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Multinational Finance Sixth Edition

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Fundamentals of

Multinational Finance Sixth Edition

MICHAEL H. MOFFETT Thunderbird School of Global Management at Arizona State University

ARTHUR I. STONEHILL Oregon State University and University of Hawaii at Manoa

DAVID K. EITEMAN University of California, Los Angeles

New York, NY

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Copyright © 2018, 2015, 2012 by Pearson Education, Inc. or its affiliates. All Rights Reserved. Manufactured in the United States of America. This publication is protected by copyright, and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photo- copying, recording, or otherwise. For information regarding permissions, request forms, and the appropriate contacts within the Pearson Education Global Rights and Permissions department, please visit www.pearsoned.com/permissions/.

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Library of Congress Cataloging-in-Publication Data

Names: Moffett, Michael H., author. | Stonehill, Arthur I., author. | Eiteman, David K., author. Title: Fundamentals of multinational finance / Michael Moffett, Arthur Stonehill, David Eiteman. Description: 6th edition. | New York, NY : Pearson, [2017] Identifiers: LCCN 2017014647 | ISBN 9780134472133 Subjects: LCSH: International business enterprises—Finance. | International finance. | Foreign exchange. Classification: LCC HG4027.5 .M64 2017 | DDC 332/.042—dc23 LC record available at https://lccn.loc.gov/2017014647

ISBN 10: 0-13-447213-6 ISBN 13: 978-0-13-447213-3

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Preface The subject of this book is the financial management of multinational enterprises (MNEs)— multinational financial management. MNEs are firms—both for-profit companies and not- for-profit organizations—that have operations in more than one country and conduct their business through branches, foreign subsidiaries, or joint ventures with host country firms.

Fundamentals of Multinational Finance, Sixth Edition, reflects the juxtaposed forces of an increasingly digital global marketplace and a resurgence of nationalist culture and identity. Financial forces, markets, and management are in many ways at the crux of this challenge. This edition has been revised to reflect a business world trying to find a new balance between new business startups like the micro-multinational, a maturing China, a separatist Britain (Brexit), and an attempt by governments globally to channel, regulate (and tax) multinational firms that continue to grow in stature and strength. The book focuses on the challenges faced in multinational financial management—with three points of emphasis.

■■ Organizations. Multinational enterprises (MNEs) applies to organizations of all kinds— the publicly traded, the privately held, the state-run, the state-owned organizations—all forms that permeate global business today. Who owns and operates the organization alters its goals and therefore its management.

■■ Markets. Country players in the emerging world are rapidly taking their place as both producers and consumers on an equal basis with the industrial countries and their tradi- tional corporate components. Although they may still be categorized as emerging, they are the economic drivers and primary challenges for global finance and global financial management.

■■ Leadership. Individuals in positions of leadership within these organizations and markets are faced with a changing global landscape in which emerging market finance is no longer on the outer edge of financial management, but moving to its core. These leaders of MNEs face numerous foreign exchange and political risks that are actually more volatile, with global capital moving in and out of countries at an ever-increasing rate.

These risks can be daunting but they also present opportunities for creating value if prop- erly understood and managed. In the end, the primary question is whether business leaders are able to integrate the global strategic and financial challenges that business faces.

New in the Sixth Edition Our primary challenge with the Sixth Edition is to strike a balance between our growing success with the Fifth Edition and the relevant and exacting recommendations by selected reviewers—the innovator’s dilemma. Surveys of adopters were extremely useful in this revision, and a number of specific developments included.

■■ . All chapters are structured around a series of pedagogical Learning Objectives aligned with the platform for Fundamentals of Multinational Finance’s teaching.

■■ Interest Rate Risk and Swaps. A new chapter has been introduced that details the various interest rate risks of the MNE and the practical use of interest rate and cross–currency swaps.

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■■ The Impossible Trinity. A core international financial principle, the Impossible Trinity’s use as a unifying theoretical link across multiple subjects and chapters has been expanded.

■■ The Foreign Exchange Market and Digital Trade. New material in this edition explores in depth how the changing structure of the global foreign exchange market—trading, com- munication, and settlement—is posing challenges for private players and public regulators and overseers.

