International Corporate Finance - GBV

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VH- fin-niii' : V - " - ' -:InternationalCorporate Finance10TH EDITIONJEFF MADURAFlorida Atlantic University SOUTH-WESTERR 10CENGAGE Learning"Australia Brazil Japan Korea Mexico Singapore Spain United Kingdom United States

iffiftiftS.:ContentsPreface, xxvAbout the Author, xxxiPART 1: The International Financial Environment11: MULTINATIONAL FINANCIAL MANAGEMENT: AN OVERVIEW3Managing the MNC, 3Facing Agency Problems, 4Governance: How SOX Improved Corporate Governance of MNCs, 5Management Structure of an MNC, 6Why Firms Pursue International Business, 6Theory of Comparative Advantage, 6Imperfect Markets Theory, 8Product Cycle Theory, 8How Firms Engage in International Business, 8International Trade, 9Licensing, 10Franchising, 10Joint Ventures, 10Acquisitions of Existing Operations, 10Establishing New Foreign Subsidiaries, 11Summary of Methods, 11I\Valuation Model for an MNC, 13Domestic Model, 13Valuing International Cash Flows, 13Uncertainty Surrounding an MNCs Cash Flows, 15Uncertainty of an MNCs Cost of Capital, 17Organization of the Text, 17Summary, 18Point Counter-Point: Should an MNC Reduce Its Ethical Standards to CompeteInternationally? 18Self-Test, 19Questions and Applications, 19Advanced Questions, 20Discussion in the Boardroom, 22Running Your Own MNC, 22Blades, Inc. Case: Decision to Expand Internationally, 23Small Business Dilemma: Developing a Multinational SportingGoods Corporation, 24Internet/Excel Exercises, 25References, 25Term Paper on the International Credit Crisis, 26

x Contents2: INTERNATIONAL FLOW OF FUNDS27Balance of Payments, 27Current Account, 27Capital and Financial Accounts, 28International Trade Flows, 30Distribution of U.S. Exports and Imports, 30U.S. Balance-of-Trade Trend, 32International Trade Issues, 34Events That Increased International Trade, 34Trade Friction, 36Governance: Managerial Decision about Outsourcing, 37Factors Affecting International Trade Flows, 39Impact of Inflation, 39Impact of National Income, 39Impact of Government Policies, 39Impact of Exchange Rates, 40Interaction of Factors, 41Correcting a Balance-of-Trade Deficit, 41Limitations of a Weak Home Currency Solution, 41International Capital Flows, 43Distribution ofDFI by U.S. Firms, 44Distribution of DFI in the United States, 44Factors Affecting DFI, 44Factors Affecting International Portfolio Investment, 45Impact of International Capital Flows, 45Agencies That Facilitate International Flows, 47International Monetary Fund, 47World Bank, 48!World Trade Organization, 48 International Financial Corporation, 48International Development Association, 49Bank for International Settlements, 49OECD, 49Regional Development Agencies, 49How Trade Affects an MNCs Value, 49Summary, 50Point Counter-Point: Should Trade Restrictions Be Used to Influence Human Rights Issues? 50Self-Test, 50Questions and Applications, 51Advanced Questions, 51Discussion in the Boardroom, 51Running Your Own MNC, 51Blades, Inc. Case: Exposure to International Flow of Funds, 52Small Business Dilemma: Identifying Factors That Will Affect the Foreign Demand at theSports Exports Company, 52Internet/Excel Exercises, 53References, 533: INTERNATIONAL FINANCIAL MARKETSForeign Exchange Market, 55History of Foreign Exchange, 55Foreign Exchange Transactions, 5655

