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MULTINATIONAL BUSINESS FINANCE THIRTEENTH EDIT ION

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MULTINATIONAL BUSINESS FINANCE THIRTEENTH EDIT ION

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Global Finance in Practice

Organization Multinational Business Finance

Preface

Preface

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Global Finance in Practice

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Preface

Acknowledgments

Multinational Business Finance

Yong-Cheol Kim University of Wisconsin-Milwaukee

Yen-Sheng Lee Bellevue University

Robert Mefford University of San Francisco John Petersen George Mason University Rahul Verma University of Houston-Downtown

Otto Adleberger Essen University, Germany

Alan Alford Northeastern University

Stephen Archer Willamette University

Bala Arshanapalli Indiana University Northwest

Hossein G. Askari George Washington University

Robert T. Aubey University of Wisconsin at Madison

David Babbel University of Pennsylvania

James Baker Kent State University

Morten Balling Arhus School of Business, Denmark

Arindam Bandopadhyaya University of Massachusetts at Boston

Ari Beenhakker University of South Florida

Carl Beidleman Lehigh University

Robert Boatler Texas Christian University

Gordon M. Bodnar John Hopkins University

Nancy Bord University of Hartford

Finbarr Bradley University of Dublin, Ireland

Tom Brewer Georgetown University

Michael Brooke University of Manchester, England

Robert Carlson Assumption University, Thailand

Kam C. Chan University of Dayton

Chun Chang University of Minnesota

Sam Chee Boston University Metropolitan College

Kevin Cheng New York University

It-Keong Chew University of Kentucky

Frederick D. S. Choi New York University

Jay Choi Temple University

Nikolai Chuvakhin Pepperdine University

Mark Ciechon University of California, Los Angeles

J. Markham Collins University of Tulsa

Alan N. Cook Baylor University

Kerry Cooper Texas A&M University

Robert Cornu Cranfield School of Management, U.K.

Roy Crum University of Florida

Steven Dawson University of Hawaii at Manoa

David Distad University of California, Berkeley

Gunter Dufey University of Michigan, Ann Arbor

Mark Eaker Duke University

Rodney Eldridge George Washington University

Imad A. Elhah University of Louisville

Vihang Errunza McGill University

Cheol S. Eun Georgia Tech University

Mara Faccio University of Notre Dame

Larry Fauver University of Tennessee

Joseph Finnerty University of Illinois at Urbana- Champaign

William R. Folks, Jr. University of South Carolina

Lewis Freitas University of Hawaii at Manoa

Preface

Anne Fremault Boston University

Fariborg Ghadar George Washington University

Ian Giddy New York University

Martin Glaum Justus-Lievig-Universitat Giessen, Germany

Deborah Gregory University of Georgia

Robert Grosse Thunderbird

Christine Hekman Georgia Tech University

Steven Heston University of Maryland

James Hodder University of Wisconsin, Madison

Alfred Hofflander University of California, Los Angeles

Janice Jadlow Oklahoma State University

Veikko Jaaskelainen Helsinki School of Economics and Business Administration

Benjamas Jirasakuldech University of the Pacific

Ronald A. Johnson Northeastern University

John Kallianiotis University of Scranton

Fred Kaen University of New Hampshire

Charles Kane Boston College

Robert Kemp University of Virginia

W. Carl Kester Harvard Business School

Seung Kim St. Louis University

Yong Kim University of Cincinnati

Gordon Klein University of California, Los Angeles

Steven Kobrin University of Pennsylvania

Paul Korsvold Norwegian School of Management

Chris Korth University of South Carolina

Chuck C. Y. Kwok University of South Carolina

John P. Lajaunie Nicholls State University

Sarah Lane Boston University

Martin Laurence William Patterson College

Eric Y. Lee Fairleigh Dickinson University

Donald Lessard Massachusetts Institute of Technology

Arvind Mahajan Texas A&M University

Rita Maldonado-Baer New York University

Anthony Matias Palm Beach Atlantic College

Charles Maxwell Murray State University

Sam McCord Auburn University

Jeanette Medewitz University of Nebraska at Omaha

Robert Mefford University of San Francisco

Paritash Mehta Temple University

Antonio Mello University of Wisconsin at Madison

Eloy Mestre American University

Kenneth Moon Suffolk University

Gregory Noronha Arizona State University

Edmund Outslay Michigan State University

Lars Oxelheim Lund University, Sweden

Jacob Park Green Mountain College

Yoon Shik Park George Washington University

Harvey Poniachek New York University

Yash Puri University of Massachusetts at Lowell

R. Ravichandrarn University of Colorado at Boulder

Scheherazade Rehman George Washington University

Jeff Rosenlog Emory University

David Rubinstein University of Houston

Alan Rugman Oxford University, U.K.

