Blades inc case study answers chapter 1

International Financial Management

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International Financial Management 12th Edition

Jeff Madura Florida Atlantic University

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Brief Contents

Preface, xx

About the Author, xxvi

PART 1: The International Financial Environment 1 1 Multinational Financial Management: An Overview 3

2 International Flow of Funds 33

3 International Financial Markets 63

4 Exchange Rate Determination 107

5 Currency Derivatives 135

PART 2: Exchange Rate Behavior 187 6 Government Influence on Exchange Rates 189

7 International Arbitrage and Interest Rate Parity 225

8 Relationships among Inflation, Interest Rates, and Exchange Rates 255

PART 3: Exchange Rate Risk Management 293 9 Forecasting Exchange Rates 295

10 Measuring Exposure to Exchange Rate Fluctuations 323

11 Managing Transaction Exposure 355

12 Managing Economic Exposure and Translation Exposure 393

PART 4: Long-Term Asset and Liability Management 415 13 Direct Foreign Investment 417

14 Multinational Capital Budgeting 435

15 International Corporate Governance and Control 471

16 Country Risk Analysis 497

17 Multinational Capital Structure and Cost of Capital 521

18 Long-Term Debt Financing 545

PART 5: Short-Term Asset and Liability Management 571 19 Financing International Trade 573

20 Short-Term Financing 593

21 International Cash Management 615

Appendix A: Answers to Self-Test Questions 650

Appendix B: Supplemental Cases 663

Appendix C: Using Excel to Conduct Analysis 684

Appendix D: International Investing Project 692

Appendix E: Discussion in the Boardroom 695

Glossary 702 Index 709

vii

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Contents

Preface, xx

About the Author, xxvi

PART 1: The International Financial Environment 1

1: MULTINATIONAL FINANCIAL MANAGEMENT: AN OVERVIEW 3

1-1 Managing the MNC, 3 1-1a How Business Disciplines Are Used to Manage the MNC, 4 1-1b Agency Problems, 4 1-1c Management Structure of an MNC, 6

1-2 Why Firms Pursue International Business, 8 1-2a Theory of Comparative Advantage, 8 1-2b Imperfect Markets Theory, 8 1-2c Product Cycle Theory, 8

1-3 How Firms Engage in International Business, 9 1-3a International Trade, 10 1-3b Licensing, 10 1-3c Franchising, 11 1-3d Joint Ventures, 11 1-3e Acquisitions of Existing Operations, 11 1-3f Establishment of New Foreign Subsidiaries, 11 1-3g Summary of Methods, 12

1-4 Valuation Model for an MNC, 13 1-4a Domestic Model, 13 1-4b Multinational Model, 14 1-4c Uncertainty Surrounding an MNC’s Cash Flows, 16 1-4d Summary of International Effects, 20 1-4e How Uncertainty Affects the MNC’s Cost of Capital, 21

1-5 Organization of the Text, 21

Term Paper on the International Credit Crisis, 31

2: INTERNATIONAL FLOW OF FUNDS 33

2-1 Balance of Payments, 33 2-1a Current Account, 33 2-1b Capital Account, 35 2-1c Financial Account, 36

2-2 Growth in International Trade, 36 2-2a Events That Increased Trade Volume, 37 2-2b Impact of Outsourcing on Trade, 38 2-2c Trade Volume among Countries, 39 2-2d Trend in U.S. Balance of Trade, 41

2-3 Factors Affecting International Trade Flows, 42 2-3a Cost of Labor, 42 2-3b Inflation, 42

ix

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2-3c National Income, 43 2-3d Credit Conditions, 43 2-3e Government Policies, 43 2-3f Exchange Rates, 47

2-4 International Capital Flows, 51 2-4a Factors Affecting Direct Foreign Investment, 51 2-4b Factors Affecting International Portfolio Investment, 52 2-4c Impact of International Capital Flows, 52

2-5 Agencies That Facilitate International Flows, 54 2-5a International Monetary Fund, 54 2-5b World Bank, 55 2-5c World Trade Organization, 56 2-5d International Financial Corporation, 56 2-5e International Development Association, 56 2-5f Bank for International Settlements, 56 2-5g OECD, 57 2-5h Regional Development Agencies, 57

3: INTERNATIONAL FINANCIAL MARKETS 63

3-1 Foreign Exchange Market, 63 3-1a History of Foreign Exchange, 63 3-1b Foreign Exchange Transactions, 64 3-1c Foreign Exchange Quotations, 67 3-1d Interpreting Foreign Exchange Quotations, 69

3-2 International Money Market, 74 3-2a Origins and Development, 75 3-2b Money Market Interest Rates among Currencies, 76

3-3 International Credit Market, 77 3-3a Syndicated Loans in the Credit Market, 78 3-3b Regulations in the Credit Market, 79 3-3c Impact of the Credit Crisis, 80

3-4 International Bond Market, 80 3-4a Eurobond Market, 81 3-4b Development of Other Bond Markets, 82 3-4c Risk of International Bonds, 83 3-4d Impact of the Greek Crisis, 84

3-5 International Stock Markets, 85 3-5a Issuance of Stock in Foreign Markets, 85 3-5b Issuance of Foreign Stock in the United States, 86 3-5c Non-U.S. Firms Listing on U.S. Exchanges, 87 3-5d Investing in Foreign Stock Markets, 88 3-5e How Market Characteristics Vary among Countries, 89 3-5f Integration of Stock Markets, 90 3-5g Integration of International Stock Markets and Credit Markets, 91

