The eleventh edition of Multinational Financial Management is a comprehensive survey of the essential areas of the international financial market environment, including foreign exchange and derivative markets, risk management, and international capital markets and portfolio investment. Designed for upper-level undergraduate and masters-level courses in international finance and management, this textbook offers readers a conceptual framework for analyzing key financial decisions of multinational firms. The authors both explain and simplify multinational financial management by illustrating how its basic principles share the same foundation as domestic corporate finance.
Assuming no prior knowledge of international economics or finance, this substantially revised new edition builds upon the fundamental principles of domestic financial management to examine the unique dimensions of international finance. Readers are presented with a solid theoretical knowledgebase for examining decision problems, as well as practical analytical techniques that clarify the often-ambiguous guidelines used by international financial executives. All the traditional areas of corporate finance are explored from the perspective of a multinational corporation, focusing on elements rarely encountered in domestic finance such as multiple currencies, segmented capital markets, and political risks of nationalization or expropriation.
Table of Contents
List of Figures xixList of Tables xxiii
Preface xxvii
World Currencies and Symbols xxxi
Acronyms and Symbols xxxv
Part I The International Financial Management Environment
1 Introduction: Multinational Corporations and Financial Management 3
1.1 The Rise of the Multinational Corporation 4
1.1.1 Evolution of the Multinational Corporation 7
1.1.2 The Process of Overseas Expansion by Multinationals 14
1.1.3 A Behavioral Definition of the Multinational Corporation 17
1.1.4 The Global Manager 18
1.2 The Internationalization of Business and Finance 18
1.2.1 Political and Labor Union Concerns About Global Competition 19
1.2.2 Consequences of Global Competition 22
1.3 Multinational Financial Management: Theory and Practice 24
1.3.1 Functions of Financial Management 25
1.3.2 Theme of This Book 25
1.3.3 Relationship to Domestic Financial Management 26
1.3.4 The Global Financial Marketplace 28
1.3.5 The Role of the Financial Executive in an Efficient Market 28
1.4 Outline of the Book 29
1.4.1 The International Financial Management Environment 29
1.4.2 The Foreign Exchange and Derivatives Markets 29
1.4.3 Foreign Exchange Risk Management 29
1.4.4 The International Capital Markets and Portfolio Management 29
1.4.5 International Capital Budgeting 30
Questions 30
Appendix: The Origins and Consequences of International Trade 31
Questions 35
2 The Determination of Exchange Rates 37
2.1 Setting The Equilibrium Spot Exchange Rate 38
2.1.1 Factors That Affect the Equilibrium Exchange Rate 39
2.1.2 Calculating Exchange Rate Changes 41
2.2 Expectations and The Asset Market Model of Exchange Rates 43
2.2.1 The Nature of Money and Currency Values 44
2.2.2 Central Bank Reputations and Currency Values 44
2.3 The Fundamentals of Central Bank Intervention 49
2.3.1 How Real Exchange Rates Affect Relative Competitiveness 50
2.3.2 Foreign Exchange Market Intervention 50
2.3.3 The Effects of Foreign Exchange Market Intervention 53
2.4 The Equilibrium Approach To Exchange Rates 55