R. J. Rummel University of Hawaii at Manoa

Mehdi Salehizadeh San Diego State University

Michael Salt San Jose State University

Roland Schmidt Erasmus University, the Netherlands

Lemma Senbet University of Maryland

Alan Shapiro University of Southern California

Hany Shawky State University of New York, Albany

Hamid Shomali Golden Gate University

Vijay Singal Virginia Tech University

Preface

Sheryl Winston Smith University of Minnesota

Luc Soenen California Polytechnic State University

Marjorie Stanley Texas Christian University

Joseph Stokes University of Massachusetts- Amherst

Jahangir Sultan Bentley College

Lawrence Tai Loyola Marymount University

Kishore Tandon CUNY—Bernard Baruch College

Russell Taussig University of Hawaii at Manoa

Lee Tavis University of Notre Dame

Sean Toohey University of Western Sydney, Australia

Norman Toy Columbia University

Joseph Ueng University of St. Thomas

Gwinyai Utete Auburn University

Harald Vestergaard Copenhagen Business School

K. G. Viswanathan Hofstra University

Joseph D. Vu University of Illinois, Chicago

Mahmoud Wahab University of Hartford

Masahiro Watanabe Rice University

Michael Williams University of Texas at Austin

Brent Wilson Brigham Young University

Bob Wood Tennessee Technological University

Alexander Zamperion Bentley College

Emilio Zarruk Florida Atlantic University

Tom Zwirlein University of Colorado, Colorado Springs

Industry (present or former affiliation)

Paul Adaire Philadelphia Stock Exchange

Barbara Block Tektronix, Inc.

Holly Bowman Bankers Trust

Payson Cha HKR International, Hong Kong

John A. Deuchler Private Export Funding Corporation

Kåre Dullum Gudme Raaschou Investment Bank, Denmark

Steven Ford Hewlett Packard

David Heenan Campbell Estate, Hawaii

Sharyn H. Hess Foreign Credit Insurance Association

Aage Jacobsen Gudme Raaschou Investment Bank, Denmark

Ira G. Kawaller Chicago Mercantile Exchange

Kenneth Knox Tektronix, Inc.

Arthur J. Obesler Eximbank

I. Barry Thompson Continental Bank

Gerald T. West Overseas Private Investment Corporation

Willem Winter First Interstate Bank of Oregon

!

!

Preface

!

Arthur I. Stonehill

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 Euro- pean Management Journal The Investment Analyst (U.K.) Nationaløkonomisk Tidskrift (Denmark) Sosialøkonomen (Norway) Journal of Financial Education

David K. Eiteman

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,

Michael H. Moffett

About the Authors

About the Authors

Journal of Financial and Quantitative Analysis Journal of Applied Corporate Finance Journal of International Money and Finance Journal of Interna- tional Financial Management and Accounting Contemporary Policy Issues Brookings Dis- cussion Papers in International Economics

Handbook of Modern Finance International Accounting and Finance Handbook Encyclopedia of International Business

International Business Global Business

PART I Global Financial Environment 1

PART II Foreign Exchange Theory and Markets 157

PART III Foreign Exchange Exposure 245

PART IV Financing the Global Firm 349

PART V Foreign Investment Decisions 439

PART VI Managing Multinational Operations 527

Brief Contents

PART I Global Financial Environment 1

Chapter 1 Current Multinational Challenges and the Global Economy 2

Summary Points 17 MINI-CASE: Nine Dragons Paper and the 2009 Credit Crisis 17 Questions ! Problems ! Internet Exercises 24

Chapter 2 Corporate Ownership, Goals, and Governance 27

Summary Points 49 MINI-CASE: Luxury Wars—LVMH vs. Hermès 49 Questions ! Problems ! Internet Exercises 54

Chapter 3 The International Monetary System 59

Summary Points 78 MINI-CASE: The Yuan Goes Global 79 Questions ! Problems ! Internet Exercises 84

Chapter 4 The Balance of Payments 87

Summary Points 112 MINI-CASE: Global Remittances 113 Questions ! Problems ! Internet Exercises 117

Contents

Contents

Chapter 5 The Continuing Global Financial Crisis 122

Summary Points 150 MINI-CASE: Letting Go of Lehman Brothers 151 Questions ! Problems ! Internet Exercises 153

