not have the same cost
everywhere: taking the best financing
decision involves to take into account
cross-country differences that affect the
cost of capital
degree of financial integration, quality of
corporate governance, macroeconomic conditions, ...
1.5 THE RISK MANAGEMENT DECISION
CURRENCY RISK
Companies with international activities are exposed to currency risk
→ risk of a sudden change in an exchange rate
3
, Fluctuations in exchange rates can affect a
firm’s cash flows and value
Exple: Suppose your company is based in
the US, sells goods whose price is
denominated in US dollar to Japan
↓ of the JPY-USD exchange rate: ↑ in the
yen value of your goods relative to other
suppliers, ↓ market share, ↓CF’s
Firms do hedge currency risk by using different methods
e.g., currency derivative contracts such as forwards, options, swaps, ...
POLITICAL RISK
Companies with international activities are
exposed to political risk
→ risk of adverse political devlopments in a
foreign country in which a MNC has operations
e.g., expropriation of foreign assets, unexpected
changes in the tax laws ...
4
1. INTRODUCTION
1.1 WHAT DOES INTERNATIONAL FINANCIAL MANAGEMENT REFER TO?
3 sets of decisions:
1. Investment decisions: In what does a firm invest?
2. Financing decisions: How does a firm finances its operations?
3. Risk management decisions: How to hedge risks that affect profitability?
One predefined objective: shareholders’ wealth maximization
• Anglo-Saxon countries: most important corporate objective
• This does not have to be the case (see Loderer et al. 2010, ’Shareholder value: principles,
declarations, and actions’)
Role of the finance director in a company with international activities
Same decisions BUT…
• Considers more opportunities: can invest in many countries, can raise funds in many capital
markets, can choose other securities (i.e., securities available on the international bond market)
• Takes into account additional market imperfections: legal restrictions, transportation and
transaction costs, taxes, ... are different from country to country
• Assesses and hedges additional risks: currency risk, political risk
1.2 MOTIVATIONS
GLOBALIZATION
Fact 1: We are living in a highly globalized world
→ Gygli et al. 2019, ’The KOF Globalisation Index - revisited’:
compute the KOF globalization index: measures globalization for
every country in the world distinguish between:
• Economic globalization: "long distance flows of goods,
capital and services [...]"
• Social globalization: "spread of ideas, information, images
and people"
• Political globalization: "diffusion of government policies";
"ability to engage in international political cooperation"
1
,INTERNATIONAL NANCIAL OPENESS
Index based on both the number and the severity of restrictions on capital flows (source: Quinn et al.
2008, ’Does Capital Account Liberalization Lead to Growth?’)
BUSINESS INTERNALIZATION
Fact 2: for a large number of companies, international activities have become an important part of their
total activity.
→ case of multinational corporations (MNCs)
- MNC: undertakes foreign direct investments (FDIs)
- FDI: investment involving a certain measure of control of a foreign business.
"The term MNC suggests a firm obtaining raw materials from one national market and financial capital
from another, producing goods with labor and capital equipment in a third country, and selling the
finished product in yet other national markets. Indeed, some MNCs have operations in dozens of
different countries. MNCs obtain financing from major money centers around the world in many different
currencies to finance their operations. [...]"
Airbus: more than 20 manufacturing sites and 12 final assembly lines spread across multiple countries
2
,1.3 THE INVESTMENT DECISION
How does the international dimension affect the investment decision?
National markets are more and more but not perfectly integrated
⇒ the same investment in different countries does not have the same value: taking the best investment
decisions involves to take into account cross-country differences
Level of cash flows:
Taxes (imports, exports, profit, ...); Cost
of labor; Legal restrictions (quotas, ...);
Exchange rates; ...
Risk:
Currency risk; political risk; ...
1.4 THE FINANCING DECISION
How does the international dimension
affect the financing decision?
National capital markets are more and
more but not perfectly integrated
⇒ the same security issued to obtain
funds does not have the same cost
everywhere: taking the best financing
decision involves to take into account
cross-country differences that affect the
cost of capital
degree of financial integration, quality of
corporate governance, macroeconomic conditions, ...
1.5 THE RISK MANAGEMENT DECISION
CURRENCY RISK
Companies with international activities are exposed to currency risk
→ risk of a sudden change in an exchange rate
3
, Fluctuations in exchange rates can affect a
firm’s cash flows and value
Exple: Suppose your company is based in
the US, sells goods whose price is
denominated in US dollar to Japan
↓ of the JPY-USD exchange rate: ↑ in the
yen value of your goods relative to other
suppliers, ↓ market share, ↓CF’s
Firms do hedge currency risk by using different methods
e.g., currency derivative contracts such as forwards, options, swaps, ...
POLITICAL RISK
Companies with international activities are
exposed to political risk
→ risk of adverse political devlopments in a
foreign country in which a MNC has operations
e.g., expropriation of foreign assets, unexpected
changes in the tax laws ...
4