2.5 Disequilibrium Theory and Exchange Rate Overshooting 55
2.5.1 The Equilibrium Theory of Exchange Rates and Its Implications 56
2.6 Conclusions 58
Questions 60
Problems 61
References 62
3 The International Monetary System 63
3.1 Alternative Exchange Rate Systems 64
3.1.1 The Trilemma and Exchange Rate Regime Choice 64
3.1.2 Free Float 66
3.1.3 Managed Float 67
3.1.4 Target-Zone Arrangement 69
3.1.5 Fixed Rate System 69
3.2 A Brief History of the International Monetary System 70
3.2.1 The Classical Gold Standard 71
3.2.2 How the Classical Gold Standard Worked in Practice: 1821-1914 73
3.2.3 The Gold Exchange Standard and Its Aftermath: 1925-1944 73
3.2.4 The Bretton Woods System: 1946-1971 74
3.2.5 The Post-Bretton Woods System: 1971 to the Present 76
3.2.6 Assessment of the Floating Rate System 77
3.3 The European Monetary System and Monetary Union 78
3.3.1 The Exchange Rate Mechanism 79
3.3.2 Lessons from the European Monetary System 79
3.3.3 The Currency Crisis of September 1992 79
3.3.4 The Exchange Rate Mechanism Is Abandoned in August 1993 80
3.3.5 European Monetary Union 81
3.3.6 Optimum Currency Area 88
3.3.7 Exchange Rate Regimes Today 93
3.4 Emerging Market Currency Crises 96
3.4.1 Transmission Mechanisms 96
3.4.2 Origins of Emerging Market Crises 96
3.4.3 Policy Proposals for Dealing with Emerging Market Crises 97
3.5 Summary and Conclusions 98
Questions 99
Problems 100
References 100
4 Parity Conditions in International Finance and Currency Forecasting 101
4.1 Arbitrage and the Law of One Price 102
4.2 Purchasing Power Parity 104
4.2.1 The Lesson of Purchasing Power Parity 108
4.2.2 Expected Inflation and Exchange Rate Changes 109
4.2.3 The Monetary Approach 110
4.2.4 Empirical Evidence 110
4.3 The Fisher Effect 113
4.3.1 Empirical Evidence 114
4.4 The International Fisher Effect 118
4.4.1 Empirical Evidence 119
4.5 Interest Rate Parity Theory 120
4.5.1 Empirical Evidence 123
4.6 The Relationship Between The Forward Rate and The Future Spot Rate 123
4.6.1 Empirical Evidence 126
4.7 Currency Forecasting 126
4.7.1 Requirements for Successful Currency Forecasting 127
4.7.2 Market-Based Forecasts 127
4.7.3 Model-Based Forecasts 129
4.7.4 Model Evaluation 130
4.7.5 Forecasting Controlled Exchange Rates 132
4.8 Summary and Conclusions 132
Questions 133
Problems 135
References 137
5 The Balance of Payments and International Economic Linkages 139
5.1 Balance-Of-Payments Categories 140
5.1.1 Current Account 141
5.1.2 Capital Account 144
5.1.3 Financial Account 144
5.1.4 Balance-of-Payments Measures 145
5.1.5 The Missing Numbers 146
5.2 The International Flow of Goods, Services, and Capital 146
5.2.1 Domestic Saving and Investment and the Financial Account 146
5.2.2 The Link between the Current and Financial Accounts 147
5.2.3 Government Budget Deficits and Current-Account Deficits 149
5.2.4 The Current Situation 150
5.3 Coping with the Current-Account Deficit 153
5.3.1 Currency Depreciation 153
5.3.2 Protectionism 157
5.3.3 Ending Foreign Ownership of Domestic Assets 158
5.3.4 Boosting the Saving Rate 158
5.3.5 External Policies 159
5.3.6 Current-Account Deficits and Unemployment 160
5.3.7 The Bottom Line on Current-Account Deficits and Surpluses 161
5.4 Summary and Conclusions 161
Questions 162
Problems 163
References 164
Part II The Foreign Exchange and Derivative Markets
6 The Foreign Exchange Market 167
6.1 Organization of the Foreign Exchange Market 168