■■ International Taxation. Integrally linked to a world of digital commerce, multina- tional tax management continues to rise in its significance in multinational financial management. We have greatly expanded our coverage of this truly critical financial man- agement topic.

■■ Political Risk and Financial Losses. The chapter on foreign direct investment and political risk has been revised to reflect the growing use of restrictions on convertibility, transfer- ability, and the possibility of repudiation or expropriation.

■■ New and Edgier Mini-Cases. Eleven of the 18 Mini-Cases are completely new to the Sixth Edition, and explore many of the edgier debates rising between global business, social policy, and corporate social responsibility. Topics include Argentine debt and vulture investors, Apple’s global profit positioning and tax structure, Brexit and its potential impact on Rolls-Royce, Volkswagen’s governance structure and its defeat device “ strategy,” political risk in Kazakhstan’s oil and gas industry, and crowdfunding startups in Kenya, to name but a few.

■■ Expanded Quantitative Applications. We have worked diligently to increase the quantita- tive elements across subjects and chapters to push students to explore the depth of analysis and comprehension.

■■ End-of-Chapter Assessment. Questions and Problems are revised throughout and aligned with .

Fundamentals of Multinational Finance, Sixth Edition, however, retains and revises con- tinuing forces of change as seen in the growing dominance of China’s economy and currency, the disruptive financial forces of quantitative easing and near-zero interest rates, and the chal- lenge of the multinational firm to navigate foreign exchange risks.

International finance is a subject of sophistication, constant change, yet rich in history. We have tried to bridge the traditional business practices with digital practices with a mix of currency notations and symbols throughout the book, using both the common three-letter cur- rency codes—USD, CNY, EUR—with the traditional currency symbols—$, ¥, £, €—which are seeing a resurgence as countries like Russia and Turkey have introduced new “currency identities” of their own.

Audience Fundamentals of Multinational Finance, Sixth Edition, is aimed at university-level courses in international financial management, international business finance, international finance, and similar titles. It can be used at either the undergraduate or graduate level as well as in executive education and corporate learning courses.

A prerequisite course or experience in corporate finance or financial management would be ideal. However, we review the basic finance concepts before we extend them to the

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multinational case. We also review the basic concepts of international economics and inter- national business.

We recognize the fact that a large number of our potential adopters live outside of the United States and Canada. Therefore, we utilize a significant number of non-U.S. examples, Mini-Cases, and Global Finance in Practice examples seen in the business and news press (anecdotes and illustrations).

Organization Fundamentals of Multinational Finance, Sixth Edition, has been redesigned and restruc- tured for tightness—critical elements of the field but in a much shorter delivery framework. This has been accomplished by integrating a number of previous topics along financial management threads. The book is in five parts, the parts unified by the common thread of the globalization process by which a firm moves from a domestic to a multinational busi- ness orientation.

■■ Part 1 introduces the global financial environment ■■ Part 2 explains foreign exchange theory and markets ■■ Part 3 explores foreign exchange rate exposure ■■ Part 4 details the financing of the global firm ■■ Part 5 analyzes international investment decisions

Pedagogical Tools To make Fundamentals of Multinational Finance, Sixth Edition, as comprehensible as possible, we use a large number of proven pedagogical tools. Again, our efforts have been informed by the detailed reviews and suggestions of a panel of professors who are recognized individually for excellence in the field of international finance, particularly at the undergraduate level. Among these pedagogical tools are the following:

■■ A student–friendly writing style combined with a structured presentation of material, begin- ning with learning objectives for each chapter, and ending with a summarization of how those learning objectives were realized.

■■ A wealth of illustrations and exhibits to provide a visual parallel to the concepts and content presented. The entire book utilizes a multicolor presentation which we believe provides a visual attractiveness that contributes significantly to reader attention and retention.

■■ A running case on a hypothetical U.S.-based firm, Trident Corporation, provides a cohesive framework for the multifaceted globalization process, and is reinforced in several end-of- chapter problems.

■■ A Mini-Case at the end of each chapter illustrates the chapter content and extends it to the multinational financial business environment. And as noted, 11 of the 18 are new to the Sixth Edition.

