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International Financial Management

Australia • Brazil • Mexico • Singapore • United Kingdom • United States

International Financial tnemeganaM

13th Edition

Jeff Madura Florida Atlantic University

International Financial Management, 13th Edition Jeff Madura

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Printed in Canada Print Number: 01 Print Year: 2016

Dedicated to my mother Irene

Brief Contents

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 103 5 Currency Derivatives 131

PART 2: Exchange Rate Behavior 185 6 Government Influence on Exchange Rates 187 7 International Arbitrage and Interest Rate Parity 227 8 Relationships among Inflation, Interest Rates, and Exchange Rates 257

PART 3: Exchange Rate Risk Management 295 9 Forecasting Exchange Rates 297 10 Measuring Exposure to Exchange Rate Fluctuations 325 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 437 15 International Corporate Governance and Control 477 16 Country Risk Analysis 503 17 Multinational Capital Structure and Cost of Capital 527 18 Long-Term Debt Financing 551

PART 5: Short-Term Asset and Liability Management 575 19 Financing International Trade 577 20 Short-Term Financing 595 21 International Cash Management 611

Appendix A: Answers to Self-Test Questions 643

Appendix B: Supplemental Cases 656

Appendix C: Using Excel to Conduct Analysis 676

Appendix D: International Investing Project 684

Appendix E: Discussion in the Boardroom 687

Appendix F: Use of Bitcoin to Conduct International Transactions 695

Glossary 697 Index 705

Contents

Preface, xix

About the Author, xxvi

PART 1: The International Financial Environment 1

1: MULTINATIONAL FINANCIAL MANAGEMENT: AN OVERVIEW 3 1-1 Managing the MNC, 4

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 MNCs Pursue International Business, 8 1-2a Theory of Comparative Advantage, 8 1-2b Imperfect Markets Theory, 8 1-2c Product Cycle Theory, 9

1-3 Methods to Conduct International Business, 10 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, 12 1-3g Summary of Methods, 12

1-4 Valuation Model for an MNC, 13 1-4a Domestic Model, 14 1-4b Multinational Model, 14 1-4c Uncertainty Surrounding an MNC’s Cash Flows, 17 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

2: INTERNATIONAL FLOW OF FUNDS 33 2-1 Balance of Payments, 33

2-1a Current Account, 33 2-1b Financial Account, 35 2-1c Capital Account, 36 2-1d Relationship between the Accounts, 37

2-2 Growth in International Trade, 37 2-2a Events That Increased Trade Volume, 37 2-2b Impact of Outsourcing on Trade, 39 2-2c Trade Volume among Countries, 40 2-2d Trend in U.S. Balance of Trade, 42

2-3 Factors Affecting International Trade Flows, 43 2-3a Cost of Labor, 43

2-3b Inflation, 44 2-3c National Income, 44 2-3d Credit Conditions, 44 2-3e Government Policies, 44 2-3f Exchange Rates, 48

2-4 International Capital Flows, 52 2-4a Factors Affecting Direct Foreign Investment, 52 2-4b Factors Affecting International Portfolio Investment, 53 2-4c Impact of International Capital Flows, 53

2-5 Agencies That Facilitate International Flows, 55 2-5a International Monetary Fund, 55 2-5b World Bank, 56 2-5c World Trade Organization, 57 2-5d International Finance Corporation, 57 2-5e International Development Association, 57 2-5f Bank for International Settlements, 57 2-5g OECD, 58 2-5h Regional Development Agencies, 58

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, 70 3-1d Derivative Contracts in the Foreign Exchange Market, 74

3-2 International Money Market, 75 3-2a European and Asian Money Markets, 76 3-2b Money Market Interest Rates among Currencies, 76 3-2c Risk of International Money Market Securities, 77

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

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

3-5 International Stock Markets, 83 3-5a Issuance of Stock in Foreign Markets, 83 3-5b Issuance of Foreign Stock in the United States, 84 3-5c Comparing the Size among Stock Markets, 85 3-5d How Governance Varies among Stock Markets, 86 3-5e Integration of International Stock Markets and Credit Markets, 87