6.1.1 The Participants 169
6.1.2 Size 172
6.2 The Spot Market 174
6.2.1 Spot Quotations 174
6.2.2 The Mechanics of Spot Transactions 181
6.3 The Forward Market 181
6.3.1 Forward Quotations 183
6.3.2 Forward Contract Maturities 186
6.4 Summary and Conclusions 186
Questions 186
Problems 187
References 188
7 Currency Futures and Options Markets 189
7.1 Futures Contracts 190
7.1.1 Forward Contract versus Futures Contract 191
7.2 Currency Options 194
7.2.1 Market Structure 195
7.2.2 Using Currency Options 196
7.2.3 Option Pricing and Valuation 201
7.2.4 Using Forward or Futures Contracts versus Options Contracts 203
7.2.5 Futures Options 205
7.3 Reading Currency Futures and Options Prices 206
7.4 Summary and Conclusions 206
Questions 208
Problems 209
Appendix: Option Pricing Using Black-Scholes 210
A.1 The Black-Scholes Model 210
A.2 Implied Volatilities 212
A.3 Shortcomings of the Black-Scholes Option Pricing Model 212
Problems 213
Appendix: Put-Call Option Interest Rate Parity 213
Problems 215
References 215
8 Currency, Interest Rate, and Credit Derivatives and Swaps 217
8.1 Interest Rate and Currency Swaps 218
8.1.1 Interest Rate Swaps 218
8.1.2 Currency Swaps 221
8.1.3 Economic Advantages of Swaps 228
8.2 Interest Rate Forwards and Futures 229
8.2.1 Forward Forwards 229
8.2.2 Forward Rate Agreement 230
8.2.3 Eurodollar Futures 231
8.3 Structured Notes 233
8.3.1 Inverse Floaters 233
8.3.2 Callable Step-Up Note 234
8.3.3 Step-Down Coupon Note 234
8.4 Credit Default Swaps 235
8.4.1 Single-Name CDS 235
8.4.2 CDS Indexes 237
8.5 Summary and Conclusions 238
Questions 239
Problems 239
Reference 241
Part III Foreign Exchange Risk Management
9 Measuring and Managing Translation and Transaction Exposure 245
9.1 Alternative Measures of Foreign Exchange Exposure 246
9.1.1 Translation Exposure 246
9.1.2 Transaction Exposure 246
9.1.3 Operating Exposure 247
9.2 Alternative Currency Translation Methods 247
9.2.1 Current/Noncurrent Method 248
9.2.2 Monetary/Nonmonetary Method 248
9.2.3 Temporal Method 248
9.2.4 Current Rate Method 249
9.3 Transaction Exposure 251
9.4 Designing a Hedging Strategy 251
9.4.1 Objectives 252
9.4.2 Costs and Benefits of Standard Hedging Techniques 255
9.4.3 Centralization versus Decentralization 258
9.4.4 Managing Risk Management 259
9.4.5 Accounting for Hedging and FASB 133 260
9.4.6 Empirical Evidence on Hedging 260
9.5 Managing Translation Exposure 261
9.5.1 Funds Adjustment 261
9.5.2 Evaluating Alternative Hedging Mechanisms 262
9.6 Managing Transaction Exposure 263
9.6.1 Forward Market Hedge 263
9.6.2 Money Market Hedge 265
9.6.3 Risk Shifting 267
9.6.4 Pricing Decisions 268
9.6.5 Exposure Netting 269
9.6.6 Currency Risk Sharing 270
9.6.7 Currency Collars 270
9.6.8 Cross-Hedging 273
9.6.9 Foreign Currency Options 274
9.7 Summary and Conclusions 277
Questions 278
Problems 279
References 282
Appendix: Statement of Financial Accounting Standards No
52 283
10 Measuring and Managing Economic Exposure 287
10.1 Foreign Exchange Risk and Economic Exposure 288
10.1.1 Real Exchange Rate Changes and Exchange Risk 289
10.1.2 Importance of the Real Exchange Rate 290
10.1.3 Inflation and Exchange Risk 291
10.1.4 Competitive Effects of Real Exchange Rate Changes 292
10.2 The Economic Consequences of Exchange Rate Changes 294
10.2.1 Transaction Exposure 294
10.2.2 Operating Exposure 295
10.3 Identifying Economic Exposure 298
10.3.1 Aspen Skiing Company 298