3-6 How Financial Markets Serve MNCs, 91

Appendix 3: Investing in International Financial Markets, 99

4: EXCHANGE RATE DETERMINATION 107

4-1 Measuring Exchange Rate Movements, 107 4-2 Exchange Rate Equilibrium, 108

4-2a Demand for a Currency, 109

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4-2b Supply of a Currency for Sale, 110 4-2c Equilibrium, 110 4-2d Change in the Equilibrium Exchange Rate, 111

4-3 Factors That Influence Exchange Rates, 112 4-3a Relative Inflation Rates, 113 4-3b Relative Interest Rates, 114 4-3c Relative Income Levels, 115 4-3d Government Controls, 116 4-3e Expectations, 116 4-3f Interaction of Factors, 117 4-3g Influence of Factors across Multiple Currency Markets, 119 4-3h Impact of Liquidity on Exchange Rate Adjustment, 120

4-4 Movements in Cross Exchange Rates, 120 4-4a Explaining Movements in Cross Exchange Rates, 122

4-5 Capitalizing on Expected Exchange Rate Movements, 122 4-5a Institutional Speculation Based on Expected Appreciation, 122 4-5b Institutional Speculation Based on Expected Depreciation, 123 4-5c Speculation by Individuals, 124 4-5d The “Carry Trade”, 124

5: CURRENCY DERIVATIVES 135

5-1 Forward Market, 135 5-1a How MNCs Use Forward Contracts, 135 5-1b Bank Quotations on Forward Rates, 136 5-1c Premium or Discount on the Forward Rate, 137 5-1d Movements in the Forward Rate over Time, 138 5-1e Offsetting a Forward Contract, 138 5-1f Using Forward Contracts for Swap Transactions, 139 5-1g Non-Deliverable Forward Contracts, 139

5-2 Currency Futures Market, 140 5-2a Contract Specifications, 140 5-2b Trading Currency Futures, 141 5-2c Comparing Futures to Forward Contracts, 142 5-2d Credit Risk of Currency Futures Contracts, 143 5-2e How Firms Use Currency Futures, 143 5-2f Speculation with Currency Futures, 145

5-3 Currency Options Market, 146 5-3a Option Exchanges, 146 5-3b Over-the-Counter Market, 146

5-4 Currency Call Options, 147 5-4a Factors Affecting Currency Call Option Premiums, 147 5-4b How Firms Use Currency Call Options, 148 5-4c Speculating with Currency Call Options, 149

5-5 Currency Put Options, 151 5-5a Factors Affecting Currency Put Option Premiums, 151 5-5b Hedging with Currency Put Options, 152 5-5c Speculating with Currency Put Options, 152 5-5d Contingency Graph for the Purchaser of a Call Option, 154 5-5e Contingency Graph for the Seller of a Call Option, 154 5-5f Contingency Graph for the Buyer of a Put Option, 154 5-5g Contingency Graph for the Seller of a Put Option, 155

Contents xi

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5-5h Conditional Currency Options, 156 5-5i European Currency Options, 157

Appendix 5A: Currency Option Pricing, 168

Appendix 5B: Currency Option Combinations, 172

Part 1 Integrative Problem: The International Financial Environment, 186

PART 2: Exchange Rate Behavior 187

6: GOVERNMENT INFLUENCE ON EXCHANGE RATES 189

6-1 Exchange Rate Systems, 189 6-1a Fixed Exchange Rate System, 189 6-1b Freely Floating Exchange Rate System, 191 6-1c Managed Float Exchange Rate System, 192 6-1d Pegged Exchange Rate System, 193 6-1e Dollarization, 198

6-2 A Single European Currency, 198 6-2a Monetary Policy in the Eurozone, 199 6-2b Impact on Firms in the Eurozone, 199 6-2c Impact on Financial Flows in the Eurozone, 199 6-2d Exposure of Countries within the Eurozone, 200 6-2e Impact of Crises within the Eurozone, 200 6-2f Impact on a Country That Abandons the Euro, 202 6-2g Impact of Abandoning the Euro on Eurozone Conditions, 202

6-3 Government Intervention, 203 6-3a Reasons for Government Intervention, 203 6-3b Direct Intervention, 204 6-3c Indirect Intervention, 207

6-4 Intervention as a Policy Tool, 208 6-4a Influence of a Weak Home Currency, 208 6-4b Influence of a Strong Home Currency, 208

Appendix 6: Government Intervention during the Asian Crisis, 217

7: INTERNATIONAL ARBITRAGE AND INTEREST RATE PARITY 225

7-1 International Arbitrage, 225 7-1a Locational Arbitrage, 225 7-1b Triangular Arbitrage, 227 7-1c Covered Interest Arbitrage, 230 7-1d Comparison of Arbitrage Effects, 234

7-2 Interest Rate Parity (IRP), 234 7-2a Derivation of Interest Rate Parity, 235 7-2b Determining the Forward Premium, 236 7-2c Graphic Analysis of Interest Rate Parity, 238 7-2d How to Test Whether Interest Rate Parity Holds, 240 7-2e Interpretation of Interest Rate Parity, 240 7-2f Does Interest Rate Parity Hold?, 240 7-2g Considerations When Assessing Interest Rate Parity, 241

7-3 Variation in Forward Premiums, 242 7-3a Forward Premiums across Maturities, 242 7-3b Changes in Forward Premiums over Time, 243

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8: RELATIONSHIPS AMONG INFLATION, INTEREST RATES,

AND EXCHANGE RATES 255

8-1 Purchasing Power Parity (PPP), 255 8-1a Interpretations of Purchasing Power Parity, 255 8-1b Rationale behind Relative PPP Theory, 256 8-1c Derivation of Purchasing Power Parity, 256 8-1d Using PPP to Estimate Exchange Rate Effects, 257 8-1e Graphic Analysis of Purchasing Power Parity, 258 8-1f Testing the Purchasing Power Parity Theory, 260 8-1g Why Purchasing Power Parity Does Not Hold, 263

