Financial management of multinational firms

Financial Management of Multinational Firms FNGB 7451 MSGF Program Gautam Goswami Graduate School of Business Fordham University BASIC THEME • Multinational Financial Manager’s function • Multinational Financial Management Vs Domestic Financial Management • Examples: - Corporate Finance - Investment Finance - Banking (Financial Intermediation) - International Finance RATIONALE OF THE MULTINATIONAL FIRM • Theory of Comparative Advantage – Example • Economic and business rationale: – Host country’s perspective – Multinational business perspective • Risk management through: - Geographic diversification - Currency diversification INTRODUCTION – Course Overview Foreign Exchange Markets: • Spot, Forward, Futures, Options • Arbitrage, Hedging and Speculation Fundamental Theories in Corporate Finance: - Net Present Value (NPV) - Adjusted Net Present Value - Capital Asset Pricing Model (CAPM) - Cost of Capital (WACC) - Option Pricing Model (OPM) - Capital Structure Theory INTRODUCTION – Course Overview Fundamental Theories in Corporate Finance (Cont.): - Purchasing Power Parity (PPP) - Interest Rate Parity (IRP) - Put-Call Parity (PCP) - Fisher Effect (FE) - Generalized Fisher Effect (GFE) - International Fisher Effect (IFE) INTRODUCTION – Course Overview Financial Management Issues: 3.1 Valuation: - Stock / Bond Valuation - Project Valuation - Cost of Capital 3.2 Working Capital Management - Hedging Foreign Currency Cash-Flows INTRODUCTION – Course Overview 3.3 Measurement and Management of: » Accounting & Economic Exposure » Contractual Exposure (Case: Jaguar Plc.) 3.4 Estimating Cost of Capital for Emerging Market Cash Flows (Case 46 Paginas Amarelas) 3.5 Capital Budgeting and Cross Border Valuation (Case: Wiley International) INTRODUCTION – Course Overview 3.6 International Financing: (Case: Petrolera Zueta (Petrozuata) Euro debt Market Debt Financing Equity Financing 3.7 Valuations for Acquisitions or Large Investments - Evaluating a Joint Venture (Case 47 Continental Cablevision) - Evaluating the Equity in Project Financing (Case: Airbus A3XX) Today’s Trends • Globalization • Deregulation • Innovative Instruments • Technology • Securitization Benchmark Interest Rates • Treasury Rate • Fed Funds Rate • LIBOR • Commercial Paper Rate • Prime Rate THEORIES OF INTERNATIONAL FINANCE IFE STATES: the spot rate adjusts to the interest rate differential between two countries et  eo rh  r f  eo  rf IFE = PPP + FE t et (1  rh )  e0 (1  rf ) t THEORIES OF INTERNATIONAL FINANCE Fisher postulated The nominal interest rate differential should reflect the inflation rate differential Expected rates of return are equal in the absence of government intervention INTEREST RATE PARITY THEORY The Theory states: the forward rate (F) differs from the spot rate (S) at equilibrium by an amount equal to the interest differential ( rh  r f) between two countries INTEREST RATE PARITY THEORY The forward premium or discount equals the interest rate differential (F - S)/S = (rh where  r f) rh = the home rate r f = the foreign rate INTEREST RATE PARITY THEORY In equilibrium, returns on currencies will be the same i e No profit will be realized and interest parity exists which can be written F   rh   S   rf  INTEREST RATE PARITY THEORY • Covered Interest Arbitrage Conditions required: interest rate differential does not equal the forward premium or discount Funds will move to a country with a more attractive rate INTEREST RATE PARITY THEORY Market pressures develop: a As one currency is more demanded spot and sold forward b Inflow of fund depresses interest rates c Parity eventually reached THE RELATIONSHIP BETWEEN THE FORWARD AND THE FUTURE SPOT RATE THE UNBIASED FORWARD RATE A States that if the forward rate is unbiased, then it should reflect the expected future spot rate B Stated as ft = et THE RELATIONSHIP BETWEEN THE FORWARD AND THE FUTURE SPOT RATE Exchange Rate Forecasting: - Using PPP: - Using IFE:  I US Et  E0 1 I f ET  E  RUS (T )  R f (T ) CURRENCY FORECASTING FORECASTING MODELS A Created to forecast exchange rates in addition to parity conditions B Two types of forecast: Market-based Model-based CURRENCY FORECASTING MARKET-BASED FORECASTS: derived from market indicators A The current forward rate contains implicit information about exchange rate changes for one year B Interest rate differentials may be used to predict exchange rates beyond one year CURRENCY FORECASTING MODEL-BASED FORECASTS: include fundamental and technical analysis A B Fundamental relies on key macroeconomic variables and policies which most like affect exchange rates Technical relies on use of Historical volume and price data Charting and trend analysis RATIONALE OF THE MULTINATIONAL FIRM • Rate of Return and Risk – Rate of Return • On common stock of multinational firms • Convenient proxy for international diversification – Risk Management through: • Geographic diversification • Currency diversification WHAT IS GLOBALIZATION? WHAT IS GLOBALIZATION? An ENGLISH princess with an EGYPTIAN boyfriend crashes in a FRENCH tunnel driving a GERMAN car with a DUTCH engine, driven by a BELGIAN driver, who was high on SCOTTISH whiskey, followed closely by ITALIAN Paparazzi, treated by an AMERICAN doctor, using BRAZILIAN medicines, dies! ... THEME • Multinational Financial Manager’s function • Multinational Financial Management Vs Domestic Financial Management • Examples: - Corporate Finance - Investment Finance - Banking (Financial. .. RATIONALE OF THE MULTINATIONAL FIRM • Theory of Comparative Advantage – Example • Economic and business rationale: – Host country’s perspective – Multinational business perspective • Risk management. .. (IFE) INTRODUCTION – Course Overview Financial Management Issues: 3.1 Valuation: - Stock / Bond Valuation - Project Valuation - Cost of Capital 3.2 Working Capital Management - Hedging Foreign Currency