10.3.2 Petróleos Mexicanos 298
10.3.3 Toyota Motor Company 299
10.4 Calculating Economic Exposure 300
10.4.1 Spectrum’s Accounting Exposure 301
10.4.2 Spectrum’s Economic Exposure 301
10.5 An Operational Measure of Exchange Risk 305
10.5.1 Limitations 306
10.6 Managing Operating Exposure 307
10.6.1 Marketing Management of Exchange Risk 307
10.6.2 Production Management of Exchange Risk 310
10.6.3 Planning for Exchange Rate Changes 313
10.6.4 Financial Management of Exchange Risk 314
10.7 Summary and Conclusions 316
Questions 318
Problems 319
References 322
Part IV The International Capital Markets and Portfolio Management
11 International Financing and National Capital Markets 325
11.1 Corporate Sources and Uses of Funds 326
11.1.1 Financial Markets versus Financial Intermediaries 326
11.1.2 Financial Systems and Corporate Governance 327
11.1.3 Globalization of Financial Markets 330
11.2 National Capital Markets As International Financial Centers 332
11.2.1 International Financial Markets 334
11.2.2 Foreign Access to Domestic Markets 335
11.3 Development Banks 340
11.3.1 The World Bank Group 341
11.3.2 Regional and National Development Banks 342
11.3.3 Private Sector Alternatives 343
11.4 Project Finance 344
11.5 Summary and Conclusions 345
Questions 345
Problems 346
References 347
12 The Euromarkets 348
12.1 The Eurocurrency Market 348
12.1.1 Modern Origins 349
12.1.2 Eurodollar Creation 350
12.1.3 Eurocurrency Loans 351
12.1.4 Relationship between Domestic and Eurocurrency Money Markets 353
12.1.5 Euromarket Trends 354
12.2 Eurobonds 355
12.2.1 Swaps 355
12.2.2 Links between the Domestic and Eurobond Markets 355
12.2.3 Rationale for Existence of Eurobond Market 358
12.2.4 Eurobonds versus Eurocurrency Loans 360
12.3 Note Issuance Facilities and Euronotes 360
12.3.1 Note Issuance Facilities versus Eurobonds 362
12.3.2 Euro-Medium-Term Notes 363
12.4 Euro-Commercial Paper 364
12.5 The Asiacurrency Market 365
12.6 Summary and Conclusions 365
Questions 366
Problems 366
References 367
13 International Portfolio Management 368
13.1 The Risks and Benefits of International Equity Investing 369
13.1.1 International Diversification 370
13.1.2 Investing in Emerging Markets 376
13.1.3 Barriers to International Diversification 380
13.1.4 Ways to Invest Internationally 381
13.2 International Bond Investing 383
13.3 Optimal International Asset Allocation 383
13.4 Measuring the Total Return From Foreign Portfolio Investing 385
13.4.1 Bonds 385
13.4.2 Stocks 385
13.5 Measuring Exchange Risk on Foreign Securities 386
13.5.1 Hedging Currency Risk 386
13.6 Summary and Conclusions 387
Questions 387
Problems 388
References 390
Part V International Capital Budgeting
14 Country Risk Analysis 395
14.1 Learning Objectives 395
14.2 Measuring Political Risk 396
14.2.1 Political Stability 397
14.2.2 Economic Factors 399
14.2.3 Subjective Factors 400
14.3 Economic and Political Factors Underlying Country Risk 405
14.3.1 Fiscal Irresponsibility 406
14.3.2 Monetary Instability 406
14.3.3 Controlled Exchange Rate System 408
14.3.4 Wasteful Government Spending 408
14.3.5 Resource Base 408
14.3.6 Country Risk and Adjustment to External Shocks 409
14.3.7 Market-Oriented versus Statist Policies 410
14.3.8 Key Indicators of Country Risk and Economic Health 413
14.4 Country Risk Analysis in International Lending 418
14.4.1 The Mathematics of Sovereign Debt Analysis 418
14.4.2 Country Risk and the Terms of Trade 420
