Multinational Financial Management

Dr. Alan C. Shapiro is the Ivadelle and Theodore Johnson Professor of Banking and Finance. Prior to joining USC in 1978, he was an Assistant Professor at the Wharton School of the University of Pennsylvania (1971-1978). He has also been a Visiting Professor at Yale University, UCLA, the Stockholm School of Economics, University of British Columbia, and the U.S. Naval Academy. His specialties are corporate and international financial management.

PREFACE III

Part I Environment of International Financial Management 1

1 INTRODUCTION: MULTINATIONAL ENTERPRISE AND MULTINATIONAL FINANCIAL MANAGEMENT 2

Learning Objectives 2

Key Terms 2

1.1 The Rise of the Multinational Corporation 4

1.2 The Internationalization of Business and Finance 26

1.3 Multinational Financial Management: Theory and Practice 42

1.4 Outline of the Book 49

Questions 51

Web Resources 51

Web Exercises 52

Appendix 1A: The Origins and Consequences of International Trade 53

The Gains from Trade 53

Specialized Factors of Production 54

Monetary Prices and Exchange Rates 55

Tariffs 55

Questions 56

2 THE DETERMINATION OF EXCHANGE RATES 57

Learning Objectives 57

Key Terms 57

2.1 Setting the Equilibrium Spot Exchange Rate 58

2.2 Expectations and the Asset Market Model of Exchange Rates 65

2.3 The Fundamentals of Central Bank Intervention 82

2.4 The Equilibrium Approach to Exchange Rates 91

2.5 Summary and Conclusions 95

Questions 95

Problems 97

Web Resources 97

Web Exercises 98

Bibliography 98

3 THE INTERNATIONAL MONETARY SYSTEM 99

Learning Objectives 99

Key Terms 99

3.1 Alternative Exchange Rate Systems 100

3.2 A Brief History of the International Monetary System 105

3.3 The European Monetary System and Monetary Union 121

3.4 Emerging Market Currency Crises 135

3.5 Summary and Conclusions 138

Questions 139

Problems 140

Web Resources 141

Web Exercises 141

Bibliography 141

4 PARITY CONDITIONS IN INTERNATIONAL FINANCE AND CURRENCY FORECASTING 142

Learning Objectives 142

Key Terms 142

4.1 Arbitrage and the Law of One Price 143

4.2 Purchasing Power Parity 147

4.3 The Fisher Effect 158

4.4 The International Fisher Effect 166

4.5 Interest Rate Parity Theory 169

4.6 The Relationship Between the Forward Rate and the Future Spot Rate 175

4.7 Currency Forecasting 179

4.8 Summary and Conclusions 186

Questions 188

Problems 189

Web Resources 190

Web Exercises 191

Bibliography 191

5 THE BALANCE OF PAYMENTS AND INTERNATIONAL ECONOMIC LINKAGES 193

Learning Objectives 193

Key Terms 193

5.1 Balance-of-Payments Categories 194

5.2 The International Flow of Goods, Services, and Capital 200

5.3 Coping With the Current-Account Deficit 211

5.4 Summary and Conclusions 222

Questions 223

Problems 224

Web Resources 225

Web Exercises 225

6 COUNTRY RISK ANALYSIS 226

Learning Objectives 226

Key Terms 226

6.1 Measuring Political Risk 227

6.2 Economic and Political Factors Underlying Country Risk 239

6.3 Country Risk Analysis in International Banking 256

6.4 Summary and Conclusions 260

Questions 260

Problems 261

Web Resources 262

Web Exercises 262

Bibliography 262

Part II Foreign Exchange and Derivatives Markets 263

7 THE FOREIGN EXCHANGE MARKET 264

Learning Objectives 264

Key Terms 264

7.1 Organization of The Foreign Exchange Market 265

7.2 The Spot Market 273

7.3 The Forward Market 283

7.4 Summary and Conclusions 289

Questions 289

Problems 290

Web Resources 290

Web Exercises 291

Bibliography 291

8 CURRENCY FUTURES AND OPTIONS MARKETS 292

Learning Objectives 292

Key Terms 292

8.1 Futures Contracts 293

8.2 Currency Options 299

8.4 Summary and Conclusions 320

Questions 320

Problems 320

Web Resources 321

Web Exercises 322

Bibliography 322

Appendix 8A: Option Pricing Using Black-Scholes 322

Implied Volatilities 323

Shortcomings of the Black-Scholes Option Pricing Model 324

Problems 325

Appendix 8B: Put-Call Option Interest Rate Parity 325

Problems 327

9 SWAPS AND INTEREST RATE DERIVATIVES 328

Learning Objectives 328

Key Terms 328

9.1 Interest Rate and Currency Swaps 329

9.2 Interest Rate Forwards and Futures 342

9.3 Structured Notes 346

9.4 Summary and Conclusions 349

Questions 350

Problems 350

Web Resources 351

Web Exercises 352

Bibliography 352

Part III Foreign Exchange Risk Management 353

10 MEASURING AND MANAGING TRANSLATION AND TRANSACTION EXPOSURE 354

Learning Objectives 354

Key Terms 354

10.1 Alternative Measures of Foreign Exchange Exposure 355

10.2 Alternative Currency Translation Methods 357

10.3 Transaction Exposure 359

10.4 Designing a Hedging Strategy 362

10.5 Managing Translation Exposure 372

10.6 Managing Transaction Exposure 374

10.7 Summary and Conclusions 393