■■ Global Finance in Practice boxes in every chapter to illuminate the theory with accounts of actual business practices. These applications extend the concepts without adding to the length of the text itself.

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■■ Every chapter has a number of end of chapter exercises requiring the use of the Internet, while a variety of Internet references are dispersed throughout the chapters in text and exhibits.

■■ A multitude of end-of-chapter Questions and Problems, which assess the students’ under- standing of the course material. All end-of-chapter Problems are solved using spreadsheet solutions. Selected end-of-chapter Problem answers are now included at the back of the book.

A Rich Array of Support Materials A robust package of materials for both instructor and student accompanies the text to facili- tate learning and to support teaching and testing.

■■ . Fundamentals of Multnational Finance, Sixth Edition, is now available with . , a fully integrated homework and tutorial system, solves one of

the biggest teaching problems in finance courses: providing students with unlimited practice homework problems along with a structured blueprint for studying the material.

offers:

■■ Textbook problems online ■■ Algorithmically generated values for more practice ■■ Partial credit ■■ Personalized study plans ■■ Extra help for students ■■ Online gradebook

End-of-chapter Questions and Problems that provide assessment and practice oppor- tunities are available in . Internet exercises, glossary flash cards, and Web links are also available in .

■■ Online Instructor’s Manual. The Online Instructor’s Manual, prepared by the authors with assistance from Shannon Donovan at Bridgewater State University, contains complete answers to all end-of-chapter Questions, Problems, and chapter Mini-Cases. All quantitative end-of-chapter Problems are solved using spreadsheets, which are also available online.

■■ Online Test Bank. The Online Test Bank, revised by Brian Nethercutt, contains over 1,200 multiple-choice and short-essay questions. The multiple-choice questions are labeled by topic and by category— recognition, conceptual, and analytical types.

■■ Computerized Test Bank. The Test Bank is also available in Pearson Education’s Test- Gen Software. Fully networkable, it is available for Windows and Macintosh. TestGen-EQ’s graphical interface enables instructors to view, edit, and add questions; transfer questions to tests; and print different forms of tests. Search-and-sort features enable the instructor to locate questions quickly and arrange them in a preferred order. The TestGen plug-in auto- matically grades the exams, stores the results on a disk, and allows the instructor to view and print a variety of reports.

■■ Online Mini-Case PowerPoint Presentations. Each of the 18 Mini-Cases has a stand-alone PowerPoint presentation available online.

■■ Online PowerPoint Presentation Slides. The extensive set of PowerPoint slides provides lecture outlines and selected graphics from the text for each chapter.

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■■ Web Site. A dedicated Web site at www.pearsonhighered.com/moffett contains selected solutions and spreadsheets for end-of-chapter Problems and other bonus material.

All of the teaching resources are available online for download at the Instructor Resource Center at www.pearsonhighered.com/irc.

International Editions Fundamentals of Multinational Finance and Multinational Business Finance have been used throughout the world to teach students of international finance. Our books are published in a number of foreign languages including Chinese, French, Spanish, Indonesian, Portuguese, and Ukrainian.

Acknowledgments The authors are very thankful for the many detailed reviews of previous editions and sug- gestions from a number of colleagues. The final version of Fundamentals of Multinational Finance, Sixth Edition, reflects most of the suggestions provided by these reviewers. The survey reviewers were anonymous, but the detailed reviewers were:

Dev Prasad, University of Massachusetts Lowell Anand M. Vijh, University of Iowa, Tippie College of Business Yoon S. Shin, Loyola University Maryland Raymond M. Johnson, Auburn University Montgomery Cheryl Riffe, Columbus State Community College

We would also like to thank all those with Pearson who have worked so diligently on this edition. In addition, Gillian Hall, our outstanding project manager at The Aardvark Group, deserves much gratitude.

Finally, we would like to dedicate this book to our parents, Bennie Ruth and the late Hoy Moffett, the late Harold and Norma Stonehill, and the late Wilford and Sylvia Eiteman, who gave us the motivation to become academicians and authors. We thank our wives, Megan, Kari, and Keng-Fong, for their patience while we were preparing Fundamentals of Multinational Finance.

