Agency Problems Financial Account

The conflict of goals between managers and shareholders. *Direct foreign investment
Agency Cost Investments in fixed assets in foreign countries
The cost related to making sure managers are doing what *Portfolio investment
shareholders want them to do. Transactions involving long term financial assets (such as
Centralized Systems vs Decentralized stocks and bonds) between countries that do not affect the
Centralized transfer of control.
Less agency cost. *Other capital investment
Better communication. Transactions involving short-term financial assets (such as
Decentralized money market securities) between countries.
More agency cost Errors and omissions and reserves
Why Firms Pursue International Business (3 reasons) Measurement errors can occur when attempting to measure
1. Theory of Competitive Advantage the value of funds transferred into or out of a country.
2. Imperfect Markets Theory Cost of Labor
3. Product Cycle Theory Firms in countries where labor costs are low commonly
Theory of Competitive Advantage have an advantage when competing globally, especially in
Specialization increases production efficiency. labor intensive industries
Imperfect Markets Theory Inflation
Factors of production are somewhat immobile providing Current account decreases if inflation increases relative to
incentive to seek out foreign opportunities. trade partners.
Product Cycle Theory National Income
As a firm matures, it recognizes opportunities outside its Current account decreases if national income increases
domestic market. relative to other countries.
How Firms Engage in International Business Credit Conditions
1. International trade Tend to tighten when economic conditions weaken causing
2. Licensing banks to be less willing to extend financing to MNCs
3. Franchising Government Policies: can increase imports through:
4. Joint Ventures - Restrictions on imports
5. Acquisitions of existing operations - Subsidies for exporters
6. Establishing new foreign subsidiaries - Restrictions on piracy
International trade - Environmental restrictions
1. Exporting- to exploit new markets - Labor laws
2. Importing- to obtain low costs - Tax breaks
Licensing - Country security laws
Arrangement whereby one firm provides its technology (copyrights, - Government ownership or subsidies
patents, trademarks, etc) in exchange for fees or other consideration - Country security laws
Franchising - Policies to punish country governments
One firm provides a specialized sales or service strategy, support Exchange Rates
assistance, and possibly an initial investment in the franchise in Current account decreases if currency appreciates relative
exchange for periodic fees to other currencies.
Joint Ventures Impact of Government Policies
A venture that is jointly owned and operated by two or more firms *Restrictions on Imports:
Acquisitions of existing operations Taxes (tariffs) on imported goods increase prices and limit
Firms frequently acquire other firms in foreign countries as a means consumption. Quotas limit the volume of imports.
of penetrating foreign markets. Such acquisitions give firms full
control over their foreign businesses and enable the MNC to quickly *Subsidies for Exporters:
obtain a large portion of foreign market share - Government subsidies help firms produce at a lower cost than their
Establishing new foreign subsidiaries global competitors.
Firms penetrate foreign markets by establishing new operations in
foreign countries to produce and sell their products. Large investment. *Restrictions on Piracy:
Chapter 2 - A government can affect international trade flows by its lack of
Balance of Payments restrictions on piracy.
Summary of transactions between domestic and foreign
residents for a specific country over a specified period of *Environmental Restrictions:
time - Environmental restrictions impose higher costs on local firms,
Current Account placing them at a global disadvantage compared to firms in other
Main components: countries that are not subject to the same restrictions.
1. Merchandise (goods) and services
2. factor income (interest) Labor Laws:
3. Transfers - Countries with more restrictive laws will incur higher expenses for
Capital Account labor, other factors being equal.
Includes the value of financial assets transferred across
country borders by people who move to a different country. Business Laws:
Also includes the value of 1 patents and trademarks that are - Firms in countries with more restrictive bribery laws may not be
transferred across country borders able to compete globally in some situations.

Tax Breaks:
- Though not necessarily a subsidy, but still a form of government
financial support that might benefit many firms that export products.
