International Corporate Finance

Value Creation with Currency Derivatives in Global Capital Markets

Laurent L. Jacque

• Publisher: Wiley
• Year: 2019
• ISBN:
  9781119550433
• Edition: 2
• Topic: Business
• Subtopic: Corporate Finance
• Index: Business

As globalization is redefining the field of corporate finance, international finance is now part and parcel of the basic literacy of any financial executive. This is why International Corporate Finance is a "must" text for upper-undergraduates, MBAs aspiring to careers in global financial services and budding finance professionals.

International Corporate Finance offers thorough coverage of the international monetary system, international financing, foreign exchange risk management and cross-border valuation. Additionally, the book offers keen insight on how disintermediation, deregulation and securitization are re-shaping global capital markets.

What is different about International Corporate Finance?

• Each chapter opens with a real-life mini-case to anchor theoretical concepts to managerial situations.
• Provides simple decision rules and "how to do" answers to key managerial issues.
• Cross-border Mergers & Acquisitions, Project Finance, Islamic Finance, Asian Banking & Finance are completely new chapters that no other textbooks currently cover.
• Accompanied with a comprehensive instructor support package which includes case studies, an Instructor's Manual, PowerPoint slides, Multiple Choice Questions and more.

CHAPTER 1
What Is International Corporate Finance?

The only trouble with going abroad is that you have to leave home to do it.

An English aristocrat when Britannia ruled the waves!

As we enter the third millennium, information technology – by crushing the cost of communications – is accelerating the globalization of manufacturing, commerce, and especially finance. News traveling at the speed of light through the Internet reaches an estimated 250,000 computer terminals in trading rooms around the world, morphing national financial markets into one huge, efficient global marketplace for capital. Indeed, the relentless rise of the digital cyber-economy is weakening the grip of the nation-state as government policies are subjected to a continuing referendum by financial markets. And yet die-hard sovereigns are holding firmly to their prerogatives of having a national currency, a national regulatory framework, and a national tax code of their own and much more. International business's vastly expanded global reach is redefining the risks and opportunities faced by financial executives, whether they are at the helms of international trading firms; old-fashioned brick-and-mortar multinational corporations (MNCs) such as Royal Dutch-Shell, IBM, Michelin, Nestlé, or Toyota; or “virtual” multinational enterprises such as Google, Facebook, or eBay.

In this first chapter, we explain what is unique about international corporate finance. To do so, it is helpful to sketch how the process of globalization fueled by the relentless rise of the multinational enterprise is reshaping the global economy, thereby providing a backdrop against which to better identify the unique dimensions of international corporate finance. At the end of this chapter, the reader should have become convinced that the study of international corporate finance is a sine qua non condition of success in tomorrow's business world. The old divide between domestic and international finance is blurring, so much so that our English aristocrat would no longer need to leave home to go abroad, because abroad has become home – at least in the world of finance.

In this introductory chapter the reader will gain an understanding of:

• What globalization is and how the multinational corporation is its handmaiden.
• What makes international corporate finance uniquely different from domestic corporate finance.
• How the exchange rate variable uniquely complicates financial decision making.
• How the locus of decision making in the finance function migrates as firms morph from strictly domestic entities to fully developed multinational corporations.
• What the international control conundrum is about.
• How multinational corporations can uniquely leverage their financial systems to minimize taxes and lower their cost of capital.

THE UNEVEN REACH OF GLOBALIZATION

Globalization is about the increasing integration of national economies as cross-border movements of labor, goods, and services, as well as money, continue at an unabated pace. In the words of Narayana Murthy, president and CEO of Infosys, an up-and-coming Indian multinational, “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.” And in his best-selling book, The World Is Flat, Thomas L. Friedman argues that the world economy has become a level playing field.