3-6 How Financial Markets Serve MNCs, 88

Appendix 3: Investing in International Financial Markets, 95

4: EXCHANGE RATE DETERMINATION 103 4-1 Measuring Exchange Rate Movements, 103 4-2 Exchange Rate Equilibrium, 104

4-2a Demand for a Currency, 105 4-2b Supply of a Currency for Sale, 106

x Contents

4-2c Equilibrium Exchange Rate, 106 4-2d Change in the Equilibrium Exchange Rate, 107

4-3 Factors That Influence Exchange Rates, 108 4-3a Relative Inflation Rates, 109 4-3b Relative Interest Rates, 110 4-3c Relative Income Levels, 111 4-3d Government Controls, 112 4-3e Expectations, 112 4-3f Interaction of Factors, 114 4-3g Influence of Factors across Multiple Currency Markets, 115 4-3h Impact of Liquidity on Exchange Rate Adjustments, 116

4-4 Movements in Cross Exchange Rates, 116 4-5 Capitalizing on Expected Exchange Rate Movements, 117

4-5a Institutional Speculation Based on Expected Appreciation, 118 4-5b Institutional Speculation Based on Expected Depreciation, 119 4-5c Speculation by Individuals, 120 4-5d The “Carry Trade”, 120

5: CURRENCY DERIVATIVES 131 5-1 Forward Market, 131

5-1a How MNCs Use Forward Contracts, 131 5-1b Bank Quotations on Forward Rates, 132 5-1c Premium or Discount on the Forward Rate, 133 5-1d Movements in the Forward Rate over Time, 134 5-1e Offsetting a Forward Contract, 134 5-1f Using Forward Contracts for Swap Transactions, 135 5-1g Non-Deliverable Forward Contracts, 135

5-2 Currency Futures Market, 136 5-2a Contract Specifications, 136 5-2b Trading Currency Futures, 137 5-2c Credit Risk of Currency Futures Contracts, 138 5-2d Comparing Currency Futures and Forward Contracts, 138 5-2e How MNCs Use Currency Futures, 139 5-2f Speculation with Currency Futures, 141

5-3 Currency Options Market, 142 5-3a Currency Options Exchanges, 142 5-3b Over-the-Counter Currency Options Market, 142

5-4 Currency Call Options, 142 5-4a Factors Affecting Currency Call Option Premiums, 143 5-4b How MNCs Use Currency Call Options, 144 5-4c Speculating with Currency Call Options, 145

5-5 Currency Put Options, 148 5-5a Factors Affecting Currency Put Option Premiums, 149 5-5b How MNCs Use Currency Put Options, 149 5-5c Speculating with Currency Put Options, 150

5-6 Other Forms of Currency Options, 152 5-6a Conditional Currency Options, 152 5-6b European Currency Options, 154

Appendix 5A: Currency Option Pricing, 165

Appendix 5B: Currency Option Combinations, 169

Part 1 Integrative Problem: The International Financial Environment, 183

Contents xi

PART 2: Exchange Rate Behavior 185

6: GOVERNMENT INFLUENCE ON EXCHANGE RATES 187 6-1 Exchange Rate Systems, 187

6-1a Fixed Exchange Rate System, 187 6-1b Freely Floating Exchange Rate System, 189 6-1c Managed Float Exchange Rate System, 190 6-1d Pegged Exchange Rate System, 191 6-1e Dollarization, 197 6-1f Black Markets for Currencies, 197

6-2 A Single European Currency, 198 6-2a Monetary Policy in the Eurozone, 198 6-2b Impact on Firms in the Eurozone, 199 6-2c Impact on Financial Flows in the Eurozone, 199 6-2d Impact of Eurozone Country Crisis on Other Eurozone Countries, 199 6-2e Impact of a Country Abandoning the Euro, 202

6-3 Direct Intervention, 203 6-3a Reasons for Direct Intervention, 203 6-3b The Direct Intervention Process, 204 6-3c Direct Intervention as a Policy Tool, 207 6-3d Speculating on Direct Intervention, 208