8-2 International Fisher Effect (IFE), 264 8-2a Fisher Effect, 264 8-2b Using the IFE to Predict Exchange Rate Movements, 265 8-2c Implications of the International Fisher Effect, 266 8-2d Derivation of the International Fisher Effect, 267 8-2e Graphical Analysis of the International Fisher Effect, 269

8-3 Tests of the International Fisher Effect, 271 8-3a Limitations of the IFE, 272 8-3b IFE Theory versus Reality, 273

8-4 Comparison of the IRP, PPP, and IFE, 274

Part 2 Integrative Problem: Exchange Rate Behavior, 284

Midterm Self-Exam, 285

PART 3: Exchange Rate Risk Management 293

9: FORECASTING EXCHANGE RATES 295

9-1 Why Firms Forecast Exchange Rates, 295 9-2 Forecasting Techniques, 296

9-2a Technical Forecasting, 296 9-2b Fundamental Forecasting, 298 9-2c Market-Based Forecasting, 302 9-2d Mixed Forecasting, 304 9-2e Guidelines for Implementing a Forecast, 305

9-3 Forecast Error, 306 9-3a Measurement of Forecast Error, 306 9-3b Forecast Errors among Time Horizons, 307 9-3c Forecast Errors over Time Periods, 307 9-3d Forecast Errors among Currencies, 307 9-3e Forecast Bias, 307 9-3f Comparison of Forecasting Methods, 310 9-3g Forecasting under Market Efficiency, 311

9-4 Using Interval Forecasts, 312 9-4a Methods of Forecasting Exchange Rate Volatility, 312

10: MEASURING EXPOSURE TO EXCHANGE RATE FLUCTUATIONS 323

10-1 Relevance of Exchange Rate Risk, 323 10-1a The Investor Hedge Argument, 324 10-1b Currency Diversification Argument, 325 10-1c Stakeholder Diversification Argument, 325 10-1d Response from MNCs, 325

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10-2 Transaction Exposure, 326 10-2a Estimating “Net” Cash Flows in Each Currency, 326 10-2b Exposure of an MNC’s Portfolio, 327 10-2c Transaction Exposure Based on Value at Risk, 331

10-3 Economic Exposure, 335 10-3a Exposure to Local Currency Appreciation, 335 10-3b Exposure to Local Currency Depreciation, 336 10-3c Economic Exposure of Domestic Firms, 337 10-3d Measuring Economic Exposure, 337

10-4 Translation Exposure, 339 10-4a Determinants of Translation Exposure, 340 10-4b Exposure of an MNC’s Stock Price to Translation Effects, 341

11: MANAGING TRANSACTION EXPOSURE 355

11-1 Policies for Hedging Transaction Exposure, 355 11-1a Hedging Most of the Exposure, 355 11-1b Selective Hedging, 355

11-2 Hedging Exposure to Payables, 356 11-2a Forward or Futures Hedge on Payables, 356 11-2b Money Market Hedge on Payables, 357 11-2c Call Option Hedge on Payables, 357 11-2d Comparison of Techniques to Hedge Payables, 360 11-2e Evaluating the Hedge Decision, 363

11-3 Hedging Exposure to Receivables, 363 11-3a Forward or Futures Hedge on Receivables, 363 11-3b Money Market Hedge on Receivables, 364 11-3c Put Option Hedge on Receivables, 364 11-3d Comparison of Techniques for Hedging Receivables, 367 11-3e Evaluating the Hedge Decision, 370 11-3f Summary of Hedging Techniques, 370

11-4 Limitations of Hedging, 371 11-4a Limitation of Hedging an Uncertain Payment, 371 11-4b Limitation of Repeated Short-Term Hedging, 371

11-5 Alternative Hedging Techniques, 373 11-5a Leading and Lagging, 374 11-5b Cross-Hedging, 374 11-5c Currency Diversification, 374

Appendix 11: Nontraditional Hedging Techniques, 388

12: MANAGING ECONOMIC EXPOSURE AND TRANSLATION EXPOSURE 393

12-1 Managing Economic Exposure, 393 12-1a Assessing Economic Exposure, 395 12-1b Restructuring to Reduce Economic Exposure, 396 12-1c Issues Involved in the Restructuring Decision, 398

12-2 A Case of Hedging Economic Exposure, 399 12-2a Savor Co.’s Dilemma, 399 12-2b Possible Strategies for Hedging Economic Exposure, 401 12-2c Savor’s Hedging Strategy, 402 12-2d Limitations of Savor’s Hedging Strategy, 403

12-3 Hedging Exposure to Fixed Assets, 403

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12-4 Managing Translation Exposure, 404 12-4a Hedging with Forward Contracts, 404 12-4b Limitations of Hedging Translation Exposure, 405

Part 3 Integrative Problem: Exchange Risk Management, 413

PART 4: Long-Term Asset and Liability Management 415

13: DIRECT FOREIGN INVESTMENT 417

13-1 Motives for Direct Foreign Investment, 417 13-1a Revenue-Related Motives, 417 13-1b Cost-Related Motives, 418 13-1c Comparing Benefits of DFI among Countries, 420 13-1d Measuring an MNC’s Benefits of DFI, 421

13-2 Benefits of International Diversification, 421 13-2a Diversification Analysis of International Projects, 423 13-2b Diversification among Countries, 424

13-3 Host Government Views of DFI, 425 13-3a Incentives to Encourage DFI, 425 13-3b Barriers to DFI, 427 13-3c Government-Imposed Conditions on Engaging in DFI, 428