Country Trade Requirements: Chapter 3
- Requiring various forms or obtaining licenses before countries can International Monetary Fund
export to the country (Bureaucracy) is a strong trade barrier. Held in Bretton Woods to:
1. promote cooperation among countries on international monetary
Government Ownership or Subsidies: issues
- Some governments maintain ownership in firms that are major 2. promote stability in exchange rates
exporters. 3. provide temporary funds to member countries attempting to correct
imbalances of international payments
Country Security Laws: 4. promote free mobility of capital funds across imbalances of
- Governments may impose certain restrictions when national international payments
security is a concern, which can affect on trade. 5. promote free trade

Policies to Punish Country Governments: Many expect countries to ^resolved international financial crisis
restrict imports from countries that ...
o- Fail to enforce environmental laws and child labor laws US $ backed by gold
0- Initiate war against another country Spot Market
o- Unwilling to participate in a war exchanged quickly
Bid/Ask Spread
Summary of Government Policies: (Ask - Bid)/ Ask
-Every government implements some policies Spot Rate
Forecasted Rate (nobody knows; unavailable)
-No formula ensure a completely fair contest for market share Forward Rate
How exchange rates may correct a balance of trade deficit: Estimated and available information
When a home currency is exchanged for a foreign currency to buy - can know for 2 days, 2 weeks, 2 years
foreign goods, then the home currency faces downward pressure, International Money Market
leading to increased foreign demand for the country's products. - invest or borrow / 1 yr or less
*banking regulation support
Why exchange rates may not correct a balance of trade deficit: *basel accords
Exchange rates will not automatically correct any international trade International Credit Market
balances when other forces are at work. 1-5 years
Limitations of a Weak Home Currency Solution Libor based- variable interest rate market
Competition: foreign companies may lower their prices to remain Usually syndicated- diversified risk for markets
competitive. International Bond Market
Over 5 yrs and usually 10 years
Impact of other currencies: a country that has balance of trade *Foreign bonds: a company from outside country of bond issue sells
deficit with many countries is not likely to solve all deficits bonds in local currency
simultaneously. - Sony sells USD bonds in US
-GM sells Yen Bond in Japan
Prearranged international trade transactions: international
transactions cannot be adjusted immediately. The lag is estimated to *Euro bonds: are sold in a currency different than currency of
be 18 months or longer, leading to a J-curve effect. (Exhibit 2.6) country where bonds issued

Intracompany trade: Many firms purchase products that are *Usually (not always) USD
produced by their subsidiaries. These transactions are not necessarily Examples:
affected by currency fluctuations. 1. McDonalds sells (issues) USD Bond in UK
When South Korea's export growth stalled, some South Korean firms 2 Guiness sells euro bonds in US
suggested that South Korea's primary export problem was the
weakness in the Japanese yen. How would you interpret this
statement? Sarbanes Oxley is the reason for US companies to issue bonds in
South Korean's are concerned when Japanese goods become cheaper foreign countries, due to less regulation than at home currency.
When does the US interest rate go down? - entails more risk > higher interest rate
When funds are provided for both foreign and domestic, and not Bond Features
solely domestic * Coupons or None
- Coupon bonds entitles interest per year
- Nones do not

*Owner or Bearer
- bearer bonds do not have a name on them

*Euro Bonds, since they are not in currency of country where issued,
are not subject to rules and regulations of the country where issued

Example: SEC of bank of London

Euro Dollars
Euro(first part) means its in the wrong place
Dollar(second part) means the currency
Equity Markets The key economic factors that can influence exchange rate
1. Foreign Offerings movements through their effects on demand and supply conditions
2. Yankee Offerings are relative inflation rates, interest rates, and income levels, and
3. ADRS government controls. When these factors lead to a change in
Foreign Offerings international trade or financial flows, they affect the demand for a
US firm offer shares on Japanese MKT. (Tokyo Stock Exchange) currency or the supply of currency for sale and thus the equilibrium
(McDonalds on Tokyo Exchange) exchange rate.
Yankee Offerings Assume that the U.S. inflation rate becomes high relative to Canadian
Foreign firms offer shares on US Stock (Toyota on NYSE) inflation. Other things being equal, how should this affect the (a) U.S.
ADRS (American Deposit Receipts) demand for Canadian dollars, (b) supply of Canadian dollars for sale,
Represent stock portfolio (or individual) of foreign exchange and (c) equilibrium value of the Canadian dollar?