The reality is, however, somewhat more nuanced. Globalization is a multifaceted process that has evolved unevenly, with certain markets becoming dramatically more integrated than others. If one breaks down the world economy into three principal markets for (1) labor, (2) goods and services, and (3) capital, we immediately sense that globalization is an uneven three-speed process upholding major price differences across national markets. If the world were indeed a level playing field, there would be no price differences in the cost of labor, goods, services, or capital, and what is known as the Law of One Price would hold true. Yet, globalization is at best sluggish in the labor markets where most international migration is still being curbed by severe national immigration quotas: Wages are lower in Vietnam than in China, China's wages are lower than Poland's, and Poland's wages are lower than Switzerland's. Globalization is healthy in the market for goods and services, but international trade is still regulated, with most countries maintaining tariff and nontariff barriers. Meanwhile, it is unbridled and nearly all-encompassing in the market for capital. This process has been fueled by four forces:

1. Technology aided by the marriage of computers and telecommunications. As the cost of transportation, communications, and computing continues to decline exponentially, overcoming the natural barriers of spatial distance has become cheaper. The “death of distance” has enabled a nimbler division of labor among trading nations, allowing domestic and multinational corporations to leverage economies of scale better through outsourcing and offshoring.
2. Economic liberalization and deregulation. The falling of regulatory barriers that traditionally hampered the cross-national flow of goods and services as well as foreign direct and portfolio investment is proving to be a powerful catalyst for increasing integration in markets of goods, services, and capital. Multiple rounds of multilateral negotiations within the framework of the General Agreement on Tariffs and Trade (GATT) and now the World Trade Organization (WTO) have resulted in the steady lowering of tariff and nontariff barriers as well as the reduction of trade subsidies. Over the past 35 years, world trade in goods and services has grown more than twice as fast as world gross domestic product (GDP). Similarly, with the breakdown of the Bretton Woods international monetary system of fixed exchange rates, countries have progressively dismantled exchange controls and restored currency convertibility, thereby fueling foreign direct investment and international portfolio investment.
3. Privatization and emerging capital markets. The dislocation of the Soviet empire and its many satellites unleashed the “invisible hand” of free market forces where command economies once struggled under the yoke of state bureaucracies. Emerging capital markets – fueled by the rapid privatization of major telecom companies, banks, and utilities, along with large-scale international portfolio investment – are energizing the efficient allocation of capital to productive investments and facilitating foreign direct investment.
4. Market for financial derivatives. The explosive growth of derivatives markets for forwards, futures, options, and swaps has allowed them to become effective conduits for transferring currency, commodity, interest rate, and credit risks to players best equipped to bear those risks.

THE RISE OF THE MULTINATIONAL CORPORATION

The growth of international trade, which now accounts for 30 percent of global gross national product (GNP), whereas it stood at only 11.6 percent in 1970,¹ is second only to the spectacular rise in foreign direct investment embodied in the multinational corporation (see “International Corporate Finance in Practice 1.1”).

Integration of the world market for goods and services happens to a significant extent within the multinational corporation itself, with as much as 40 percent of all cross-border trade in goods and services being of an intra-corporate nature (between sister affiliates of the same firm domiciled in different countries) rather than of an arm's-length nature (between independent firms). Supply chains now span the entire world. For example, consumer electronics may be designed in the United States, components manufactured in Japan and China and then assembled in Vietnam or the Philippines, and the finished product marketed around the world.

Lenin predicted that foreign direct investment would be the weapon of colonial imperialism and would signal the final stage of capitalism. By an ironic twist of history, foreign direct investment was growing about four times faster than the world GNP and at about three times the pace of world trade when the Soviet empire (the cradle of Marxism-Leninism) finally collapsed in 1989. Indeed, the torrential flow of foreign direct investment personified by huge, ubiquitous, and stateless multinational corporations has continued unabated and is no longer the prerogative of only old imperialist powers of the rich North. In fact, countries such as Brazil, Russia, India, China, and Turkey, long shackled by communism, state socialism, or isolationist authoritarian governments, are not only playing host to foreign direct investors but are themselves becoming the proud homes of emerging-market multinationals: China-based Lenovo acquired IBM's PC business in 2005, and Indian Tata Motors took over the iconic British Jaguar and Land Rover in 2009, while China's Haier became one of the key global players in the white goods industry and Brazil-based Embraer competes head-on with Boeing and Airbus. But why do firms venture into distant and often unfriendly lands? There are at least three major motivations for doing so:

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INTERNATIONAL CORPORATE FINANCE IN PRACTICE 1.1

What Are Multinational Corporations (MNCs)?

A multinational corporation is a parent company...