PART II Foreign Exchange Theory and Markets 157

Chapter 6 The Foreign Exchange Market 158

Summary Points 177 MINI-CASE: The Saga of the Venezuelan Bolivar Fuerte 178 Questions ! Problems ! Internet Exercises 180

Chapter 7 International Parity Conditions 185

Summary Points 204 MINI-CASE: Emerging Market Carry Trades 205 Questions ! Problems ! Internet Exercises 206 Appendix: An Algebraic Primer to International Parity Conditions 212

Chapter 8 Foreign Currency Derivatives and Swaps 216

Summary Points 235 MINI-CASE: McDonald’s Corporation’s British Pound Exposure 236 Questions ! Problems ! Internet Exercises 237

PART III Foreign Exchange Exposure 245

Chapter 9 Foreign Exchange Rate Determination and Forecasting 246

Summary Points 268 MINI-CASE: The Japanese Yen Intervention of 2010 269 Questions ! Problems ! Internet Exercises 271

Contents

Chapter 10 Transaction Exposure 275

Summary Points 290 MINI-CASE: Banbury Impex (India) 291 Questions ! Problems ! Internet Exercises 295 Appendix: Complex Option Hedges 301

Chapter 11 Translation Exposure 309

Summary Points 320 MINI-CASE: LaJolla Engineering Services 320 Questions ! Problems 323

Chapter 12 Operating Exposure 326

Summary Points 343 MINI-CASE: Toyota’s European Operating Exposure 343 Questions ! Problems ! Internet Exercises 346

PART IV Financing the Global Firm 349

Chapter 13 The Global Cost and Availability of Capital 350

Summary Points 366 MINI-CASE: Novo Industri A/S (Novo) 367 Questions ! Problems ! Internet Exercises 371

Chapter 14 Raising Equity and Debt Globally 376

Summary Points 400 MINI-CASE: Korres Natural Products and the Greek Crisis 401 Questions ! Problems ! Internet Exercises 406 Appendix: Financial Structure of Foreign Subsidiaries 411

Contents

Chapter 15 Multinational Tax Management 415

Summary Points 430 MINI-CASE: The U.S. Corporate Income Tax Conundrum 430 Questions ! Problems ! Internet Exercises 434

PART V Foreign Investment Decisions 439

Chapter 16 International Portfolio Theory and Diversification 440

Summary Points 453 MINI-CASE: Portfolio Theory, Black Swans, and [Avoiding] Being the Turkey 454 Questions ! Problems ! Internet Exercises 456

Chapter 17 Foreign Direct Investment and Political Risk 460

Summary Points 485 MINI-CASE: Corporate Competition from the Emerging Markets 486 Questions ! Internet Exercises 487

Chapter 18 Multinational Capital Budgeting and Cross-Border Acquisitions 490

Summary Points 513 MINI-CASE: Yanzhou (China) Bids for Felix Resources (Australia) 514 Questions ! Problems ! Internet Exercises 521

PART VI Managing Multinational Operations 527

Chapter 19 Working Capital Management 528

Summary Points 549 MINI-CASE: Honeywell and Pakistan International Airways 549 Questions ! Problems ! Internet Exercises 552

Contents

Chapter 20 International Trade Finance 556

Summary Points 574 MINI-CASE: Crosswell International and Brazil 575 Questions ! Problems ! Internet Exercises 579

Answers to Selected End-of-Chapter Problems 582

Glossary 586

Index 603

Credits 626

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Global Financial Environment

CHAPTER 1 Current Multinational Challenges and the Global Economy

CHAPTER 2 Corporate Ownership, Goals, and Governance

CHAPTER 3 The International Monetary System

CHAPTER 4 The Balance of Payments

CHAPTER 5 The Continuing Global Financial Crisis

PART I

1

Current Multinational Challenges and the Global Economy

I define globalization as producing where it is most cost-effective, selling where it is most profitable, and sourcing capital where it is cheapest, without worrying about national boundaries.

—Narayana Murthy, President and CEO, Infosys.

The subject of this book is the financial management of multinational enterprises (MNEs). 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 foreign subsidiar- ies, branches, or joint ventures with host country firms.

MNEs are struggling to survive and prosper in a very different world than in the past. Today’s MNEs depend not only on the emerging markets for cheaper labor, raw materials, and outsourced manufacturing, but also increasingly on those same emerging markets for sales and profits. These markets—whether they are emerging, less developed, developing, or BRICs (Brazil, Russia, India, and China)—represent the majority of the earth’s population, and therefore, customers. And adding market complexity to this changing global landscape is the risky and challenging international macroeconomic environment, both from a long- term and short-term perspective, following the global financial crisis of 2007–2009. How to identify and navigate these risks is the focus of this book.

