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FIN 436

Terms in this set (111)

Direct foreign investment
Investments in fixed assets in foreign countries.

Portfolio investment
Transactions involving long term financial assets (such as stocks and bonds) between countries that do not affect the transfer of control.

Other capital investment
Transactions involving short-term financial assets (such as money market securities) between countries.

Errors and omissions and reserves
Measurement errors can occur when attempting to measure the value of funds transferred into or out of a country
Financial Account
Cost of ensuring that managers maximize shareholder wealth.
Agency Costs
Monitoring managers of distant subsidiaries in foreign countries is more difficult.

Foreign subsidiary managers raised in different cultures may not follow uniform goals.

Sheer size of larger MNCs can create large agency problems.

Some non-U.S. managers tend to downplay the short-term effects of decisions.
Costs for MNCs are higher than domestic firms
Establishing a centralized database of information
Ensuring that all data are reported consistently among subsidiaries
Implementing a system that automatically checks for unusual discrepancies relative to norms
Speeding the process by which all departments and subsidiaries have access to all the data they need
Making executives more accountable for financial statements
How SOX Improved Corporate Governance of MNCs
___ Allows managers of the parent to control foreign subsidiaries and therefore reduce the power of subsidiary managers.

_____ Gives more control to subsidiary managers who are closer to the subsidiary's operation and environment.
Centralized
Decentralized
Specialization increases production efficiency.

Factors of production are somewhat immobile, providing incentive to seek out foreign opportunities.

As a firm matures, it recognizes opportunities outside its domestic market
Theory of Competitive Advantage

Imperfect Markets Theory

Product Cycle Theory
International Trade
Licensing
Franchising
Joint Ventures
Acquisitions of Existing Operations
Establishment of New Foreign Subsidiaries
How Firms Engage in International Business
Relatively conservative approach that can be used by firms to:
penetrate markets (by exporting).
obtain supplies at a low cost (by importing).
Minimal risk — no capital at risk
International Trade
Obligates a firm to provide its technology (copyrights, patents, trademarks, or trade names) in exchange for fees or some other specified benefits.

Allows firms to use their technology in foreign markets without a major investment and without transportation costs that result from exporting.
Licensing
Obligates firm to provide a specialized sales or service strategy, support assistance, and possibly an initial investment in the franchise in exchange for periodic fees.

Allows penetration into foreign markets without a major investment in foreign countries.
Franchising
A venture that is jointly owned and operated by two or more firms. A firm may enter the foreign market by engaging in a joint venture with firms that reside in those markets.
Joint Ventures
Acquisitions of firms in foreign countries allows firms to have full control over their foreign businesses and to quickly obtain a large portion of foreign market share.

Subject to the risk of large losses because of larger investment.

Liquidation may be difficult if the foreign subsidiary performs poorly.
Acquisitions of Existing Operations
Firms can penetrate markets by establishing new operations in foreign countries.

Requires a large investment.

Acquiring new as opposed to buying existing allows operations to be tailored exactly to the firms needs.

May require smaller investment than buying existing firm.
Establishment of New Foreign Subsidiaries
Any method of increasing international business that requires a direct investment in foreign operations is referred to as
direct foreign investment (DFI)
Exposure to international economic conditions
international political risk
exchange rate risk
Uncertainty Surrounding MNC Cash Flows
If foreign currencies related to the MNC subsidiary weaken against the U.S. dollar, the MNC will receive a lower amount of dollar cash flows than was expected.
exchange rate risk
A foreign government may increase taxes or impose barriers on the MNC's subsidiary.
International political risk
If economic conditions in a foreign country weaken, purchase of products decline and MNC sales in that country may be lower than expected.
International economic conditions
A higher level of uncertainty increases the ____ required by investors and the MNC's valuation decreases.
ROI
summary of flow of funds due to purchases of goods or services or the provision of income on financial assets.

summary of flow of funds resulting from the sale of assets between one specified country and all other countries over a specified period of time.

refers to special types of investment, including DFI and portfolio investment.
current account

capital account

financial account
Payments for Goods and Services (service and merchandise; exports and imports)

Primary Income Payments

Secondary Income
Current Account
Originally included the financial account.