Contents xiForeign Exchange Quotations, 58Interpreting Foreign Exchange Quotations, 61Forward, Futures, and Options Markets, 64International Money Market, 65Origins and Development, 66Money Market Interest Rates among Currencies, 67Standardizing Global Bank Regulations, 68International Credit Market, 69Syndicated Loans, 69Impact of the Credit Crisis on the Credit Market, 70International Bond Market, 70Eurobond Market, 70Development of Other Bond Markets, 72International Stock Markets, 72Issuance of Stock in Foreign Markets, 72Issuance of Foreign Stock in the United States, 73Listing of Non-U.S. Firms on U.S. Stock Exchanges, 75Governance: Effect of Sarbanes-Oxley Act on Foreign Stock Listings, 75Investing in Foreign Stock Markets, 75Governance: How Stock Market Characteristics Vary among Countries, 76How Financial Markets Serve MNCs, 78Summary, 79Point Counter-Point: Should Firms That Go Public Engage in International Listings? 79Self-Test, 80Questions and Applications, 80Advanced Questions, 81Discussion in the Boardroom, 82Running Your Own MNC, 82Blades, Inc. Case: Decisions to Use International Financial Markets, 82Small Business Dilemma: Use of the Foreign Exchange Markets by the Sports ExportsCompany, 83Internet/Excel Exercises, 83References, 84Appendix 3: Investing in International Financial Markets, 854: EXCHANGE RATE DETERMINATIONMeasuring Exchange Rate Movements, 95Exchange Rate Equilibrium, 96Demand for a Currency, 97Supply of a Currency for Sale, 97Equilibrium, 98Factors That Influence Exchange Rates, 99Relative Inflation Rates, 100Relative Interest Rates, 101Relative Income Levels, 102Government Controls, 102Expectations, 103Interaction of Factors, 104Influence of Factors across Multiple Currency Markets, 105Movements in Cross Exchange Rates, 106Explaining Movements in Cross Exchange Rates, 10795

xii ContentsAnticipation of Exchange Rate Movements, 107Bank Speculation Based on Expected Appreciation, 107Bank Speculation Based on Expected Depreciation, 108Speculation by Individuals, 109Summary, 110Point Counter-Point: How Can Persistently Weak Currencies Be Stabilized? 110Self-Test, 111Questions and Applications, 111Advanced Questions, 112Discussion in the Boardoom, 114Running Your Own MNC, 114Blades, Inc. Case: Assessment of Future Exchange Rate Movements, 114Small Business Dilemma: Assessment by the Sports Exports Company of Factors That Affectthe British Pound's Value, 115Internet/Excel Exercises, 116References, 1165: CURRENCY DERIVATIVESForward Market, 117How MNCs Use Forward Contracts, 117Non-Deliverable Forward Contracts, 120Currency Futures Market, 121Contract Specifications, 122Trading Currency Futures, 123Trading Platforms for Currency Futures, 123Comparison to Forward Contracts, 123Pricing Currency Futures, 124Credit Risk of Currency Futures Contracts, 125\How Firms Use Currency Futures, 125'Closing Out a Futures Position, 125Speculation with Currency Futures, 126Currency Options Market, 127Option Exchanges, 127Over-the-Counter Market, 128Currency Call Options, 128Factors Affecting Currency Call Option Premiums, 129How Firms Use Currency Call Options, 129Speculating with Currency Call Options, 130Currency Put Options, 133Factors Affecting Currency Put Option Premiums, 133Hedging with Currency Put Options, 134Speculating with Currency Put Options, 134Contingency Graphs for Currency Options, 136Contingency Graph for a Purchaser of a Call Option, 136Contingency Graph for a Seller of a Call Option, 136Contingency Graph for a Buyer of a Put Option, 136Contingency Graph for a Seller of a Put Option, 137Conditional Currency Options, 138European Currency Options, 139Summary, 140Point Counter-Point: Should Speculators Use Currency Futures or Options? 140117

Contents xiiiSelf-Test, 140Questions and Applications, 141Advanced Questions, 144Discussion in the Boardroom, 147Running Your Own MNC, 147Blades, Inc. Case: Use of Currency Derivative Instruments, 147Small Business Dilemma: Use of Currency Futures and Options by the Sports ExportsCompany, 148Internet/Excel Exercises, 149References, 149Appendix 5A: Currency Option Pricing, 150Appendix 5B: Currency Option Combinations, 154Part 1 Integrative Problem: The International Financial Environment, 167PART 2 : Exchange Rate Behavior6: GOVERNMENT INFLUENCE ON EXCHANGE RATES169171Exchange Rate Systems, 171Fixed Exchange Rate System, 171Freely Floating Exchange Rate System, 173Managed Float Exchange Rate System, 174Pegged Exchange Rate System, 175Dollarization, 178Classification of Exchange Rate Arrangements, 179A Single European Currency, 180Impact on European Monetary Policy, 180Impact on the Valuation of Businesses in Europe}. 180Impact on Financial Flows, 181"*Impact on Exchange Rate Risk, 181Status Report on the Euro, 181Government Intervention, 182Reasons for Government Intervention, 182Direct Intervention, 183Indirect Intervention, 185Intervention as a Policy Tool, 186Influence of a Weak Home Currency, 186Influence of a Strong Home Currency, 186Summary, 188Point Counter-Point: Should China Be Forced to Alter the Value of Its Currency? 188Self-Test, 189Questions and Applications, 189Advanced Questions, 190Discussion in the Boardroom, 191Running Your Own MNC, 191Blades, Inc. Case: Assessment of Government Influence on Exchange Rates, 192Small Business Dilemma: Assessment of Central Bank Intervention by the Sports ExportsCompany, 193Internet/Excel Exercises, 193References, 193Appendix 6: Government Intervention during the Asian Crisis, 194