Financial Globalization and Risk

Back in the halcyon pre-crisis days of the late 20th and early 21st centuries, it was taken as self evident that financial globalisation was a good thing. But the subprime crisis and eurozone dramas are shaking that belief. Never mind the fact that imbalances amid globalisation can stoke up bubbles; what is the bigger risk now—particularly in the eurozone—is that financial globalisation has created a system that is interconnected in some dangerous ways.

—“Crisis Fears Fuel Debate on Capital Controls,” Gillian Tett, The Financial Times, December 15, 2011.

2

CHAPTER 1

3Current Multinational Challenges and the Global Economy CHAPTER 1

The theme dominating global financial markets today is the complexity of risks associated with financial globalization—far beyond whether it is simply good or bad, but how to lead and manage multinational firms in the rapidly moving marketplace.

! The international monetary system, an eclectic mix of floating and managed fixed exchange rates today, is under constant scrutiny. The rise of the Chinese renminbi is changing much of the world’s outlook for currency exchange, reserve currencies, and the roles of the dollar and the euro (see Chapter 3).

! Large fiscal deficits plague most of the major trading countries of the world, including the current eurozone crisis, complicating fiscal and monetary policies, and ultimately, interest rates and exchange rates (see Chapters 4 and 5).

! Many countries experience continuing balance of payments imbalances, and in some cases, dangerously large deficits and surpluses—whether it be the twin surpluses enjoyed by China, the current account surplus of Germany amidst a sea of eurozone deficits, or the continuing current account deficit of the United States, all will inevi- tably move exchange rates (see Chapters 4 and 5).

! Ownership, control, and governance changes radically across the world. The publicly traded company is not the dominant global business organization—the privately held or family-owned business is the prevalent structure—and their goals and measures of performance differ dramatically (see Chapter 2).

! Global capital markets that normally provide the means to lower a firm’s cost of capital, and even more critically increase the availability of capital, have in many ways shrunk in size, openness, and accessibility by many of the world’s organizations (see Chapters 1 and 5).

! Today’s emerging markets are confronted with a new dilemma: the problem of being the recipients of too much capital—sometimes. Financial globalization has resulted in the flow of massive quantities of capital into and out of many emerging markets, complicating financial management (Chapters 6 and 9).

These are but a sampling of the complexity of topics. The Mini-Case at the end of this chapter, Nine Dragons Paper and the 2009 Credit Crisis, highlights many of these MNE issues in emerging markets today. As described in Global Finance in Practice 1.1, the global credit crisis and its aftermath has damaged the world’s largest banks and reduced the rate of eco- nomic growth worldwide, leading to higher rates of unemployment and putting critical pres- sures on government budgets from Greece to Ireland to Portugal to Mexico.

The Global Financial Marketplace Business—domestic, international, global—involves the interaction of individuals and indi- vidual organizations for the exchange of products, services, and capital through markets. The global capital markets are critical for the conduct of this exchange. The global financial crisis of 2008–2009 served as an illustration and a warning of how tightly integrated and fragile this marketplace can be.

Assets, Institutions, and Linkages Exhibit 1.1 provides a map to the global capital markets. One way to characterize the global financial marketplace is through its assets, institutions, and linkages.

4 CHAPTER 1 Current Multinational Challenges and the Global Economy

GLOBAL FINANCE IN PRACTICE 1.1

Global Capital Markets: Entering a New Era

The current financial crisis and worldwide recession have abruptly halted a nearly three-decade-long expansion of global capital markets. From 1980 through 2007, the world’s financial assets—including equities, private and public debt, and bank deposits—nearly quadrupled in size relative to global GDP. Global capital flows similarly surged. This growth reflected numerous interrelated trends, including advances in information and communication technology, financial market liberalization, and innovations in financial products and ser- vices. The result was financial globalization.

But the upheaval in financial markets in late 2008 marked a break in this trend. The total value of the world’s financial assets fell by $16 trillion to $178 trillion, the largest setback on record. Although equity markets have bounced back from their recent lows, they remain well below their peaks. Credit markets have healed somewhat but are still impaired.