Includes the value of financial assets transferred across country borders by people who move to a different country.

Includes patents and trademarks.

Relatively minor(in terms of dollar amounts) to financial account.
Capital Account
Removal of the Berlin Wall
Single European Act of 1987
North American Free Trade Agreement (NAFTA)
General Agreement on Tariffs and Trade (GATT)
European Union
Inception of Euro
Events That Increased Trade Volume
The process of subcontracting to a third party in another country to provide supplies or services that were previously produced internally.
Outsourcing
The annual international trade volume of the United States is between ___ and ___% of its annual GDP.
10 20
Cost of Labor
Inflation
National Income
Credit Conditions
Government Policies
Factors Affecting International Trade Flows
The goal of a multinational corporation (MNC) is the maximization of shareholder wealth.
true
If managers of foreign subsidiaries make decisions that maximize the values of their respective subsidiaries, they automatically maximize the value of the entire corporation.
false
A centralized management style, where major decisions about a foreign subsidiary are made by the parent company, results in an automatic increase in agency costs.
false
A decentralized management style, where subsidiary managers make the relevant decisions regarding their subsidiary, may result in better decision making, as subsidiary managers are generally better informed about their subsidiary's operations.
true
The Sarbanes-Oxley Act ensures a more transparent process for managers to report on the productivity and financial condition of their firm.
true
The Theory of Comparative Advantage begins by assuming that a given firm first becomes established in its home country and may subsequently penetrate foreign markets via geographic or product differentiation.
false
Under the Product Cycle Theory, foreign demand can be initially satisfied by exporting.
true
In a joint venture, one firm is obligated to provide another firm with a specialized sales or service strategy in exchange for periodic fees.
false
International trade is the most common form of direct foreign investment (DFI).
false
Although MNCs may need to convert currencies occasionally, they do not face any exchange rate risk, as exchange rates are stable over time.
false
The goal of a multinational corporation (MNC) is
maximize shareholder wealth
Agency costs faced by multinational corporations (MNCs) may be larger than those faced by purely domestic firms because
large, monitoring, different cultures
Which of the following is not a form of corporate control that can be used to reduce agency problems in MNCs?
decentralized management style
Which of the following is not one of the more common methods used by MNCs to improve their internal control process?
consistent data reporting, more accountable execs, speeding the process by which all depts, centralized database of information
b. A U.S. firm manufacturing computers imports the needed components from Taiwan.
Theory of Comparative Advantage
a. A U.S. firm manufacturing widgets builds a plant in Mexico to reduce labor costs.
Imperfect Markets Theory
a. A U.S. firm manufacturing computers establishes a plant in Germany in order to reduce transportation costs and to retain its advantage over its German competitors.
Product cycle theory
The most risky method(s) by which firms conduct international business is (are):
c. [The acquisitions of existing operations.] and [The establishment of new subsidiaries.] only
The least risky method by which firms conduct international business is:
international trade
________ obligates a firm to provide a specialized sales or service strategy, support assistance, and possible an initial investment in exchange for periodic fees.
franchising
Which of the following is not mentioned in the text as a reason for the increased globalization of business?
a. An increased standardization of products and services across countries in recent years
Which of the following is not mentioned in the text as an additional risk resulting from international business?
financial risk
Which of the following is not an example of how an MNC can be affected by exchange rate movements?
c. Remitted earnings from the foreign subsidiary of a U.S.-based MNC may increase due to a stronger home currency.
The balance of payments measures all transactions between domestic residents over time.
false
Portfolio investment represents transactions involving long-term financial assets (such as stocks and bonds) between countries that affect the transfer of control.
false
A balance of trade deficit indicates an excess of imports over exports.
true
The capital account reflects changes in country ownership of long-term (but not short-term) assets.
false
An increase in the U.S. inflation rate relative to Japan would increase the U.S. current account balance, as foreign importers would find U.S. goods more attractive (cheaper) than their own products.
false
An expected strengthening of a country's home currency will attract more capital from foreign investors and thus improve the country's capital account balance.
false
In order to use the IMF's compensatory financing facility (CFF), a country must show that its financial problems are temporary and must be willing to work with the IMF in resolving the problem.
true
A special drawing right (SDR) is an actual currency used by Germany, France, Japan, and Britain to counteract the instability in these currencies.
false
The World Bank frequently enters into cofinancing agreements. Under these agreements, financing is provided by the World Bank and/or official aid agencies, export credit agencies, or commercial banks.
true
The capital account includes the value of financial assets transferred across country borders by people who move to a different country.
true
A summary of transactions between domestic and foreign residents for a specific country over a specified period of time is the
balance of payments
The ________ is the difference between exports and imports.
balance of trade
________ represent(s) income received by investors on foreign investments in financial assets (securities).
factor income
Included in the capital account are
c. Long-term and short-term direct foreign investment and trading of securities.
The current account balance is not directly affected by
interest rates
Which of the following factors does probably not directly affect a country's capital account and its components?
inflation
________ represent aid, grants, and gifts from one country to another.
d. Transfer payments
According to the "J curve effect," a weakening of the U.S. dollar relative to its trading partners' currencies would result in an initial ________ in the current account balance, followed by a subsequent ________ in the current account balance.
decrease increase
Which of the following would not result in a current account deficit?
low national income
An investor engaging in a transaction whereby he or she contracts to purchase British pounds one year from now is an example of a spot market transaction.
falst
A forward contract is an agreement between a firm and a bank to exchange currencies at a specified rate (the forward rate) in a specified number of days.
true
An MNC frequently uses either forward or futures contracts to hedge its exposure to foreign receivables. To do so, the MNC can either sell the foreign currency forward or sell futures contracts.
true
A currency put option provides the right, but not the obligation, to buy a specific currency at a specific price within a specific period of time.
false
The LIBOR varies among currencies because the market supply of and demand for funds vary among currencies.
true
An American Depository Receipt (ADR) is a drawing right, and it is available only for U.S. stocks.
false
With an ECN, investors can place orders on their computers that are then executed by the computer system and confirmed through the Internet to the investor.
true
Typically, a given stock will appear undervalued to investors from all countries at the same time.
false
The market in which the immediate exchange of currencies takes place is known as the ________ market.
spot
The market in which financial intermediaries transfer short-term funds from surplus units to deficit units is known as the ________ market.
international money
The average daily foreign exchange trading by banks around the world is closest to $________.
1.5 trillion
Which of the following is not a possible bid/ask quotation for the Barbados dollar?
$.52 / $.51
Assume a bank's bid rate for the Danish kroner (DKK) is $0.1875, while its ask rate is $0.1895. Assume you convert $1,000 to Danish kroner to take on your trip to Denmark. Immediately after conversion, a family emergency arises, and you are unable to go on your trip. Thus, you convert the Danish kroner back to dollars.