6-4 Indirect Intervention, 209 6-4a Government Control of Interest Rates, 209 6-4b Government Use of Foreign Exchange Controls, 210

Appendix 6: Government Intervention during the Asian Crisis, 218

7: INTERNATIONAL ARBITRAGE AND INTEREST RATE PARITY 227 7-1 Locational Arbitrage, 227

7-1a Gains from Locational Arbitrage, 228 7-1b Realignment due to Locational Arbitrage, 228

7-2 Triangular Arbitrage, 229 7-2a Gains from Triangular Arbitrage, 230 7-2b Realignment due to Triangular Arbitrage, 232

7-3 Covered Interest Arbitrage, 232 7-3a Covered Interest Arbitrage Process, 232 7-3b Realignment due to Covered Interest Arbitrage, 234 7-3c Arbitrage Example When Accounting for Spreads, 235 7-3d Covered Interest Arbitrage by Non-U.S. Investors, 236 7-3e Comparing Different Types of Arbitrage, 236

7-4 Interest Rate Parity (IRP), 236 7-4a Derivation of Interest Rate Parity, 237 7-4b Determining the Forward Premium, 238 7-4c Graphic Analysis of Interest Rate Parity, 240 7-4d How to Test Whether Interest Rate Parity Holds, 242 7-4e Does Interest Rate Parity Hold?, 242 7-4f Considerations When Assessing Interest Rate Parity, 243

7-5 Variation in Forward Premiums, 244 7-5a Forward Premiums across Maturities, 244 7-5b Changes in Forward Premiums over Time, 245

xi i Contents

8: RELATIONSHIPS AMONG INFLATION, INTEREST RATES, AND EXCHANGE RATES 257

8-1 Purchasing Power Parity (PPP), 257 8-1a Interpretations of Purchasing Power Parity, 257 8-1b Rationale behind Relative PPP Theory, 258 8-1c Derivation of Purchasing Power Parity, 258 8-1d Using PPP to Estimate Exchange Rate Effects, 259 8-1e Graphic Analysis of Purchasing Power Parity, 260 8-1f Testing the Purchasing Power Parity Theory, 263 8-1g Does Purchasing Power Parity Exist?, 265

8-2 International Fisher Effect (IFE), 266 8-2a Deriving a Country’s Expected Inflation Rate, 266 8-2b Estimating the Expected Exchange Rate Movement, 267 8-2c Implications of the International Fisher Effect, 267 8-2d Derivation of the International Fisher Effect, 270 8-2e Graphic Analysis of the International Fisher Effect, 272 8-2f Testing the International Fisher Effect, 273 8-2g Limitations of the IFE Theory, 274 8-2h IFE Theory versus Reality, 275 8-2i Comparison of IRP, PPP, and IFE Theories, 275

Part 2 Integrative Problem: Exchange Rate Behavior, 286 Midterm Self-Exam, 287

PART 3: Exchange Rate Risk Management 295

9: FORECASTING EXCHANGE RATES 297 9-1 Why Firms Forecast Exchange Rates, 297 9-2 Forecasting Techniques, 299

9-2a Technical Forecasting, 299 9-2b Fundamental Forecasting, 299 9-2c Market-Based Forecasting, 303 9-2d Mixed Forecasting, 306

9-3 Assessment of Forecast Performance, 307 9-3a Measurement of Forecast Error, 307 9-3b Forecast Errors among Time Horizons, 308 9-3c Forecast Errors over Time Periods, 308 9-3d Forecast Errors among Currencies, 308 9-3e Comparing Forecast Errors among Forecast Techniques, 309 9-3f Graphic Evaluation of Forecast Bias, 309 9-3g Statistical Test of Forecast Bias, 311 9-3h Shifts in Forecast Bias over Time, 312

9-4 Accounting for Uncertainty Surrounding Forecasts, 312 9-4a Sensitivity Analysis Applied to Fundamental Forecasting, 313 9-4b Interval Forecasts, 313