14.4.3 The Government’s Cost/Benefit Calculus 421
14.5 Summary and Conclusions 422
Questions 424
Problems 424
References 426
15 The Cost of Capital for Foreign Investments 427
15.1 The Cost of Equity Capital 428
15.2 The Weighted Average Cost of Capital For Foreign Projects 429
15.3 Discount Rates for Foreign Investments 430
15.3.1 Evidence from the Stock Market 431
15.3.2 Key Issues in Estimating Foreign Project Discount Rates 432
15.3.3 Proxy Companies 433
15.3.4 The Relevant Base Portfolio 434
15.3.5 The Relevant Market Risk Premium 438
15.3.6 Recommendations 439
15.4 The Cost of Debt Capital 439
15.4.1 Annual Exchange Rate Change 440
15.4.2 Using Sovereign Risk Spreads 441
15.5 Establishing a Worldwide Capital Structure 441
15.5.1 Foreign Subsidiary Capital Structure 442
15.5.2 Joint Ventures 446
15.6 Valuing Low-Cost Financing Opportunities 447
15.6.1 Taxes 448
15.6.2 Government Credit and Capital Controls 449
15.6.3 Government Subsidies and Incentives 450
15.7 Summary and Conclusions 452
Questions 453
Problems 454
References 455
16 Corporate Strategy and Foreign Direct Investment 457
16.1 Theory of the Multinational Corporation 458
16.1.1 Product and Factor Market Imperfections 458
16.1.2 Financial Market Imperfections 459
16.1.3 The Strategy of Multinational Enterprise 460
16.1.4 Innovation-Based Multinationals 460
16.1.5 The Mature Multinationals 460
16.1.6 The Senescent Multinationals 463
16.1.7 Foreign Direct Investment and Survival 464
16.2 Designing a Global Expansion Strategy 469
16.2.1 Awareness of Profitable Investments 469
16.2.2 Selecting a Mode of Entry 469
16.2.3 Auditing the Effectiveness of Entry Modes 470
16.2.4 Using Appropriate Evaluation Criteria 471
16.2.5 Estimating the Longevity of a Competitive Advantage 471
16.3 Summary and Conclusions 472
Questions 474
Problems 475
References 475
17 Capital Budgeting for the Multinational Corporation 477
17.1 Basics of Capital Budgeting 478
17.1.1 Net Present Value 478
17.1.2 Incremental Cash Flows 479
17.1.3 Alternative Capital-Budgeting Frameworks 482
17.2 Issues in Foreign Investment Analysis 483
17.2.1 Parent versus Project Cash Flows 484
17.2.2 Political and Economic Risk Analysis 485
17.2.3 Exchange Rate Changes and Inflation 486
17.3 Foreign Project Appraisal: The Case of International Diesel Corporation 487
17.3.1 Estimation of Project Cash Flows 487
17.3.2 Estimation of Parent Cash Flows 492
17.4 Political Risk Analysis 495
17.4.1 Expropriation 495
17.4.2 Blocked Funds 496
17.5 Growth Options and Project Evaluation 497
17.6 Summary and Conclusions 500
Questions 501
Problems 502
References 503
Appendix: Managing Political Risks 503
18 Managing the Internal Capital Markets of Multinational Corporations 509
18.1 The Value of The Multinational Financial System 510
18.1.1 Mode of Transfer 510
18.1.2 Timing Flexibility 511
18.1.3 Value 512
18.2 Intercompany Fund-Flow Mechanisms: Costs and Benefits 513
18.2.1 Tax Factors and the Tax Cuts and Jobs Act of 2017 513
18.2.2 Transfer Pricing 516
18.2.3 Offshore Centers 520
18.2.4 Fees and Royalties 521
18.2.5 Leading and Lagging 522
18.2.6 Intercompany Loans 524
18.2.7 Dividends 527
18.2.8 Equity versus Debt 529
18.3 Designing a Global Remittance Policy 530
18.3.1 Prerequisites 532
18.3.2 Information Requirements 532
18.3.3 Behavioral Consequences 532
18.4 Summary and Conclusions 534
Questions 534
Problems 535
References 536
Glossary G-1
Index I-1