14: MULTINATIONAL CAPITAL BUDGETING 435

14-1 Subsidiary versus Parent Perspective, 435 14-1a Tax Differentials, 435 14-1b Restrictions on Remitted Earnings, 436 14-1c Exchange Rate Movements, 436 14-1d Summary of Factors, 436

14-2 Input for Multinational Capital Budgeting, 437 14-3 Multinational Capital Budgeting Example, 439

14-3a Background, 439 14-3b Analysis, 440

14-4 Other Factors to Consider, 441 14-4a Exchange Rate Fluctuations, 442 14-4b Inflation, 445 14-4c Financing Arrangement, 445 14-4d Blocked Funds, 448 14-4e Uncertain Salvage Value, 448 14-4f Impact of Project on Prevailing Cash Flows, 450 14-4g Host Government Incentives, 450 14-4h Real Options, 451

14-5 Adjusting Project Assessment for Risk, 451 14-5a Risk-Adjusted Discount Rate, 451 14-5b Sensitivity Analysis, 452 14-5c Simulation, 452

Appendix 14: Incorporating International Tax Law in Multinational Capital Budgeting, 464

15: INTERNATIONAL CORPORATE GOVERNANCE AND CONTROL 471

15-1 International Corporate Governance, 471 15-1a Governance by Board Members, 471 15-1b Governance by Institutional Investors, 472 15-1c Governance by Shareholder Activists, 472

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15-2 International Corporate Control, 473 15-2a Motives for International Acquisitions, 473 15-2b Trends in International Acquisitions, 474 15-2c Barriers to International Corporate Control, 474 15-2d Model for Valuing a Foreign Target, 475 15-2e Impact of the SOX Act on the Valuation of Targets, 476

15-3 Factors Affecting Target Valuation, 476 15-3a Target-Specific Factors, 477 15-3b Country-Specific Factors, 477

15-4 Example of the Valuation Process, 478 15-4a International Screening Process, 478 15-4b Estimating the Target’s Value, 479 15-4c Changes in Valuation over Time, 481

15-5 Disparity in Foreign Target Valuations, 482 15-5a Expected Cash Flows of the Foreign Target, 482 15-5b Exchange Rate Effects on Remitted Earnings, 483 15-5c Required Return of Acquirer, 483

15-6 Other Corporate Control Decisions, 483 15-6a International Partial Acquisitions, 483 15-6b International Acquisitions of Privatized Businesses, 484 15-6c International Divestitures, 484

15-7 Control Decisions as Real Options, 486 15-7a Call Option on Real Assets, 486 15-7b Put Option on Real Assets, 487

16: COUNTRY RISK ANALYSIS 497

16-1 Country Risk Characteristics, 497 16-1a Political Risk Characteristics, 497 16-1b Financial Risk Characteristics, 499

16-2 Measuring Country Risk, 501 16-2a Techniques for Assessing Country Risk, 501 16-2b Deriving a Country Risk Rating, 502 16-2c Comparing Risk Ratings among Countries, 505

16-3 Incorporating Risk in Capital Budgeting, 505 16-3a Adjustment of the Discount Rate, 505 16-3b Adjustment of the Estimated Cash Flows, 507 16-3c Analysis of Existing Projects, 510

16-4 Preventing Host Government Takeovers, 510 16-4a Use a Short-Term Horizon, 510 16-4b Rely on Unique Supplies or Technology, 511 16-4c Hire Local Labor, 511 16-4d Borrow Local Funds, 511 16-4e Purchase Insurance, 511 16-4f Use Project Finance, 511

17: MULTINATIONAL CAPITAL STRUCTURE AND COST OF CAPITAL 521

17-1 Components of Capital, 521 17-1a External Sources of Debt, 522 17-1b External Sources of Equity, 523

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17-2 The MNC’s Capital Structure Decision, 524 17-2a Influence of Corporate Characteristics, 524 17-2b Influence of Host Country Characteristics, 525 17-2c Response to Changing Country Characteristics, 526

17-3 Subsidiary versus Parent Capital Structure Decisions, 526 17-3a Impact of Increased Subsidiary Debt Financing, 527 17-3b Impact of Reduced Subsidiary Debt Financing, 527 17-3c Limitations in Offsetting a Subsidiary’s Leverage, 527

17-4 Multinational Cost of Capital, 527 17-4a MNC’s Cost of Debt, 527 17-4b MNC’s Cost of Equity, 528 17-4c Estimating an MNC’s Cost of Capital, 528 17-4d Comparing Costs of Debt and Equity, 528 17-4e Cost of Capital for MNCs versus Domestic Firms, 529 17-4f Cost-of-Equity Comparison Using the CAPM, 531

17-5 Cost of Capital across Countries, 533 17-5a Country Differences in the Cost of Debt, 533 17-5b Country Differences in the Cost of Equity, 535

18: LONG-TERM DEBT FINANCING 545

18-1 Financing to Match the Inflow Currency, 545 18-1a Using Currency Swaps to Execute the Matching Strategy, 546 18-1b Using Parallel Loans to Execute the Matching Strategy, 547

18-2 Debt Denomination Decision by Subsidiaries, 550 18-2a Debt Decision in Host Countries with High Interest Rates, 551 18-2b Debt Denomination to Finance a Project, 554

18-3 Debt Maturity Decision, 556 18-3a Assessment of the Yield Curve, 556 18-3b Financing Costs of Loans with Different Maturities, 556

18-4 Fixed versus Floating Rate Debt Decision, 557 18-4a Financing Costs of Fixed versus Floating Rate Loans, 558 18-4b Hedging Interest Payments with Interest Rate Swaps, 558