How many dollars will you have left after the two conversions?
d. $989.45
Assume a bank's bid rate for the Danish kroner (DKK) is $0.1875, while its ask rate is $0.1895. Assume you convert $1,000 to Danish kroner to take on your trip to Denmark. Immediately after conversion, a family emergency arises, and you are unable to go on your trip. Thus, you convert the Danish kroner back to dollars.

How many Danish kroner will you receive when converting the dollars initially?
a. 5,277.04
Assume a bank's bid rate for the Danish kroner (DKK) is $0.1875, while its ask rate is $0.1895. Assume you convert $1,000 to Danish kroner to take on your trip to Denmark. Immediately after conversion, a family emergency arises, and you are unable to go on your trip. Thus, you convert the Danish kroner back to dollars.

What is the bank's bid/ask percentage spread?
1.06%
Which of the following is probably not an example of the use of forward contracts by an MNC?
Hedging pound payable by selling pound forward
A quotation representing the value of a foreign currency in dollars is referred to as a(n) ________ quotation; a quotation representing the number of units of a foreign currency per dollar is referred to as a(n) ________ quotation.
c. Direct; indirect
A bond sold in countries other than the country represented by the currency denominating it is known as a:
Eurobond
Which of the following is not a reason why an MNC may decide to issue stock in a foreign country?
a. Regulations in the market in which the stock is to be issued are more stringent than regulations in the home market.
A share of the ADR of the German firm Bergerschnus represents one share of this firm's stock that is traded on the Frankfurt Stock Exchange. The share price of Bergerschnus was 30 euros when the Frankfurt exchange closed. When the U.S. market opens, the euro is worth $1.15.