10: MEASURING EXPOSURE TO EXCHANGE RATE FLUCTUATIONS 325 10-1 Relevance of Exchange Rate Risk, 325 10-2 Transaction Exposure, 326

10-2a Estimating “Net” Cash Flows in Each Currency, 328 10-2b Transaction Exposure of an MNC’s Portfolio, 329

Contents xi i i

10-2c Transaction Exposure Based on Value at Risk, 332 10-3 Economic Exposure, 335

10-3a Exposure to Foreign Currency Depreciation, 336 10-3b Exposure to Foreign Currency Appreciation, 337 10-3c Measuring Economic Exposure, 337

10-4 Translation Exposure, 340 10-4a Determinants of Translation Exposure, 340 10-4b Exposure of an MNC’s Stock Price to Translation Effects, 342

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 for Hedging Payables, 360 11-2e Evaluating Past Decisions on Hedging Payables, 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 Past Decisions on Hedging Receivables, 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 Methods to Reduce Exchange Rate Risk, 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, 394 12-1b Restructuring to Reduce Economic Exposure, 395 12-1c Limitations of Restructuring Intended to Reduce Economic Exposure, 398

12-2 A Case Study on Hedging Economic Exposure, 398 12-2a Savor Co.’s Assessment of Economic Exposure, 398 12-2b Possible Strategies for Hedging Economic Exposure, 400

12-3 Managing Exposure to Fixed Assets, 401 12-4 Managing Translation Exposure, 402

12-4a Hedging Translation Exposure with Forward Contracts, 403 12-4b Limitations of Hedging Translation Exposure, 403

Part 3 Integrative Problem: Exchange Risk Management, 412

xiv Contents

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

13-2 Benefits of International Diversification, 421 13-2a Diversification Analysis of International Projects, 422 13-2b Diversification among Countries, 424

13-3 Host Government Impact on DFI, 424 13-3a Incentives to Encourage DFI, 425 13-3b Barriers to DFI, 425

13-4 Assessing Potential DFI, 427 13-4a A Case Study of Assessing Potential DFI, 427 13-4b Evaluating DFI Opportunities That Pass the First Screen, 429

14: MULTINATIONAL CAPITAL BUDGETING 437 14-1 Subsidiary versus Parent Perspective, 437

14-1a Tax Differentials, 437 14-1b Restrictions on Remitted Earnings, 438 14-1c Exchange Rate Movements, 438 14-1d Summary of Factors That Distinguish the Parent Perspective, 438

14-2 Input for Multinational Capital Budgeting, 439 14-3 Multinational Capital Budgeting Example, 441

14-3a Background, 441 14-3b Analysis, 442

14-4 Other Factors to Consider, 443 14-4a Exchange Rate Fluctuations, 444 14-4b Inflation, 447 14-4c Financing Arrangement, 447 14-4d Blocked Funds, 450 14-4e Uncertain Salvage Value, 451 14-4f Impact of Project on Prevailing Cash Flows, 452 14-4g Host Government Incentives, 453 14-4h Real Options, 453

14-5 Adjusting Project Assessment for Risk, 454 14-5a Risk-Adjusted Discount Rate, 454 14-5b Sensitivity Analysis, 454 14-5c Simulation, 457

Appendix 14: Incorporating International Tax Law in Multinational Capital Budgeting, 469

15: INTERNATIONAL CORPORATE GOVERNANCE AND CONTROL 477 15-1 International Corporate Governance, 477

15-1a Governance by Board Members, 477 15-1b Governance by Institutional Investors, 478 15-1c Governance by Shareholder Activists, 478

15-2 International Corporate Control, 479 15-2a Motives for International Acquisitions, 479 15-2b Trends in International Acquisitions, 479

Contents xv

15-2c Barriers to International Corporate Control, 480 15-2d Model for Valuing a Foreign Target, 481

15-3 Factors Affecting Target Valuation, 482 15-3a Target-Specific Factors, 482 15-3b Country-Specific Factors, 483