Part 4 Integrative Problem: Long-Term Asset and Liability Management, 569

PART 5: Short-Term Asset and Liability Management 571

19: FINANCING INTERNATIONAL TRADE 573

19-1 Payment Methods for International Trade, 573 19-1a Prepayment, 573 19-1b Letters of Credit, 574 19-1c Drafts, 574 19-1d Consignment, 575 19-1e Open Account, 575 19-1f Impact of the Credit Crisis on Payment Methods, 575

19-2 Trade Finance Methods, 576 19-2a Accounts Receivable Financing, 576 19-2b Factoring, 576 19-2c Letters of Credit (L/Cs), 577 19-2d Banker’s Acceptances, 581 19-2e Working Capital Financing, 583

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19-2f Medium-Term Capital Goods Financing (Forfaiting), 584 19-2g Countertrade, 584

19-3 Agencies That Facilitate International Trade, 585 19-3a Export-Import Bank of the United States, 585 19-3b Private Export Funding Corporation, 587 19-3c Overseas Private Investment Corporation, 587

20: SHORT-TERM FINANCING 593

20-1 Sources of Foreign Financing, 593 20-1a Internal Short-Term Financing, 593 20-1b External Short-Term Financing, 594 20-1c Access to Funding during the Credit Crisis, 594

20-2 Financing with a Foreign Currency, 594 20-2a Comparison of Interest Rates among Currencies, 595

20-3 Determining the Effective Financing Rate, 596 20-4 Criteria Considered in the Financing Decision, 597

20-4a Interest Rate Parity, 597 20-4b The Forward Rate as a Forecast, 598 20-4c Exchange Rate Forecasts, 599

20-5 Actual Results from Foreign Financing, 601 20-6 Financing with a Portfolio of Currencies, 603

20-6a Portfolio Diversification Effects, 605 20-6b Repeated Financing with a Currency Portfolio, 606

21: INTERNATIONAL CASH MANAGEMENT 615

21-1 Multinational Working Capital Management, 615 21-1a Subsidiary Expenses, 615 21-1b Subsidiary Revenue, 616 21-1c Subsidiary Dividend Payments, 616 21-1d Subsidiary Liquidity Management, 616

21-2 Centralized Cash Management, 617 21-2a Accommodating Cash Shortages, 618

21-3 Optimizing Cash Flows, 618 21-3a Accelerating Cash Inflows, 618 21-3b Minimizing Currency Conversion Costs, 619 21-3c Managing Blocked Funds, 621 21-3d Managing Intersubsidiary Cash Transfers, 621 21-3e Complications in Optimizing Cash Flow, 621

21-4 Investing Excess Cash, 622 21-4a Determining the Effective Yield, 622 21-4b Implications of Interest Rate Parity, 624 21-4c Using the Forward Rate as a Forecast, 624 21-4d Using Exchange Rate Forecasts, 626 21-4e Diversifying Cash across Currencies, 628 21-4f Dynamic Hedging, 629

Appendix 21: Investing in a Portfolio of Currencies, 635

Part 5 Integrative Problem: Short-Term Asset and Liability Management, 639

Final Self-Exam, 641

xviii Contents

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Appendix A: Answers to Self-Test Questions, 650

Appendix B: Supplemental Cases, 663

Appendix C: Using Excel to Conduct Analysis, 684

Appendix D: International Investing Project, 692

Appendix E: Discussion in the Boardroom, 695

Glossary, 702

Index, 709

Contents xix

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Preface

Businesses evolve into multinational corporations (MNCs) so that they can capitalize on international opportunities. Their financial managers must be able to assess the interna- tional environment, recognize opportunities, implement strategies, assess exposure to risk, and manage that risk. The MNCs most capable of responding to changes in the international financial environment will be rewarded. The same can be said for the students today who may become the future managers of MNCs.

INTENDED MARKET International Financial Management, 12th Edition, presumes an understanding of basic corporate finance. It is suitable for both undergraduate and master’s level courses in in- ternational financial management. For master’s courses, the more challenging questions, problems, and cases in each chapter are recommended, along with special projects.

ORGANIZATION OF THE TEXT International Financial Management, 12th Edition, is organized to provide a background on the international environment and then to focus on the managerial aspects from a corporate perspective. Managers of MNCs will need to understand the environment before they can manage within it.

The first two parts of the text establish the necessary macroeconomic framework. Part 1 (Chapters 1 through 5) introduces the major markets that facilitate international business. Part 2 (Chapters 6 through 8) describes relationships between exchange rates and economic variables and explains the forces that influence these relationships.

The rest of the text develops a microeconomic framework with a focus on the mana- gerial aspects of international financial management. Part 3 (Chapters 9 through 12) ex- plains the measurement and management of exchange rate risk. Part 4 (Chapters 13 through 18) describes the management of long-term assets and liabilities, including motives for direct foreign investment, multinational capital budgeting, country risk anal- ysis, and capital structure decisions. Part 5 (Chapters 19 through 21) concentrates on the MNC’s management of short-term assets and liabilities, including trade financing, other short-term financing, and international cash management.

Each chapter is self-contained so that professors can use classroom time to focus on the more comprehensive topics while relying on the text to cover other concepts. The manage- ment of long-term assets (Chapters 13 through 16 on direct foreign investment, multina- tional capital budgeting, multinational restructuring, and country risk analysis) is covered before the management of long-term liabilities (Chapters 17 and 18 on capital structure and debt financing) because the financing decisions depend on the investment decisions. Nevertheless, these concepts are explained with an emphasis on how the management of long-term assets and long-term liabilities is integrated. For example, multinational capital budgeting analysis demonstrates how the feasibility of a foreign project may depend on the financing mix. Some professors may prefer to teach the chapters on managing long-term liabilities prior to teaching the chapters on managing long-term assets.