xiv Contents7: INTERNATIONAL ARBITRAGE AND INTEREST RATE PARITY2O3International Arbitrage, 203Locational Arbitrage, 203Triangular Arbitrage, 205Covered Interest Arbitrage, 208Comparison of Arbitrage Effects, 212Interest Rate Parity (IRP), 213Derivation of Interest Rate Parity, 214Determining the Forward Premium, 215Graphic Analysis of Interest Rate Parity, 216How to Test Whether Interest Rate Parity Exists, 218Interpretation of Interest Rate Parity, 219Does Interest Rate Parity Hold? 219Considerations When Assessing Interest Rate Parity, 219Forward Premiums across Maturity Markets, 220Changes in Forward Premiums, 221Summary, 223Point Counter-Point: Does Arbitrage Destabilize Foreign Exchange Markets? 224Self-Test, 224Questions and Applications, 225Advanced Questions, 227Discussion in the Boardroom, 230Running Your Own MNC, 230Blades, Inc. Case: Assessment of Potential Arbitrage Opportunities, 230Small Business Dilemma: Assessment of Prevailing Spot and Forward Rates by the SportsExports Company, 231Internet/Excel Exercise, 231References, 232!\8: RELATIONSHIPS AMONG INFLATION, INTEREST RATES,AND EXCHANGE RATES233Purchasing Power Parity (PPP), 233Interpretations, of Purchasing Power Parity, 233Rationale behind Relative PPP Theory, 234Derivation of Purchasing Power Parity, 234Using PPP to Estimate Exchange Rate Effects, 235Graphic Analysis of Purchasing Power Parity, 236Testing the Purchasing Power Parity Theory, 238Why Purchasing Power Parity Does Not Occur, 241Purchasing Power Parity in the Long Run, 242International Fisher Effect (IFE), 243Implications of the' International Fisher Effect, 244Implications of the IFE for Foreign Investors, 244Derivation of the International Fisher Effect, 246Graphic Analysis of the International Fisher Effect, 248Tests of the International Fisher Effect, 249Does the International Fisher Effect Hold? 251Comparison of the IRP, PPP, and IFE, 252Summary, 253Point Counter-Point: Does PPP Eliminate Concerns about Long-Term Exchange Rate Risk? 253Self-Test, 254

Contents xvQuestions and Applications, 254Advanced Questions, 256Discussion in the Boardroom, 259Running Your Own MNC, 259Blades, Inc. Case: Assessment of Purchasing Power Parity, 259Small Business Dilemma: Assessment of the IFE by the Sports Exports Company, 260Internet/Excel Exercises, 260References, 260Part 2 Integrative Problem: Exchange Rate Behavior, 262Midterm Self-Exam, 263PART 3 : Exchange Rate Risk Management2719: FORECASTING EXCHANGE RATES273Why Firms Forecast Exchange Rates, 273Forecasting Techniques, 274Technical Forecasting, 274Fundamental Forecasting, 276Market-Based Forecasting, 280Mixed Forecasting, 283Reliance on Forecasting Services, 284Governance of Forecasting Techniques Used, 284Forecast Error, 284Measurement of Forecast Error, 284Forecast Errors among Time Horizons, 285Forecast Errors over Time Periods, 285Forecast Errors among Currencies, 286Forecast Bias, 287yGraphic Evaluation of Forecast Performance, 288Comparison of Forecasting Methods, 290Forecasting under Market Efficiency, 291Using Interval Forecasts, 292Methods of Forecasting Exchange Rate Volatility, 293Summary, 294Point Counter-Point: Which Exchange Rate Forecast Technique Should MNCs Use? 294Self-Test, 294Questions and Applications, 295Advanced Questions, 296Discussion in the Boardroom, 299Running Your Own MNC, 299Blades, Inc. Case: Forecasting Exchange Rates, 299Small Business Dilemma: Exchange Rate Forecasting by the Sports Exports Company, 300Internet/Excel Exercises, 301References, 3011O: MEASURING EXPOSURE TO EXCHANGE RATE FLUCTUATIONSRelevance of Exchange Rate Risk, 303The Investor Hedge Argument, 303Currency Diversification Argument, 304Stakeholder Diversification Argument, 304Response from MNCs, 3043O3