15-4 A Case Study of Valuing a Foreign Target, 484 15-4a International Screening Process, 484 15-4b Estimating the Target’s Value, 485 15-4c Uncertainty Surrounding the Target’s Valuation, 487 15-4d Changes in Market Valuation of Target over Time, 487

15-5 Disparity in Foreign Target Valuations, 488 15-5a Expected Cash Flows of the Foreign Target, 488 15-5b Exchange Rate Effects on Remitted Earnings, 489 15-5c Required Return of Acquirer, 489

15-6 Other Corporate Control Decisions, 490 15-6a International Partial Acquisitions, 490 15-6b International Acquisitions of Privatized Businesses, 490 15-6c International Divestitures, 491

15-7 Corporate Control Decisions as Real Options, 492 15-7a Call Option on Real Assets, 492 15-7b Put Option on Real Assets, 493

16: COUNTRY RISK ANALYSIS 503 16-1 Country Risk Characteristics, 503

16-1a Political Risk Characteristics, 503 16-1b Financial Risk Characteristics, 506

16-2 Measuring Country Risk, 507 16-2a Techniques for Assessing Country Risk, 508 16-2b Deriving a Country Risk Rating, 509 16-2c Comparing Risk Ratings among Countries, 511

16-3 Incorporating Risk in Capital Budgeting, 512 16-3a Adjustment of the Discount Rate, 512 16-3b Adjustment of the Estimated Cash Flows, 512 16-3c Analysis of Existing Projects, 515

16-4 Preventing Host Government Takeovers, 516 16-4a Use a Short-Term Horizon, 516 16-4b Rely on Unique Supplies or Technology, 516 16-4c Hire Local Labor, 516 16-4d Borrow Local Funds, 516 16-4e Purchase Insurance, 517 16-4f Use Project Finance, 517

17: MULTINATIONAL CAPITAL STRUCTURE AND COST OF CAPITAL 527 17-1 Components of Capital, 527

17-1a Retained Earnings, 527 17-1b Sources of Debt, 528 17-1c External Sources of Equity, 529

17-2 The MNC’s Capital Structure Decision, 530 17-2a Influence of Corporate Characteristics, 531 17-2b Influence of Host Country Characteristics, 531 17-2c Response to Changing Country Characteristics, 532

xvi Contents

17-3 Subsidiary versus Parent Capital Structure Decisions, 533 17-3a Impact of Increased Subsidiary Debt Financing, 533 17-3b Impact of Reduced Subsidiary Debt Financing, 533 17-3c Limitations in Offsetting a Subsidiary’s Leverage, 534

17-4 Multinational Cost of Capital, 534 17-4a MNC’s Cost of Debt, 534 17-4b MNC’s Cost of Equity, 534 17-4c Estimating an MNC’s Cost of Capital, 535 17-4d Comparing Costs of Debt and Equity, 535 17-4e Cost of Capital for MNCs versus Domestic Firms, 536 17-4f Cost-of-Equity Comparison Using the CAPM, 537

17-5 Cost of Capital across Countries, 539 17-5a Country Differences in the Cost of Debt, 540 17-5b Country Differences in the Cost of Equity, 541

18: LONG-TERM DEBT FINANCING 551 18-1 Debt Denomination Decision of Foreign Subsidiaries, 551

18-1a Foreign Subsidiary Borrows Its Local Currency, 551 18-1b Foreign Subsidiary Borrows Dollars, 553

18-2 Debt Denomination Analysis: A Case Study, 553 18-2a Identifying Debt Denomination Alternatives, 553 18-2b Analyzing Debt Denomination Alternatives, 554

18-3 Loans Facilitate Financing, 555 18-3a Using Currency Swaps, 555 18-3b Using Parallel Loans, 556

18-4 Debt Maturity Decision, 559 18-4a Assessment of the Yield Curve, 559 18-4b Financing Costs of Loans with Different Maturities, 559