The strategic aspects, such as motives for direct foreign investment, are covered before the operational aspects, such as short-term financing or investment. For professors who

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prefer to cover the MNC’s management of short-term assets and liabilities before the management of long-term assets and liabilities, the parts can be rearranged because they are self-contained.

Professors may limit their coverage of chapters in some sections where they believe the text concepts are covered by other courses or do not need additional attention beyond what is in the text. For example, they may give less attention to the chapters in Part 2 (Chapters 6 through 8) if their students take a course in international economics. If professors focus on the main principles, they may limit their coverage of Chapters 5, 15, 16, and 18. In addition, they may give less attention to Chapters 19 through 21 if they believe that the text description does not require elaboration.

APPROACH OF THE TEXT International Financial Management, 12th Edition, focuses on management decisions that maximize the value of the firm. The text offers a variety of methods to reinforce key concepts so that instructors can select the methods and features that best fit their teaching styles.

■ Part-Opening Diagram. A diagram is provided at the beginning of each part to illustrate how the key concepts covered in that part are related.

■ Objectives. A bulleted list at the beginning of each chapter identifies the key concepts in that chapter.

■ Examples. The key concepts are thoroughly described in the chapter and supported by examples.

■ International Credit Crisis. Coverage of the international credit crisis is provided in each chapter where applicable; this coverage focuses on European countries that have experienced problems in making their debt payments and on the exposure of their banks to credit problems.

■ Term Paper on the International Credit Crisis. Suggested assignments for a term paper on the international credit crisis are provided at the end of Chapter 1.

■ Web Links. Websites that offer useful related information regarding key concepts are provided in each chapter.

■ Summary. A bulleted list at the end of each chapter summarizes the key concepts. This list corresponds to the list of objectives at the beginning of the chapter.

■ Point/Counter-Point. A controversial issue is introduced, along with opposing arguments, and students are asked to determine which argument is correct and to explain why.

■ Self-Test Questions. A “Self-Test” at the end of each chapter challenges students on the key concepts. The answers to these questions are provided in Appendix A.

■ Questions and Applications. Many of the questions and other applications at the end of each chapter test the student’s knowledge of the key concepts in the chapter.

■ Continuing Case. At the end of each chapter, the continuing case allows students to use the key concepts to solve problems experienced by a firm called Blades, Inc. (a producer of roller blades). By working on cases related to the same MNC over a school term, students recognize how an MNC’s decisions are integrated.

■ Small Business Dilemma. The Small Business Dilemma at the end of each chapter places students in a position where they must use concepts introduced in the chap- ter to make decisions about a small MNC called Sports Exports Company.

■ Internet/Excel Exercises. At the end of each chapter, there are exercises that expose the students to applicable information available at various Web sites, enable the ap- plication of Excel to related topics, or a combination of these. For example, students

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learn how to obtain exchange rate information online and apply Excel to measure the value at risk.

■ Integrative Problem. An integrative problem at the end of each part integrates the key concepts of chapters within that part.

■ Midterm and Final Examinations. A midterm self-exam is provided at the end of Chapter 8, which focuses on international macro and market conditions (Chapters 1 through 8). A final self-exam is provided at the end of Chapter 21, which focuses on the managerial chapters (Chapters 9 through 21). Students can compare their answers to those in the answer key provided.

■ Supplemental Cases. Supplemental cases allow students to apply chapter concepts to a specific situation of an MNC. All supplemental cases are located in Appendix B.

■ Running Your Own MNC. This project allows each student to create a small inter- national business and apply key concepts from each chapter to run the business throughout the school term. The project is available in the textbook companion site (see the “Online Resources” section).

■ International Investing Project. Located in Appendix D, this project allows students to simulate investing in stocks of MNCs and foreign companies and requires them to assess how the values of these stocks change during the school term in response to international economic conditions. The project is also available on the textbook companion site (see the “Online Resources” section).

■ Discussion in the Boardroom. Located in Appendix E, this project allows students to play the role of managers or board members of a small MNC that they created and to make decisions about that firm. This project is also available on the textbook companion site (see the “Online Resources” section).

■ The variety of end-of-chapter and end-of-part exercises and cases offer many opportunities for students to engage in teamwork, decision making, and communication.

ONLINE RESOURCES The textbook companion site provides resources for both students and instructors.

Students: Access the following resources by going to www.cengagebrain.com and searching ISBN 9781133947837: Running Your Own MNC, International Investing Project, Discussion in the Boardroom, Key Terms Flashcards, and chapter Web links.

Instructors: Access textbook resources by going to www.cengage.com, logging in with your faculty account username and password, and using ISBN 9781133947837 to search for instructor resources or to add instructor resources to your account.

INSTRUCTOR SUPPLEMENTS The following supplements are available to instructors.

■ Instructor’s Manual. Revised by the author, the Instructor’s Manual contains the chapter theme, topics to stimulate class discussion, and answers to end-of-chapter Questions, Case Problems, Continuing Cases (Blades, Inc.), Small Business Dilem- mas, Integrative Problems, and Supplemental Cases.

■ Test Bank. The expanded test bank, which has also been revised by the author, contains a large set of questions in multiple choice or true/false format, including content questions as well as problems.

■ Cognero™ Test Bank. Cengage Learning Testing Powered by Cognero™ is a flexible online system that allows you to: author, edit, and manage test bank content from

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multiple Cengage Learning solutions; create multiple test versions in an instant; deliver tests from your LMS, your classroom, or wherever you want. The Cognero™ Test Bank contains the same questions that are in the Microsoft® Word Test Bank. All question content is now tagged according to Tier I (Business Program Interdis- ciplinary Learning Outcomes) and Tier II (Finance-specific) standards topic, Bloom’s Taxonomy, and difficulty level.