Going forward, our research suggests that global capi- tal markets are entering a new era in which the forces fueling growth have changed. For the past 30 years, most of the overall increase in financial depth—the ratio of assets to GDP—was driven by the rapid growth of equities and private debt in mature markets. Looking ahead, these asset classes in mature mar- kets are likely to grow more slowly, more in line with GDP, while government debt will rise sharply. An increasing share of global asset growth will occur in emerging markets, where GDP is ris- ing faster and all asset classes have abundant room to expand.

Source: Excerpted from “Global Capital Markets: Entering a New Era,” McKinsey Global Institute, Charles Rosburgh, Susan Lund, Charles Atkins, Stanislas Belot, Wayne W. Hu, and Moira S. Pierce, McKinsey & Company, September 2009, p. 7.

Assets. The assets—the financial assets—which are at the heart of the global capital markets are the debt securities issued by governments (e.g., U.S. Treasury Bonds). These low-risk or risk-free assets then form the foundation for the creating, trading, and pricing of other finan- cial assets like bank loans, corporate bonds, and equities (stock). In recent years, a number of

EXHIBIT 1.1

Bank

Mortgage Loan

Corporate Loan

Corporate Bond

Bank

Interbank Market (LIBOR )

Bank

Public Debt

Private Debt

Private Equity

Central Banks Institutions

Currency Currency Currency

The global capital market is a collection of institutions (central banks, commercial banks, investment banks, not for profit financial institutions like the IMF and World Bank) and securities (bonds, mortgages, derivatives, loans, etc.), which are all linked via a global network—the Interbank Market. This interbank market, in which securities of all kinds are traded, is the critical pipeline system for the movement of capital.

The exchange of securities—the movement of capital in the global financial system—must all take place through a vehicle—currency. The exchange of currencies is itself the largest of the financial markets. The interbank market, which must pass-through and exchange securities using currencies, bases all of its pricing through the single most widely quoted interest rate in the world—LIBOR (the London Interbank Offered Rate).

Global Capital Markets

5Current Multinational Challenges and the Global Economy CHAPTER 1

additional securities have been created from the existing securities—derivatives, whose value is based on market value changes in the underlying securities. The health and security of the global financial system relies on the quality of these assets.

Institutions. The institutions of global finance are the central banks, which create and control each country’s money supply; the commercial banks, which take deposits and extend loans to businesses, both local and global; and the multitude of other financial institutions created to trade securities and derivatives. These institutions take many shapes and are subject to many different regulatory frameworks. The health and security of the global financial system relies on the stability of these financial institutions.

Linkages. The links between the financial institutions, the actual fluid or medium for exchange, are the interbank networks using currency. The ready exchange of currencies in the global marketplace is the first and foremost necessary element for the conduct of financial trading, and the global currency markets are the largest markets in the world. The exchange of currencies, and the subsequent exchange of all other securities globally via currency, is the international interbank network. This network, whose primary price is the London Interbank Offered Rate (LIBOR), is the core component of the global financial system.

The movement of capital across borders and continents for the conduct of business has existed in many different forms for thousands of years. Yet, it is only within the past 50 years that these capital movements have started to move at the pace of an electron, either via a phone call or an email. And it is only within the past 20 years that this market has been able to reach the most distant corners of the earth at any moment of the day. This market has seen an explosion of innovative products and services in the past decade, some of which proved, as in the case of the 2008–2009 crisis, somewhat toxic to the touch.

The Market for Currencies The price of any one country’s currency in terms of another country’s currency is called a foreign currency exchange rate. For example, the exchange rate between the U.S. dollar ($ or USD) and the European euro (€ or EUR) may be stated as “1.4565 dollar per euro” or simply abbreviated as $1.4565/€. This is the same exchange rate as when stated “EUR1.00 = USD1.4565.” Since most international business activities require at least one of the two parties in a business transaction to either pay or receive payment in a currency, which is dif- ferent from their own, an understanding of exchange rates is critical to the conduct of global business.

A quick word about currency symbols. As noted, USD and EUR are often used as the symbols for the U.S. dollar and the European Union’s euro. These are the computer sym- bols (ISO-4217 codes) used today on the world’s digital networks. The field of international finance, however, has a rich history of using a variety of different symbols in the financial press, and a variety of different abbreviations are commonly used. For example, the British pound sterling may be £ (the pound symbol), GBP (Great Britain pound), STG (British pound sterling), ST£ (pound sterling), or UKL (United Kingdom pound). This book will also use the simpler common symbols—the $ (dollar), the € (euro), the ¥ (yen), the £ (pound)—but be warned and watchful when reading the business press!