Sarbanes Oxley a. Demand for Canadian dollars should increase
Made US trading difficult with many regulations. b. Supply of Canadian dollars for sale should decrease
1. Explain why an MNC may invest funds in a financial market c. Canadian dollar's value should increase.
outside its own country... Assume US interest rates fall relative to British interest rates. Other
A belief that a foreign currency will appreciate in time against the US things being equal, how should this affect the (a) US demand for
dollar. British pounds, (b) supply of pounds for sale, and (c) equilibrium
4. Explain how the appreciation of the Japanese yen against the U.S. value of the pound?
dollar would affect the return to a U.S. firm that borrowed Japanese a. up
yen and used the proceeds for a U.S. project... b. down
It's going to cost more USD to pay off debt of yen. c. up
7. Compute the bid/ask percentage spread for Mexican peso retail Assume that the US income level rises at a much higher rate than
transactions in which the ask rate is $.11 and the bid rate is $.10 does the Canadian income level. Other things being equal, how
(11-10)/11= should this affect the (a) US demand for Canadian dollars, (b) supply
Explain how syndicated loans are used in international markets... of Canadian dollars for sale, and (c) equilibrium value of the
Companies share the risk with each other Canadian dollar.
1. GBP USD 1.55 a. up
2. GBP USD 1.60 b. same
Dollar depreciated c. increase
Pound appreciated Assume that the Japanese government relaxes its controls on imports
1. GBP USD 1.60 by Japanese companies. Other things being equal, how should this
2. GBP USD 1.55 affect the (a) US demand for Japanese yen, (b) supply of yen for sale,
Dollar appreciated and (c) equilibrium value of the yen.
Pound depreciated a. increase
% Change in Currency b. decrease
(now - past)/ past c. increase
Currency exchange rates change due to: How to Study
(4 I's, 1 E) A good grade should result from careful study of the assigned
1. Inflation chapters, clear understanding of the assigned problems, and prepared
2. Interest participation in class, both individually and as part of your assigned
3. Income small group. The "Self Test" section of each chapter is recommended.
4. Intervention, Government The Cengage website has student resources available at no charge.
5. Expectations What are typical reasons why MNCs expand internationally?
Supply and Demand Multinational corporations can capitalize on comparative advantages
Check notes for graph (such as a technology or cost of labor) that they have relative to firm
Do Yen HW for quiz prep! in other countries, which allows them to penetrate those other
... countries' markets. Given a world of imperfect markets, comparative
Institutional speculation based on expected appreciation advantages across countries are not freely transferable. Therefore
When financial institutions believe that a currency is valued lower MNCs may be able to capitalize on comparative advantages. Many
than it should be in the foreign exchange market, they may invest in MNCs initially penetrate markets by exporting but ultimately
that currency before it appreciates. establish a subsidiary in foreign markets and attempt to differentiate
Institutional speculation based on expected depreciation their products as other firms enter those markets ( product cycle
If financial institutions believe that a currency is valued higher than it theory).
should be in the foreign exchange market, they may borrow funds in Explain why unfavorable economic or political conditions affect the
that currency and convert it to their local currency now before the MNC's cash flows, required rate of return, and valuation.
currency's value declines to its proper level. Weak economic conditions or unstable political conditions in a
Speculation by individuals foreign country can reduce cash flows received by the MNC, or they
Individuals can speculate in foreign currencies. can result in a higher required rate of return for the MNC. Either of
The "Carry Trade" these effects results in a lower valuation of the MNC.
Where investors attempt to capitalize on the differential in interest Identify the more obvious risks faced by MNCs that expand
rates between two countries. internationally.
First, there is the risk of poor economic conditions in the foreign
*Impact of appreciation in the investment currency- Increased trade country. Second there is country risk, which reflects the risk of
volume can have a major influence on exchange rate movements over changing government or public attitudes toward the MNC. Third,
a short period. there is exchange rate risk, which can affect the performance of the
MNC in the foreign country.
*Risk of the Carry Trade- Exchange rates may move opposite to what ------------------------------
the investors expected. 1. econ conditions
Chapter 4 Summary
2. country risk (gov. and public)
3. exchange rate risk
Briefly explain how changes in various economic factors affect the
US current account balance.
Each of the economic factors is described, holding other factors
constant.
a. Inflation: A relatively high US inflation rate relative to other
countries can make US goods less attractive to US and non-US
consumers, which results in fewer US exports, more US imports, and
lower (or more negative) current account balance. A relatively low
US inflation rate would have the opposite effect.
b. National income: A relatively high increase in the US national
income (compared with other countries) tends to cause a large
increase in demand for imports and can cause a lower (or more
negative) current account balance. A relatively low increase in the
US national income would have the opposite effect.
c. Exchange rates: A weaker dollar tends to make US products
cheaper to non-US firms and makes non-US products expensive to
US firms. Thus, US exports are expected to increase while US
imports are expected to decrease. However, some conditions can
prevent these effects from occurring. Normally, a stronger dollar
causes US exports to decrease and US imports to increase because it
makes US goods more expensive to non-US firms and makes non-US
goods less expensive to US firms.
d. Government restrictions. When the US government imposes new
barriers on imports, US imports decline, causing the US balance of
trade to increase (or be less negative). When non-US governments
impose new barriers on imports from the US, the US balance of trade
may decrease (or be more negative). When governments remove
trade barriers, the opposite effects are expected.