■ PowerPoint Slides. The PowerPoint Slides clarify content and provide a solid guide for student note-taking. In addition to the regular notes slides, a separate set of exhibit-only PPTs are also available.

ADDITIONAL COURSE TOOLS ■ Cengage Learning Custom Solutions. Whether you need print, digital, or hybrid

course materials, Cengage Learning Custom Solutions can help you create your perfect learning solution. Draw from Cengage Learning’s extensive library of texts and collections, add your own original work, and/or create customized media and technology to match your learning and course objectives. Our editorial team will work with you through each step, allowing you to concentrate on the most impor- tant thing—your students. Learn more about all our services at www.cengage.com/ custom.

■ The Cengage Global Economic Watch (GEW) Resource Center. This is your source for turning today’s challenges into tomorrow’s solutions. This online portal houses the most current and up-to-date content concerning the economic crisis. Organized by discipline, the GEW Resource Center offers the solutions that in- structors and students need in an easy-to-use format. Included are an overview and timeline of the historical events leading up to the crisis, links to the latest news and resources, discussion and testing content, an instructor feedback forum, and a Global Issues Database. Visit www.cengage.com/thewatch for more information.

ACKNOWLEDGMENTS Many of the revisions and expanded sections contained in this edition are due to com- ments and suggestions from students who used previous editions. In addition, many pro- fessors reviewed various editions of the text and had a major influence on its content and organization. All are acknowledged below in alphabetical order.

Tom Adamson, Midland University Raj Aggarwal, University of Akron Richard Ajayi, University of Central

Florida Alan Alford, Northeastern University Yasser Alhenawi, University of Evansville H. David Arnold, Auburn University Robert Aubey, University of Wisconsin Bruce D. Bagamery, Central Washington

University James C. Baker, Kent State University Gurudutt Baliga, University of Delaware Laurence J. Belcher, Stetson University Richard Benedetto, Merrimack College Bharat B. Bhalla, Fairfield University Rahul Bishnoi, Hofstra University

P. R. Chandy, University of North Texas Prakash L. Dheeriya, California State

University – Dominguez Hills Benjamin Dow, Southeast Missouri State

University Margaret M. Forster, University of Notre

Dame Lorraine Gilbertson, Webster University Charmaine Glegg, East Carolina University Anthony Yanxiang Gu, SUNY – Geneseo Anthony F. Herbst, Suffolk University Chris Hughen, University of Denver Abu Jalal, Suffolk University Steve A. Johnson, University of Texas –

El Paso Manuel L. Jose, University of Akron

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Dr. Joan C. Junkus, DePaul University Rauv Kalra, Morehead State University Ho-Sang Kang, University of Texas –

Dallas Mohamamd A. Karim, University

of Texas – El Paso Frederick J. Kelly, Seton Hall University Robert Kemp, University of Virginia Coleman S. Kendall, University

of Illinois – Chicago Dara Khambata, American University Chong-Uk Kim, Sonoma State University Doseong Kim, University of Akron Elinda F. Kiss, University of Maryland Thomas J. Kopp, Siena College Suresh Krishman, Pennsylvania State

University Merouane Lakehal-Ayat, St. John Fisher

College Duong Le, University of Arkansas – Little

Rock Boyden E. Lee, New Mexico State

University Jeong W. Lee, University of North Dakota Michael Justin Lee, University of Maryland Sukhun Lee, Loyola University – Chicago Richard Lindgren, Graceland University Charmen Loh, Rider University Carl Luft, DePaul University Ed Luzine, Union Graduate College K. Christopher Ma, KCM Investment Co. Davinder K. Malhotra, Philadelphia

University Richard D. Marcus, University

of Wisconsin – Milwaukee Anna D. Martin, St. Johns University Leslie Mathis, University of Memphis Ike Mathur, Southern Illinois University Wendell McCulloch Jr., California State

University – Long Beach Carl McGowan, University of Michigan –

Flint Fraser McHaffie, Marietta College Edward T. Merkel, Troy University Stuart Michelson, Stetson University Scott Miller, Pepperdine University Jose Francisco Moreno, University of the

Incarnate Word Penelope E. Nall, Gardner-Webb University Duc Anh Ngo, University of Texas – El

Paso

Srinivas Nippani, Texas A&M University Andy Noll, St. Catherine University Vivian Okere, Providence College Edward Omberg, San Diego State

University Prasad Padmanabhan, San Diego State

University Ali M. Parhizgari, Florida International

University Anne Perry, American University Rose M. Prasad, Central Michigan

University Larry Prather, East Tennessee State

University Abe Qastin, Lakeland College Frances A. Quinn, Merrimack College Mitchell Ratner, Rider University David Rayome, Northern Michigan

University S. Ghon Rhee, University of Rhode Island William J. Rieber, Butler University Mohammad Robbani, Alabama A&M

University Ashok Robin, Rochester Institute of

Technology Alicia Rodriguez de Rubio, University of

the Incarnate Word Tom Rosengarth, Westminster College Atul K. Saxena, Georgia Gwinnett College Kevin Scanlon, University of Notre Dame Michael Scarlatos, CUNY – Brooklyn

College Jeff Schultz, Christian Brothers University Jacobus T. Severiens, Kent State University Vivek Sharma, University of Michigan –

Dearborn Peter Sharp, California State University –

Sacramento Dilip K. Shome, Virginia Tech University Joseph Singer, University of Missouri –

Kansas City Naim Sipra, University of Colorado –

Denver Jacky So, Southern Illinois University –

Edwardsville Luc Soenen, California Polytechnic State

University – San Luis Obispo Ahmad Sohrabian, California State Poly-

technic University – Pomona Carolyn Spencer, Dowling College Angelo Tarallo, Ramapo College

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Amir Tavakkol, Kansas State University G. Rodney Thompson, Virginia Tech Stephen G. Timme, Georgia State

University Daniel L. Tompkins, Niagara University Niranjan Tripathy, University of North

Texas Eric Tsai, Temple University Joe Chieh-chung Ueng, University of St.