Questions 394

Problems 395

Web Resources 397

Web Exercises 398

Bibliography 398

Appendix 10A: Statement of Financial Accounting Standards No. 52 398

Application of FASB No. 52 401

11 MEASURING AND MANAGING ECONOMIC EXPOSURE 403

Learning Objectives 403

Key Terms 403

11.1 Foreign Exchange Risk and Economic Exposure 404

11.2 The Economic Consequences of Exchange Rate Changes 412

11.3 Identifying Economic Exposure 417

11.4 Calculating Economic Exposure 420

11.5 An Operational Measure of Exchange Risk 425

11.6 Managing Operating Exposure 427

11.7 Summary and Conclusions 444

Questions 444

Problems 445

Web Resources 447

Web Exercises 447

Bibliography 448

Part IV Financing the Multinational Corporation 449

12 INTERNATIONAL FINANCING AND NATIONAL CAPITAL MARKETS 450

Learning Objectives 450

Key Terms 450

12.1 Corporate Sources and Uses of Funds 451

12.2 National Capital Markets as International Financial Centers 459

12.3 Development Banks 477

12.4 Project Finance 482

12.5 Summary and Conclusions 483

Questions 484

Problems 484

Web Resources 484

Web Exercises 485

Bibliography 485

13 THE EUROMARKETS 486

Learning Objectives 486

Key Terms 486

13.1 The Eurocurrency Market 486

13.2 Eurobonds 494

13.3 Note Issuance Facilities and Euronotes 502

13.4 Euro-Commercial Paper 506

13.5 The Asiacurrency Market 508

13.6 Summary and Conclusions 509

Questions 509

Problems 509

Web Resources 510

Web Exercises 510

Bibliography 510

14 THE COST OF CAPITAL FOR FOREIGN INVESTMENTS 511

Learning Objectives 511

Key Terms 511

14.1 The Cost of Equity Capital 512

14.2 The Weighted Average Cost of Capital for Foreign Projects 513

14.3 Discount Rates for Foreign Investments 515

14.4 The Cost of Debt Capital 526

14.5 Establishing a Worldwide Capital Structure 528

14.6 Valuing Low-Cost Financing Opportunities 535

14.7 Summary and Conclusions 541

Questions 542

Problems 543

Web Resources 544

Web Exercises 544

Bibliography 544

Part V Foreign Investment Analysis 547

15 INTERNATIONAL PORTFOLIO INVESTMENT 548

Learning Objectives 548

Key Terms 548

15.1 The Risks and Benefits of International Equity Investing 549

15.2 International Bond Investing 569

15.3 Optimal International Asset Allocation 569

15.4 Measuring the Total Return from Foreign Portfolio Investing 570

15.5 Measuring Exchange Risk on Foreign Securities 572

15.6 Summary and Conclusions 574

Questions 574

Problems 575

Web Resources 576

Web Exercises 576

Bibliography 577

16 CORPORATE STRATEGY AND FOREIGN DIRECT INVESTMENT 578

Learning Objectives 578

Key Terms 578

Product and Factor Market Imperfections 579

Financial Market Imperfections 580

16.1 Theory of the Multinational Corporation 579

16.2 The Strategy of Multinational Enterprise 581

16.3 Designing a Global Expansion Strategy 591

16.4 Summary and Conclusions 595

Questions 596

Problems 597

Web Resources 597

Web Exercises 598

Bibliography 598

17 CAPITAL BUDGETING FOR THEMULTINATIONAL CORPORATION 599

Learning Objectives 599

Key Terms 599

17.1 Basics of Capital Budgeting 600

17.2 Issues in Foreign Investment Analysis 607

17.3 Foreign Project Appraisal: The Case of International Diesel Corporation 611

17.4 Political Risk Analysis 621

17.5 Growth Options and Project Evaluation 623

17.6 Summary and Conclusions 627

Questions 627

Problems 628

Web Resources 629

Web Exercises 629

Bibliography 629

Appendix 17A: Managing Political Risk 629

Preinvestment Planning 630

Operating Policies 631

Part VI Multinational Working Capital Management 635

18 FINANCING FOREIGN TRADE 636

Learning Objectives 636

Key Terms 636

18.1 Payment Terms in International Trade 637

18.2 Documents in International Trade 648

18.3 Financing Techniques in International Trade 650

18.4 Government Sources of Export Financing and Credit Insurance 654

18.5 Countertrade 660

18.6 Summary and Conclusions 663

Questions 664

Problems 664

Web Resources 665

Web Exercises 665

Bibliography 665

19 CURRENT ASSET MANAGEMENT AND SHORT-TERM FINANCING 666

Learning Objectives 666

Key Terms 666

19.1 International Cash Management 667

19.2 Accounts Receivable Management 683

19.3 Inventory Management 684

19.4 Short-Term Financing 686

19.5 Summary and Conclusions 697

Questions 698

Problems 699

Web Resources 700

Web Exercises 700

Bibliography 700

20 MANAGING THE MULTINATIONAL FINANCIAL SYSTEM 701

Learning Objectives 701

Key Terms 701

20.1 The Value of the Multinational Financial System 702

20.2 Intercompany Fund-Flow Mechanisms: Costs and Benefits 706

20.3 Designing a Global Remittance Policy 726

20.4 Summary and Conclusions 730

Questions 731

Problems 731

Web Resources 732

Web Exercises 732

Bibliography 733

GLOSSARY 735

INDEX 751