Explain why US tariffs will not necessarily reduce a US balance-of-
trade deficit.
When the US imposes tariffs on imported goods, foreign countries
may retaliate by imposing tariffs on goods exported by the US. Thus
there is a decline in the US exports that may offset any decline in US
imports.
Explain why a global recession like that in 2008-2009 might
encourage some governments to impose more trade restrictions.
A global recession might cause governments to impose trade
restrictions so that they can protect local firms from intense
competition and prevent additional layoffs within the country.
However, if other countries impose more barriers in retaliation, this
strategy could backfire.
Stetson Bank quotes a bid rate of $.784 for the Australian dollar and
an ask rate of $.80. What is the bid/ask percentage spread?
($.80 - $.784)/$.80 = .02, or 2%
Fullerton Bank quotes an ask rate of $.190 for the Peruvian currency
(new sol) and a bid rate of $.188. Determine the bid/ask percentage
spread?
($.19 - $.188)/$.19 = .0105, or 1.05%
Briefly explain how MNCs can make use of each international
financial market described in this chapter.
Multinational corporations use the spot foreign exchange market to
exchange currencies for immediate delivery. They use the forward
foreign exchange market and the currency futures market to lock in
the exchange rate at which currencies will be exchanged at a future
time. They us the currency options market when they wish to lock in
the maximum (minimum) amount to be paid (received) in the future
currency transactions but maintain flexibility in the event of
favorable exchange rate movements.
Multinational corporations use the Eurocurrency market to engage in
short-term investing or financing and use the Eurocredit market to
engage in medium-term financing. They can obtain long-term
financing by issuing bonds in the Eurobond market or by issuing
stock in the international markets.
Briefly describe how various economic factors can affect the
equilibrium exchange rate of the Japanese yen's value with respect to
that of the dollar.
Economic factors affect the yen's vale as follows.
a. If US inflation is higher than Japanese inflation, then the US
demand for Japanese goods may increase (to avoid the higher US
prices) and the Japanese demand for US goods may decrease (to
avoid the high US prices). Consequently, there is upward pressure on
the value of the yen.
b. If US interest rates increase and exceed Japans interest rates, then
the US demand for Japanese interest-bearing securities may decline
(since US interest-bearing securities are more attractive) while the
Japanese demand for US interest-breaking securities may rise. Both
forces place downward pressure on the yen's value.
c. If US national income increases more than Japanese national
income, then the US demand for Japanese goods may increase more
than the Japanese demand for US goods. Assuming that the change in
national income levels does not affect exchange rates indirectly
through effects on relative interest rates, the forces should place
upward pressure on the yen's value.
d. If government controls reduce the US demand for Japanese goods,
they place downward pressure on the yen's value. If the controls
reduce the Japanese demand for US goods, they place upward
pressure on the yen's value.
The opposite scenarios of those described here would cause the
expected pressure to be in the opposite direction.
A recent shift in the interest rate differential between the US and
Country A had a large effect on the value of Currency A. However,
the same shift in the interest rate differential between the US and
Country B had no effect on the value of Currency B. Explain why the
effects may vary.
The US capital flows with Country A may be larger than US capital
flows with Country B. Therefore, the change in the interest rate
differential has a larger effect on the capital flows with Country A,
causing the exchange rate to change. If the capital flows with Country
B are nonexistent, then interest rate changes do no change the capital
flows and so do not changed the demand and supply conditions in the
foreign exchange market.
Smart Banking Corp. can borrow $5 million at 6 percent annualized.
It can use the proceeds to invest in Canadian dollars at 9 percent
annualized over a 6-day period. The Canadian dollar is worth $.95
and is expected to be worth $.94 in 6 days. Based on this information,
should Smart Banking Corp. borrow US dollars and invest in
Canadian dollars? What would be the gain or loss in US dollars?
a. Borrow $5 million
b. Convert $5 million to C$5,263,158 (based on the spot exchange
rate of $.95 per C$).
c. Invest the C$ at 9 percent annualized, which represents a return
of .15 percent over 6 days, so the C$ received after 6 days is
C$5,271,053 (computed as C$5,263,158 * [1+.015])
d. Convert the C$ received back to US dollars after 6 days:
C$5,271,053 = $4,954,789 (based on anticipated exchange rate of
$.94 per C$ after 6 days).
e. The interest rate owed on the US dollar load is .10 percent over the
6-day period. Thus, the amount owed as a result of the loan is
$5,005,000 [computed as $5,000,000 * (1+.001)].