Glendale, Arizona M.H.M. Honolulu, Hawaii A.I.S. Pacific Palisades, California D.K.E.

About the Authors Michael H. Moffett Michael H. Moffett is Continental Grain Professor in Finance at the Thunderbird School of Global Management, where he has been since 1994. He has also held teaching or research appointments at Oregon State University (1985–1993); the University of Michigan, Ann Arbor (1991–1993); the Brookings Institution, Washington, D.C.; the University of Hawaii at Manoa; the Aarhus School of Business (Denmark); the Helsinki School of Eco- nomics and Business Administration (Finland); the International Centre for Public Enterprises (Yugoslavia); and the University of Colorado, Boulder.

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Professor Moffett received a B.A. (Economics) from the University of Texas at Austin (1977); an M.S. (Resource Economics) from Colorado State University (1979); an M.A. (Economics) from the University of Colorado, Boulder (1983); and Ph.D. (Economics) from the University of Colorado, Boulder (1985).

He has authored, co-authored, or contributed to a number of books, articles, and other publications. He has co-authored two books with Art Stonehill and David Eiteman, Multinational Business Finance, and this book, Fundamentals of Multinational Finance. His articles have appeared in the Journal of Financial and Quantitative Analysis, Journal of Applied Corporate Finance, Journal of International Money and Finance, Journal of Inter- national Financial Management and Accounting, Contemporary Policy Issues, Brookings Discussion Papers in International Economics, and others. He has contributed to a number of collected works including the Handbook of Modern Finance, the International Account- ing and Finance Handbook, and the Encyclopedia of International Business. He is also co- author of a number of books in multinational business with Michael Czinkota and Ilkka Ronkainen, International Business (7th edition) and Global Business (4th edition). Profes- sor Moffett has also published extensively in the oil and gas industry including The Global Oil and Gas Industry: Strategy, Finance, and Management, with Andrew Inkpen, Managing Human Resources in the Oil & Gas Industry, with Steve Werner and Andrew Inkpen, and The Global Oil and Gas Industry: Stories From The Field, with Andrew Inkpen and Kannan Ramaswamy.

Arthur I. Stonehill Arthur I. Stonehill is a Professor of Finance and International Business, Emeritus, at Oregon State University, where he taught for 24 years (1966–1990). During 1991– 1997 he held a split appointment at the University of Hawaii at Manoa and Copenhagen Busi- ness School. From 1997 to 2001 he continued as a Visiting Professor at the University of Hawaii at Manoa. He has also held teaching or research appointments at the University of California, Berkeley; Cranfield School of Management (U.K.); and the North European Management Institute (Norway). He was a former president of the Academy of International Business, and was a western director of the Financial Management Association.

Professor Stonehill received a B.A. (History) from Yale University (1953), an M.B.A. from Harvard Business School (1957), and a Ph.D. in Business Administration from the University of California, Berkeley (1965). He was awarded honorary doctorates from the Aarhus School of Business (Denmark, 1989), the Copenhagen Business School (Denmark, 1992), and Lund University (Sweden, 1998).

He has authored or co-authored nine books and twenty-five other publications. His articles have appeared in Financial Management, Journal of International Business Studies, California Management Review, Journal of Financial and Quantitative Analysis, Journal of International Financial Management and Accounting, International Business Review, European Management Journal, The Investment Analyst (U.K.), Nationaløkonomisk Tidskrift (Denmark), Sosialøko- nomen (Norway), Journal of Financial Education, and others.

David K. Eiteman David K. Eiteman is Professor Emeritus of Finance at the John E. Anderson Graduate School of Management at UCLA. He has also held teaching or research appoint- ments at the Hong Kong University of Science & Technology, Showa Academy of Music (Japan), the National University of Singapore, Dalian University (China), the Helsinki School of Economics and Business Administration (Finland), University of Hawaii at Manoa, Univer- sity of Bradford (U.K.), Cranfield School of Management (U.K.), and IDEA (Argentina). He is

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a former president of the International Trade and Finance Association, Society for Economics and Management in China, and Western Finance Association.