xvi ContentsTransaction Exposure, 305Estimating "Net" Cash Flows in Each Currency, 305Exposure of an MNCs Portfolio, 307Transaction Exposure Based on Value at Risk, 309Economic Exposure, 313Exposure to Local Currency Appreciation, 314Exposure to Local Currency Depreciation, 315Economic Exposure of Domestic Firms, 315Measuring Economic Exposure, 316Translation Exposure, 318Does Translation Exposure Matter? 318Determinants of Translation Exposure, 319Examples of Translation Exposure, 320Summary, 320Point Counter-Point: Should Investors Care about an MNCs Translation Exposure? 321Self-Test, 321Questions and Applications, 322Advanced Questions, 323Discussion in the Boardroom, 328Running Your Own MNC, 328Blades, Inc. Case: Assessment of Exchange Rate Exposure, 328Small Business Dilemma: Assessment of Exchange Rate Exposure by the Sports ExportsCompany, 330Internet/Excel Exercises, 330References, 33111: MANAGING TRANSACTION EXPOSUREHedging Exposure to Payables, 333Forward or Futures Hedge on Payables, 333Money Market Hedge on Payables, 334Call Option Hedge on Payables, 335Summary of Techniques to Hedge Payables, 337Optimal Technique for Hedging Payables, 337Optimal Hedge versus No Hedge on Payables, 338Evaluating the Hedge Decision, 340Hedging Exposure to Receivables, 340Forward or Futures Hedge on Receivables, 341Money Market Hedge on Receivables, 341Put Option Hedge on Receivables, 341Optimal Technique for Hedging Receivables, 344Optimal Hedge versus No Hedge, 345Evaluating the Hedge Decision, 347Comparison of Hedging Techniques, 348Hedging Policies of MNCs, 348Selective Hedging, 348Limitations of Hedging, 349Limitation of Hedging an Uncertain Amount, 349Limitation of Repeated Short-Term Hedging, 350Hedging Long-Term Transaction Exposure, 352Long-Term Forward Contract, 352Parallel Loan, 352333Iy

Contents xviiAlternative Hedging Techniques, 352Leading and Lagging, 353Cross-Hedging, 353Currency Diversification, 353Summary, 354Point Counter-Point: Should an MNC Risk Overhedging? 354Self-Test, 355Questions and Applications, 355Advanced Questions, 358Discussion in the Boardroom, 363Running Your Own MNC, 363Blades, Inc. Case: Management of Transaction Exposure, 363Small Business Dilemma: Hedging Decisions by the Sports Exports Company, 365Internet/Excel Exercises, 365References, 366Appendix 11: Nontraditional Hedging Techniques, 36712: MANAGING ECONOMIC EXPOSURE AND TRANSLATIONEXPOSUREManaging Economic Exposure, 373Assessing Economic Exposure, 374Restructuring to Reduce Economic Exposure, 375Issues Involved in the Restructuring Decision, 378A Case Study on Hedging Economic Exposure, 379Savor Co.'s Dilemma, 379Assessment of Economic Exposure, 380Assessment of Each Unit's Exposure, 380Identifying the Source of the Unit's Exposure, 381\Possible Strategies to Hedge Economic Exposure, 381Savor's Hedging Solution, 383Limitations of Savor's Optimal Hedging Strategy, 383Hedging Exposure to Fixed Assets, 383Managing Translation Exposure, 384Hedging with Forward Contracts, 385Limitations of Hedging Translation Exposure, 385Governance: Governing the Hedge of Translation Exposure, 386Summary, 386Point Counter-Point: Can an MNC Reduce the Impact of TranslationExposure by Communicating? 387Self-Test, 387Questions and Applications, 388Advanced Questions, 388Discussion in the Boardroom, 390Running Your Own MNC, 390Blades, Inc. Case: Assessment of Economic Exposure, 390Small Business Dilemma: Hedging the Sports Exports Company's Economic Exposureto Exchange Rate Risk, 391Internet/Excel Exercises, 392References, 392Part 3 Integrative Problem: Exchange Rate Risk Management, 393373