18-5 Fixed versus Floating Rate Debt Decision, 560 18-5a Financing Costs of Fixed versus Floating Rate Loans, 560 18-5b Hedging Interest Payments with Interest Rate Swaps, 561

Part 4 Integrative Problem: Long-Term Asset and Liability Management, 572

PART 5: Short-Term Asset and Liability Management 575

19: FINANCING INTERNATIONAL TRADE 577 19-1 Payment Methods for International Trade, 577

19-1a Prepayment, 577 19-1b Letters of Credit, 578 19-1c Drafts, 580 19-1d Consignment, 581 19-1e Open Account, 581 19-1f Impact of the Credit Crisis on Payment Methods, 581

19-2 Trade Finance Methods, 581 19-2a Accounts Receivable Financing, 582 19-2b Factoring, 582 19-2c Letters of Credit (L/Cs), 583 19-2d Banker’s Acceptances, 583 19-2e Medium-Term Capital Goods Financing (Forfaiting), 586 19-2f Countertrade, 586

Contents xvi i

19-3 Agencies That Facilitate International Trade, 587 19-3a Export-Import Bank of the United States, 587 19-3b Private Export Funding Corporation, 589 19-3c Overseas Private Investment Corporation, 589

20: SHORT-TERM FINANCING 595 20-1 Sources of Foreign Financing, 595

20-1a Internal Short-Term Financing, 595 20-1b External Short-Term Financing, 596 20-1c Access to Funding during a Credit Crisis, 596

20-2 Financing with a Foreign Currency, 596 20-2a Motive for Financing with a Foreign Currency, 597 20-2b Potential Cost Savings from Financing with a Foreign Currency, 597 20-2c Risk of Financing with a Foreign Currency, 598 20-2d Hedging the Foreign Currency Borrowed, 599 20-2e Reliance on the Forward Rate for Forecasting, 600 20-2f Use of Probability Distributions to Enhance the Financing Decision, 601

20-3 Financing with a Portfolio of Currencies, 602

21: INTERNATIONAL CASH MANAGEMENT 611 21-1 Multinational Working Capital Management, 611

21-1a Subsidiary Expenses, 611 21-1b Subsidiary Revenue, 612 21-1c Subsidiary Dividend Payments, 612 21-1d Subsidiary Liquidity Management, 612

21-2 Centralized Cash Management, 613 21-2a Accommodating Cash Shortages, 614

21-3 Optimizing Cash Flows, 614 21-3a Accelerating Cash Inflows, 614 21-3b Minimizing Currency Conversion Costs, 615 21-3c Managing Blocked Funds, 617 21-3d Managing Intersubsidiary Cash Transfers, 617 21-3e Complications in Optimizing Cash Flow, 617

21-4 Investing Excess Cash, 618 21-4a Benefits of Investing in a Foreign Currency, 618 21-4b Risk of Investing in a Foreign Currency, 619 21-4c Hedging the Investment in a Foreign Currency, 620 21-4d Break-Even Point from Investing in a Foreign Currency, 621 21-4e Using a Probability Distribution to Enhance the Investment Decision, 622 21-4f Investing in a Portfolio of Currencies, 623 21-4g Dynamic Hedging, 625

Part 5 Integrative Problem: Short-Term Asset and Liability Management, 631 Final Self-Exam, 633

Appendix A: Answers to Self-Test Questions, 643

Appendix B: Supplemental Cases, 656

Appendix C: Using Excel to Conduct Analysis, 676

Appendix D: International Investing Project, 684

Appendix E: Discussion in the Boardroom, 687

Appendix F: Use of Bitcoin to Conduct International Transactions, 695

Glossary, 697

Index, 705

xvi i i Contents

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 in- ternational financial environment will be rewarded. The same can be said for the stu- dents today who may become the future managers of MNCs.

Intended Market International Financial Management, 13th 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, 13th 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 be- fore 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 eco- nomic variables and explains the forces that influence these relationships.