Professor Eiteman received a B.B.A. (Business Administration) from the University of Michigan, Ann Arbor (1952); M.A. (Economics) from the University of California, Berkeley (1956); and a Ph.D. (Finance) from Northwestern University (1959).

He has authored or co-authored four books and twenty-nine other publications. His articles have appeared in The Journal of Finance, The International Trade Journal, Financial Analysts Journal, Journal of World Business, Management International, Business Horizons, MSU Business Topics, Public Utilities Fortnightly, and others.

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Brief Contents

PART 1 Global Financial Environment 1 Chapter 1 Multinational Financial Management: Opportunities and Challenges 2

Chapter 2 The International Monetary System 28

Chapter 3 The Balance of Payments 60

Chapter 4 Financial Goals and Corporate Governance 90

PART 2 Foreign Exchange Theory and Markets 121 Chapter 5 The Foreign Exchange Market 122

Chapter 6 International Parity Conditions 152

Chapter 7 Foreign Currency Derivatives: Futures and Options 186

Chapter 8 Interest Rate Risk and Swaps 210

Chapter 9 Foreign Exchange Rate Determination and Intervention 241

PART 3 Foreign Exchange Exposure 271 Chapter 10 Transaction Exposure 272

Chapter 11 Translation Exposure 301

Chapter 12 Operating Exposure 321

PART 4 Financing the Global Firm 349 Chapter 13 Global Cost and Availability of Capital 350

Chapter 14 Funding the Multinational Firm 377

Chapter 15 Multinational Tax Management 407

Chapter 16 International Trade Finance 438

PART 5 Foreign Investments and Operations 463 Chapter 17 Foreign Direct Investment and Political Risk 464

Chapter 18 Multinational Capital Budgeting and Cross-Border Acquisitions 489

Answers A-1

Glossary G-1

Index I-1

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Contents PART 1 Global Financial Environment 1

Chapter 1 Multinational Financial Management: Opportunities and Challenges 2 1.1 Financial Globalization and Risk 3 1.2 The Global Financial Marketplace 4 GLOBAL FINANCE IN PRACTICE 1.1 The Rocketing Swiss Franc 8 1.3 The Theory of Comparative Advantage 11 1.4 What Is Different About International Financial Management? 12 GLOBAL FINANCE IN PRACTICE 1.2 The Peso, Dollar, Yen—and Pokémon Go 13 1.5 The Globalization Process 15 GLOBAL FINANCE IN PRACTICE 1.3 Corporate Responsibility and Corporate Sustainability 19 Summary Points 19 MINI-CASE: Crowdfunding Kenya 20 Questions 23 Problems 23 Internet Exercises 27

Chapter 2 The International Monetary System 28 2.1 History of the International Monetary System 28 GLOBAL FINANCE IN PRACTICE 2.1 Hammering Out an Agreement at Bretton Woods 31 GLOBAL FINANCE IN PRACTICE 2.2 SDR Expanded to Include Chinese Renminbi 32 2.2 Fixed Versus Flexible Exchange Rates 38 2.3 The Impossible Trinity 38 2.4 A Single Currency for Europe: The Euro 40 2.5 Emerging Markets and Regime Choices 42 GLOBAL FINANCE IN PRACTICE 2.3 Nigeria Undermines Currency Exchange Innovation 46 Summary Points 50 MINI-CASE: Iceland—A Small Country in a Global Crisis 51 Questions 56 Problems 56 Internet Exercises 58

Chapter 3 The Balance of Payments 60 3.1 Fundamentals of BOP Accounting 61 3.2 The Accounts of the Balance of Payments 63 GLOBAL FINANCE IN PRACTICE 3.1 The Global Current Account Surplus 65 GLOBAL FINANCE IN PRACTICE 3.2 A Country’s Net International Investment Position (NIIP) 68 3.3 BOP Impacts on Key Macroeconomic Rates 71 3.4 Trade Balances and Exchange Rates 72 3.5 Capital Mobility 75 Summary Points 80 MINI-CASE: Global Remittances 81 Questions 85 Problems 86 Internet Exercises 89