Thomas Mo Vaziri, California State University Mahmoud S. Wahab, University of

Hartford Ralph C. Walter III, Northeastern Illinois

University Hong Wan, SUNY – Oswego

Elizabeth Webbink, Rutgers University Ann Marie Whyte, University of Central

Florida Marilyn Wiley, University of North Texas Rohan Williamson, Georgetown

University Larry Wolken, Texas A&M University Glenda Wong, De Paul University Shengxiong Wu, Indiana University – South J. Jimmy Yang, Oregon State University Bend Mike Yarmuth, Sullivan University Yeomin Yoon, Seton Hall University David Zalewski, Providence College Emilio Zarruk, Florida Atlantic University Stephen Zera, California State University –

San Marcos

Many of my friends and colleagues offered useful suggestions for this edition, including Kevin Brady (Florida Atlantic University), Kien Cao (Foreign Trade University), Inga Chira (Oregon State University), Jeff Coy (University of Central Florida), Sean Davis (University of North Florida), Ken Johnson (Florida International University), Marek Marciniak (West Chester University), Thanh Ngo (University of Texas – Pan American), Arjan Premti (Florida Atlantic University), Nivine Richie (University of North Carolina – Wilmington), Garrett Smith (Florida Atlantic University), Jurica Susnjara (Canadian University of Dubai), and Nik Volkov (Florida Atlantic University). In addition, this edition also benefited from the input of many people I have met outside the United States who have been willing to share their views about international financial management.

I appreciate the help and support from the people at Cengage Learning, including Clara Goosman (Product Manager), Mike Reynolds (Executive Product Manager), Heather Mooney (Marketing Manager), Kendra Brown (Content Developer), Adele Scholtz (Senior Product Assistant), and Chris Walz (Marketing Coordinator). Special thanks are due to Scott Dillon and Tamborah Moore (Senior Content Project Managers) and Matt Darnell (Copyeditor) for their efforts to ensure a quality final product.

Jeff Madura Florida Atlantic University

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About the Author

Dr. Jeff Madura is presently the SunTrust Bank Professor of Finance at Florida Atlantic University. He has written several successful finance texts, including Financial Markets and Institutions. His research on international finance has been published in numerous journals, including Journal of Financial and Quantitative Analysis; Journal of Money, Credit and Banking; Journal of International Money and Finance; Financial Management; Journal of Financial Research; Financial Review; Journal of International Financial Markets, Institutions, and Money; Global Finance Journal; International Review of Financial Analysis; and Journal of Multinational Financial Management. Dr. Madura has received multiple awards for excellence in teaching and research, and he has served as a consultant for international banks, securities firms, and other multinational corporations. He earned his B.S. and M.A. from Northern Illinois University and his D.B.A. from Florida State University. Dr. Madura has served as a director for the Southern Finance Association and the Eastern Finance Association, and he is also former president of the Southern Finance Association.

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Product Markets

Foreign Exchange Markets

Subsidiaries International

Financial Markets

Investing and FinancinggnitropmI dna gnitropxE

Dividend Remittance

and Financing

Multinational Corporation (MNC)

PART 1

The International Financial Environment

Part 1 (Chapters 1 through 5) provides an overview of the multinational corporation (MNC) and the environment in which it operates. Chapter 1 explains the goals of the MNC, along with the motives and risks of international business. Chapter 2 describes the international flow of funds between countries. Chapter 3 describes the international financial markets and how these markets facilitate ongoing operations. Chapter 4 explains how exchange rates are determined, and Chapter 5 provides background on the currency futures and options markets. Managers of MNCs must understand the international environment described in these chapters in order to make proper decisions.

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Copyright 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.

1 Multinational Financial Management: An Overview

Multinational corporations (MNCs) are defined as firms that engage in some form of international business. Their managers conduct international financial management, which involves international investing and financing decisions that are intended to maximize the value of the MNC. The goal of these managers is to maximize their firm’s value, which is the same goal pursued by managers employed by strictly domestic companies.

Initially, firms may merely attempt to export products to a certain country or import supplies from a foreign manufacturer. Over time, however, many of these firms recognize additional foreign opportunities and eventually establish subsidiaries in foreign countries. Dow Chemical, IBM, Nike, and many other firms have more than half of their assets in foreign countries. Some businesses, such as ExxonMobil, Fortune Brands, and Colgate- Palmolive, commonly generate more than half of their sales in foreign countries. It is typical also for smaller U.S. firms to generate more than 20 percent of their sales in foreign markets; examples include Ferro (Ohio) and Medtronic (Minnesota). Seventy-five percent of U.S. firms that export have fewer than 100 employees.

International financial management is important even to companies that have no international business. The reason is that these companies must recognize how their foreign competitors will be influenced by movements in exchange rates, foreign interest rates, labor costs, and inflation. Such economic characteristics can affect the foreign competitors’ costs of production and pricing policies.

This chapter provides background on the goals, motives, and valuation of a multinational corporation.

1-1 MANAGING THE MNC The commonly accepted goal of an MNC is to maximize shareholder wealth. Managers em- ployed by the MNC are expected to make decisions that will maximize the stock price and thereby serve the shareholders’ interests. Some publicly traded MNCs based outside the United States may have additional goals, such as satisfying their respective governments,