The price of the ADR should be

If the Bergerschnus ADR is convertible into three shares of stock, the ADR price would be:
$34.50

$103.50
When the Japanese yen appreciates against the U.S. dollar, this means that the U.S. dollar is strengthening relative to the yen.
false
The changes in a currency's value can have a major impact on costs and revenues of MNCs.
true
Illiquid currencies tend to exhibit less volatile exchange rate movements than liquid currencies.
false
An increase in U.S. inflation relative to Singapore inflation places upward pressure on the Singapore dollar.
true
When expecting a foreign currency to depreciate, a possible way to speculate on this movement is to borrow dollars, convert the proceeds to the foreign currency, lend in the foreign country, and use the proceeds from this investment to repay the dollar loan.
false
The equilibrium exchange rate for a foreign currency is determined by the intersection of the supply and demand curves of that currency.
true
Movements in U.S. inflation rates and interest rates will always have an effect on a currency's value, no matter what the inflation rates and interest rates are in the foreign country.
false
If the British government desires an appreciation in its currency with respect to the U.S. dollar, it would consider intervening in the foreign exchange market by buying dollars with pounds.
false
Although existing and observable factors can always be used to predict currency movements, institutional investors often take currency positions based on anticipated interest rate movements.
false
Country X frequently engages in trade flows with the U.S. (such as imports and exports). Country Y frequently engages in financial flows with the U.S. (such as financial investments). Everything else held constant, an increase in U.S. interest rates would affect the exchange rate of Country X's currency more than the exchange rate of Country Y's currency.
false
A decline in a currency's value is known as ________.
depreciation
The Norwegian kroner's (NOK) value yesterday was $0.08133. Today, its value is $0.08006. Thus, the kroner ________ by ________ percent.
c. Depreciated; 1.56
The demand curve for a currency is ________, while the supply curve for a currency is ________.
a. Downward sloping; upward sloping
The equilibrium exchange rate is the price of a currency at which its supply is ________ its demand.
EQUAL TO
If a currency's spot market is liquid, its exchange rate will ________ highly sensitive to a single large purchase or sale of the currency. Therefore, the change in the equilibrium exchange rate will be relatively ________.
not be small
Illiquid currencies tend to exhibit ________ volatile exchange rate movements, as the equilibrium prices of their currencies adjust to ________ changes in supply and demand conditions.
more even minor
Which of the following events would most likely result in an appreciation of the U.S. dollar?
a. The Fed indicates that it will raise U.S. interest rates.
Which of the following interactions will likely have the least effect on the dollar's value? Assume everything else is held constant.
a. An increase in U.S. inflation accompanied by an increase in nominal, but not real, U.S. interest rates
Assume that Britain and the U.S. conduct a large volume of international trade, but rarely engage in financial flows. Conversely, Japan and the U.S. conduct a large volume of financial flow transactions, but rarely engage in trade flows. Under this scenario, everything else held constant, a change in the U.S. ________ would affect the value of the pound, and a change in the U.S. ________ would affect the value of the yen.
inflation rate; interest rate
A speculator expecting an appreciation in the Thai baht would begin his or her transaction by:
borrowing dollars
Piggy Bank can borrow either $20 million or C$30 million. Furthermore, Piggy Bank expects the spot rate of the Canadian dollar to be $0.82 in 60 days (the current spot rate is $0.80).

What amount will the borrowed amount convert to today?
C$25 million
Piggy Bank can borrow either $20 million or C$30 million. Furthermore, Piggy Bank expects the spot rate of the Canadian dollar to be $0.82 in 60 days (the current spot rate is $0.80).

What is the profit or loss from Piggy Bank's speculation if the spot rate 60 days from now is indeed $0.82?
479,667
If a country experiences high inflation relative to the U.S., its exports to the U.S. should ________, its imports should ________, and there is ________ pressure on its currency's equilibrium value.
decrease; increase; downward
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