F. The strategy is expected to cause a gain of $4,954,789 -
$5,005,000 = -$50,211
Chapter 1 Summary
The main goal of an MNC is to maximize shareholder wealth. When
managers are tempted to serve their own interests instead of those of
shareholders, an agency problem exists. MNCs tend to experience
greater agency problems than do domestic firms. Proper incentives
and communication from the parent may help to ensure that
subsidiary managers focus on serving the overall MNC.
International business is justified by three key theories:
1. The theory of comparative advantage suggests that each country
should use its comparative advantage to specialize in its production
and rely on other countries to meet other needs.
2. The imperfect markets theory suggests that because of imperfect
markets, factors of production are immobile, which encourages
countries to specialize based on the resources they have.
3. The product cycle theory suggests that after firms are established
in their home countries, they commonly expand their product
specialization in foreign countries
...
The most common methods by which firms conduct international
business are international trade, licensing, franchising, joint ventures,
acquisitions of foreign firms, and formation of foreign subsidiaries.
Methods such as licensing and franchising involve little capital
investment but distribute some of the profits to other parties. The
acquisition of foreign firms and formation of foreign subsidiaries
require substantial capital investments but offer the potential for large
returns.
...
The valuation model of an MNC shows that the MNC's value is
favorably affected when its expected foreign cash inflows increase,
the currencies denominating those cash inflows increase, or the
MNC's required rate of return decreases. Conversely, the MNC's
value is adversely affected when its expected foreign cash inflows
decrease, the values of currencies denominating those cash flows
decrease (assuming that they have net cash inflows in foreign
currencies), or the MNC's required rate of return increases.
Chapter 2 Summary
The key components of the balance of payments are the current
account and the capital account. Current account - broad measure of
the country's international trade balance. Capital account - measure of
the country's long-term and short-term capital investments.
International trade activity has grown over time. Outsourcing,
subcontracting with a third party in a foreign country for supplies or
services they previously produced themselves, has increased. Thus
increasing international trade activity.
A country's international trade flows are affected by inflation,
national income, government restrictions, and exchange rates.
...
A country's international capital flows are affected by any factors that
influence direct foreign investment or portfolio investment. Direct
foreign investment tends to occur in those countries that have no
restrictions and much potential for economic growth. Portfolio
investment tends to occur in those countries where taxes are not
excessive, where interest rates are high, and where the local
currencies are not expected to weaken.
Several agencies facilitate the international flow of funds by
promoting international trade and finance, providing loans to enhance
global economic development, settling trade disputes between
countries, and promoting global business relationships between
countries.
IMF-
...
International Money Market- less than 1 year
International Credit Market- 1-5 years
International Bond Market- 10 years
bear bonds? coupon bonds?
International Stock Market(equity)- how long is it? sindicated?
*Know Eurobond!
Chapter 3 Summary
The foreign exchange market allows currencies to be exchanged in
order to facilitate international trade or financial transactions.
Commercial banks serve as financial intermediaries in this market. -
1943
The international money markets are composed of several large
banks that accept deposits and provide short-term loans in various
currencies. This market is used primarily by governments and large
corporations.
The international credit markets are composed of the same
commercial banks that serve the international money market. These
banks convert some of the deposits received into loans (for medium-
term periods) to governments and large corporations.
-----------
Smithonian agreement= ineffective.
US went off the gold standard.
Fiat currency- not backed by a commodity
...
The international bond markets facilitate international transfers of
long-term credit, thereby enabling governments and large
corporations to borrow funds from various countries. The
international bond market is facilitated by multinational syndicates of
investment banks that help to place the bonds.
International stock markets enable firms to obtain equity financing in
foreign countries. Thus, these markets help MNCs finance their
international expansion.
...
bid/ask spread- how liquid is the bank with the currency transaction
...
Forward market protects you- allows you to buy or sell a currency in
the future.
Option Contract- option to buy/sell at a certain rate, serves as
insurance
- Call -option to buy
- Put - option to sell