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Nov 10, 2013 (3 years and 8 months ago)

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Global Financial Management

UNIT 2: The Global Financial Environment

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Problems and Exercises

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Financial Management Overview


Globalization


Monetary Systems


Balance of Payments

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Financial Management

Financial Management

= How to make best financial
decisions for a business. Mostly related to

1.
Investing (“Capital Budgeting”)

2.
Dividend Policy

3.
Raising Necessary $$$ (“Capital Structure”)

4.
Working Capital Management

Why
Global

Financial Management
? Multinational
Corporations (MNCs) face unique challenges.

1.
Foreign Exchange (FX) Risk

2.
Country Risk

3.
Market Imperfections (e.g. trade barriers)

4.
Cultural and legal challenges

5.
Greater Opportunity Set

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Financial Management:

Main Areas of Decision
-
Making

Year
Revenue
Expenses
Net Income
Income Statement
Balance Sheet
Current Assets
Current Liabilities
Non-Current Liabilities
Owners' Equity
Non-Current Assets
3. Capital structure

Financing Activities
:
Cash from raising
money and paying
back banks and
investors.

4. Working Capital Management

Operating Activities
:

Cash to/from regular business
operations.


1.
Capital Budgeting

Investing Activities
:
Cash for the purchase
of fixed assets.

4. Dividend Policy

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Goal of “Business”

1.
Welfare Maximization.

2.
Wealth Maximization.

3.
Strategic Objectives (e.g. Market Share).

In making financial management decisions, whose interests
are/should be served?

1.
Stakeholders (banks, employees,
community, etc.)

2.
Business Groups (e.g. Japanese keiretsu).

3.
Shareholders (business owners).

4.
Inside Owners (e.g. family businesses).

What should be their objective?

Businesses don’t make decisions. People do!

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Globalization: Trends


Financial liberalization (e.g. London’s “Big Bang”).


Monetary liberalization (e.g. Thai baht float).


Global trade liberalization (negotiated through the WTO).


Regional trade blocks (e.g. ASEAN, NAFTA, the EU)


Privatization of state enterprises.


Technological improvements (e.g. internet) facilitating
globalization.

Several trends are facilitating globalization.

New Investment Policy Rules


Liberalization (78%)


Regulation (22%)

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Multinational Corporations (MNCs)

Most of the world’s largest corporations are
M
ulti
-
National
Corporations (MNCs)
, which are incorporated in one (“home”)
country, but have production facilities and sales in several foreign
countries. As MNCs expand abroad, they provide
foreign direct
investment (FDI)

to host foreign countries.

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MNCs: Sales and Profitability

* The UNCTAD report refers to MNCs as Trans
-
National Corporations (TNCs).

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Global Monetary Systems: Historical Eras

Though any country can adopt their own monetary policy, there
have been broad historical eras of monetary policies.


Metalism

(
pre
-
1870)


silver and/or gold coinage.


Gold Standard
(to 1914)


currencies pegged to gold.


Inter
-
War Period
(to 1944)


disparate policies to stabilize
economies.


Bretton Woods
(to 1972)


European currencies pegged
to US$; and US$ fixed to gold.


Flexible Exchange Rates
(post
-
1972)


Currencies not
backed by gold or silver; float in value against one
another.

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Bretton Woods

USA

US$35 = 1 oz. Gold

French
franc

German
d
-
mark

Par
Ffr
/US$

Par DM/US$

Problem:

(a)
USA imports
-
> gold reserve exports;

(b)
G
old reserve exports
-
> weak US$;

(c)
Weak US$
-
> collapse of system.

Though this system failed, the USA dollar (US$)
emerged as the #1 global reserve currency.

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Exchange Rate Regimes

Within a global flexible exchange rate system, individual countries
can establish their own regime. Regime types comprise:


No home currency (e.g. Panama uses US$).


Fixed exchange rate (e.g. China against US$).


Peg with bands (fixed against another currency, + or


a certain
percent).


Crawling peg (peg adjusted periodically).


Managed float (flexible
fx

rate, but government periodically
intervenes).


Free float (
fx

rate determined by market forces).

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Balance of Payments

The
Balance of Payments (
BoP
)
represents international
monetary flows. It consists of 3 main components.


The
Current Account (CA)


International trade in goods
and services.


The
Capital Account (KA)


international financial flows
(e.g. investments, loans, etc.)


Official Reserves


international currency held by the
central bank.

CA surplus = net exporter (foreign currency in)

CA deficit = net importer (foreign currency out)

(CA balance + KA balance) =
Δ

in official reserves.

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Balance of Payments and FX Rates

The Balance of Payments Identity:

(CA balance + KA balance) =
Δ

in official reserves.

Under a
flexible

exchange rate regime,


Δ

in official reserves = 0


FX rate adjusts so that CA balance = KA balance


Under a
fixed

exchange rate regime,


Δ

in official
reserves adjust to = (CA + KA)

Under a fixed regime, if (CA + KA) < 0 (i.e. in deficit), the
Δ

in
official reserves will be negative. If reserves fall too low, the
central bank will have to devalue (or float) the currency. FX
currency restrictions may also be imposed.

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Importance of the Capital Account (KA)

In some countries, financial flows through the capital account
may be larger than trade flows through the current account.

Capital Account

(financial), investing,
banking, etc.

Current Account

(trade), exports,
imports

Financial flows through the capital account can be short
-
term
(so
-
called “hot” money) and can change quickly. This can
create pressure on FX rate stability.

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Fixed FX Rates: Supply and Demand

In Thailand, the fixed FX rate was too high, causing official
reserves to leave the country to support the
BoP

deficit. This
can be displayed in a standard economic supply
-
demand
diagram.

Price
S (THB)
(THB/$)
26 THB/$
Fixed FX
D(THB)
Quantity (THB)
= Reserves Out
BoP Deficit
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FX Rates: Supply and Demand

In Thailand, after the baht was floated, it fell in value to 41 THB/$,
and the
BoP

deficit reversed itself.

Price
S (THB)
(THB/$)
26 THB/$
Current FX
Equil. FX
D(THB)
Quantity (THB)
Disappears
BoP Deficit
41 THB/$
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End of Unit 2 Questions and Problems

The following problems require the calculation of various statistics
using MS Excel. The problems are linked to actual Excel spreadsheets,
where students should do their work.

Directions:
Write a one or two paragraph story explaining what
happened during the “Tom Yum Kung Crisis” of 1997. Data courtesy
of the Bank of Thailand (www.BoT.or.th).

Dictionary

www.

BoT.or.th

1998
1997
1996
4.1 Export (BOP basis) (Billions of USD)
52.9
56.7
54.7
4.2 Import (BOP basis) (Billions of USD)
36.6
55.2
63.7
4.4 Current account balance (Billions of USD)
14.3
-3.1
-14.3
4.5 Net capital movement (Billions of USD)
-9.8
-4.3
19.5
4.6 Balance of payments (Billions of USD)
1.7
-10.6
2.2
4.7 International reserves (Billions of USD)
29.5
27.0
38.7
Baht : US$ (Reference rate) average (Baht : 1 USD)
41.37
31.37
25.34