The rest of the text develops a microeconomic framework with a focus on the manage- rial aspects of international financial management. Part 3 (Chapters 9 through 12) explains 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 analysis, and capital struc- ture 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 management of long-term assets (Chapters 13 through 16 on direct foreign investment, multinational 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 man- agement of long-term assets and long-term liabilities is integrated. For example, multina- tional 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 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 be- yond 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, 13th Edition, focuses on financial management de- cisions that maximize the value of multinational corporations. 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.

■ 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. A substantial set of questions and other applications at the end of each chapter test the student’s knowledge of the key concepts in the chapter.

■ Critical Thinking Question. At the end of each chapter, a critical thinking question challenges the students to use their skills to write a short essay on a specific topic that was given attention 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 chapter to make decisions about a small MNC called Sports Exports Company.

■ Internet/Excel Exercises. At the end of each chapter are exercises that expose the students to applicable information available at various websites, enable the applica- tion of Excel to related topics, or provide a combination of these. Integrative

xx Preface

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 an- swers 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. This project (located in Appendix D) 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.

Changes to this Edition All chapters in the 13th edition have been updated to include recent developments in international financial markets, and in the tools used to manage a multinational corpo- ration. In particular, the following chapters were revised substantially:

■ Chapter 2 has been revised to reflect the balance-of-payments format that is consis- tent with the recent format used by the U.S. government for reporting the specific accounts.

■ Chapter 3 has been revised to improve flow between sections, and to update the manipulation of exchange rates in the foreign exchange market.

■ Chapter 6 now includes a section on black markets for currencies, and a section on the recent challenges of the European Central Bank (ECB) to stabilize financial conditions in the eurozone.

■ Chapter 8 has been revised substantially to synthesize the relationships between the Fisher effect, purchasing power parity (PPP), and the international Fisher effect (IFE).

■ Chapter 9 has been reorganized to improve the flow. ■ Chapter 10 has been revised to improve flow between sections, and to direct atten-

tion to the value at risk method for assessing exchange rate exposure. ■ Chapter 13 now includes a new case study example. ■ Chapter 14 now includes more detailed information about how managers (and stu-

dents) can use spreadsheets to facilitate the international capital budgeting process and apply sensitivity analysis.

■ Chapter 18 has been revised to improve the flow between sections.

Preface xxi

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 9781337099738: 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 9781337099738 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 multiple Cengage Learning solutions; create multiple test versions in an instant; de- liver 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 provide a solid guide for organizing lectures. 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 Solu- tions can help you create your perfect learning solution. Draw from Cengage Learning’s exten- sive 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 important thing— your students. Learn more about all our services at www.cengage.com/custom.

MindTap Feel confident as you use the most engaging digital content available to transform today’s students into critical thinkers. Personalize your course to match the way you teach and your students learn. Improve outcomes with real-time insight into student progress, and save time. All while your students engage with your course content, enjoy the flexibility of studying anytime and anywhere, stay connected with the MindTap Mobile app, and earn better grades.

MindTap Instant Access Code ISBN: 9781337270021.

xxi i Preface

Acknowledgments Several professors reviewed previous versions of this text and influenced its content and organization. They 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 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 Krishnan, 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

Preface xxi i i

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 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

In addition, many friends and colleagues offered useful suggestions that influenced the content and organization of this edition, including Kevin Brady (Florida Atlantic University), Kien Cao (Foreign Trade University), Inga Chira (California State University, Northridge), Jeff Coy (Penn State – Erie), Sean Davis (University of North Florida), Luis Garcia-Feijoo (Florida Atlantic University), Dan Hartnett, Victor Kalafa, Sukhun Lee (Loyola University Chicago), Pat Lewis,Marek Marciniak (West Chester University), Thanh Ngo (East Carolina University), Arjan Premti (University of Wisconsin – Whitewater), Nivine Richie (University of North Carolina – Wilmington), Garrett Smith (University of Wisconsin – Whitewater), Jurica Susnjara (Kean University), Alex Tang (Morgan State University), and Nik Volkov (Mercer University).

I also benefited from the input of many business owners and managers I have met outside the United States who have been willing to share their insight about international financial management.

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