xviii ContentsPART 4 : Long-Term Asset and Liability Management 39513: DIRECT FOREIGN INVESTMENT397Motives for Direct Foreign Investment, 397Revenue-Related Motives, 397Cost-Related Motives, 398Governance: Selfish Managerial Motives for DFI, 400Comparing Benefits of DFI among Countries, 400Comparing Benefits of DFI over Time, 401Benefits of International Diversification, 402Diversification Analysis of International Projects, 404Diversification among Countries, 406Host Government Views of DFI, 407Incentives to Encourage DFI, 407Barriers to DFI, 407Government-Imposed Conditions to Engage in DFI, 408Summary, 409Point Counter-Point: Should MNCs Avoid DFI in Countries with LiberalChild Labor Laws? 409Self-Test, 409Questions and Applications, 410Advanced Questions, 411Discussion in the Boardroom, 411Running Your Own MNC, 411Blades, Inc. Case: Consideration of Direct Foreign Investment, 412Small Business Dilemma: Direct Foreign Investment Decision by theSports Exports Company, 413 Internet/Excel Exercises, 413\References, 41414: MULTINATIONAL CAPITAL BUDGETINGSubsidiary versus Parent Perspective, 415Tax Differentials, 415Restricted Remittances, 415Excessive Remittances, 416Exchange Rate Movements, 416Summary of Factors, 416Input for Multinational Capital Budgeting, 417Multinational Capital Budgeting Example, 419Background, 419Analysis, 420Other Factors to Consider, 422Exchange Rate Fluctuations, 423Inflation, 425Financing Arrangement, 425Blocked Funds, 428Uncertain Salvage Value, 429Impact of Project on Prevailing Cash Flows, 430Host Government Incentives, 430Real Options, 431415

Contents xixAdjusting Project Assessment for Risk, 431Risk-Adjusted Discount Rate, 431Sensitivity Analysis, 432Governance: Managerial Controls over the Use of Sensitivity Analysis, 432Simulation, 432Summary, 433Point Counter-Point: Should MNCs Use Forward Rates to Estimate DollarCash Flows of Foreign Projects? 434Self-Test, 434Questions and Applications, 434Advanced Questions, 437Discussion in the Boardroom, 440Running Your Own MNC, 440Blades, Inc. Case: Decision by Blades, Inc., to Invest in Thailand, 440Small Business Dilemma: Multinational Capital Budgeting by theSports Exports Company, 442Internet/Excel Exercises, 442References, 442Appendix 14: Incorporating International Tax Law in MultinationalCapital Budgeting, 44315: INTERNATIONAL CORPORATE GOVERNANCE AND CONTROLInternational Corporate Governance, 451Governance by Board Members, 451Governance by Institutional Investors, 452Governance by Shareholder Activists, 452International Corporate Control, 452iMotives for International Acquisitions, 453\Trends in International Acquisitions, 453Barriers to International Corporate Control, 454Model for Valuing a Foreign Target, 454Factors Affecting Target Valuation, 456Target-Specific Factors, 456Country-Specific Factors, 457Example of the Valuation Process, 458International Screening Process, 458Estimating the Target's Value, 459Changes in Valuation over Time, 461Disparity in Foreign Target Valuations, 462Estimated Cash Flows of the Foreign Target, 462Exchange Rate Effects on the Funds Remitted, 463Required Return of Acquirer, 463Other Corporate Control Decisions, 463International Partial Acquisitions, 463International Acquisitions of Privatized Businesses, 464International Divestitures, 464Control Decisions as Real Options, 465Call Option on Real Assets, 466Put Option on Real Assets, 466Summary, 467451

xx ContentsPoint Counter-Point: Can a Foreign Target Be Assessed Like Any Other Asset? 467Self-Test, 468Questions and Applications, 468Advanced Questions, 469Discussion in the Boardroom, 472Running Your Own MNC, 472Blades, Inc. Case: Assessment of an Acquisition in Thailand, 472Small Business Dilemma: Multinational Restructuring by the SportsExports Compan

Blades, Inc. Case: Decisions to Use International Financial Markets, 82 Small Business Dilemma: Use of the Foreign Exchange Markets by the Sports Exports Company, 83 Internet/Excel Exercises, 83 References, 84 Appendix 3: Investing in International Financial Markets, 85 4: EXCHANGE RATE DETERMINATION 95 Measuring Exchange Rate Movements, 95

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