International Finance and Globalization

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Questions and Answers

What does political risk primarily result from?

Technological advancements

Government policy alterations (correct)

Market competition

Changes in global economic conditions

Which of the following is NOT considered a market imperfection?

Transaction costs

Information symmetry (correct)

Discriminatory taxation

Legal restrictions

What was a significant change that Nestlé implemented regarding its shares?

Increased prices of registered shares

Completely abolished bearer shares

Allowed foreigners to hold registered shares (correct)

Restricted Swiss residents from owning bearer shares

How can multinational corporations expand their opportunity set?

By locating production globally to increase performance Signup and view all the answers

Which factor can restrict investors from effectively diversifying their portfolios?

High transaction costs Signup and view all the answers

Why are countries without a tradition of rule of law particularly risky for investors?

Investors' rights may not be effectively protected Signup and view all the answers

What generally characterizes the behavior of foreign investors concerning political risks?

They tend to avoid investing in politically unstable regions Signup and view all the answers

What is one motivation for multinational corporations to locate production overseas?

To maximize economies of scale Signup and view all the answers

Which country had the highest exports as a percentage of GDP in 2020?

Thailand Signup and view all the answers

What was the primary purpose of the General Agreement on Tariffs and Trade (GATT)?

To eliminate trade barriers among member countries Signup and view all the answers

Which trade agreement replaced NAFTA in 2018?

U.S.-Mexico-Canada Agreement Signup and view all the answers

In which year did China join the World Trade Organization (WTO)?

2001 Signup and view all the answers

What global event was primarily triggered by the subprime mortgage crisis in the U.S.?

The Great Recession Signup and view all the answers

What key issue stalled the WTO’s latest round of trade talks, known as the Doha Round?

Disagreements between developed and developing nations Signup and view all the answers

Which of the following statements about trade liberalization is true?

NAFTA aimed to reduce trade impediments over 15 years Signup and view all the answers

What is the fundamental goal of sound financial management?

Shareholder wealth maximization Signup and view all the answers

How are shareholders viewed in Continental Europe compared to the U.S.?

As one of many stakeholders Signup and view all the answers

What is a major characteristic of a multinational corporation (MNC)?

It has production and sales operations in multiple countries Signup and view all the answers

What is referred to as the 'agency problem' in corporate governance?

Managers pursuing personal interests over shareholders' interests Signup and view all the answers

Which of the following factors contributed to the emergence of globalized financial markets?

Technological advancements Signup and view all the answers

What is one of the main goals of global financial managers?

To minimize risks while maximizing benefits Signup and view all the answers

How did the global financial crisis of 2008-2009 affect international finance?

It caused significant distrust in financial systems Signup and view all the answers

What role does corporate governance play in a public corporation?

Regulating the relationship between management and shareholders Signup and view all the answers

What is one of the primary risks associated with international finance that does not typically affect domestic finance?

Foreign exchange risk Signup and view all the answers

Which of the following best describes the term 'expanded opportunity set' in international finance?

Access to a wider range of investment options across different countries Signup and view all the answers

What impact does foreign exchange risk have on economic functions such as investment and consumption?

It influences future profitability and purchasing power across borders Signup and view all the answers

After an investment in Toyota shares valued in yen sees a 10% increase, what happens when the yen depreciates significantly?

The investment loses value in dollar terms despite the share price increase Signup and view all the answers

What is one of the primary reasons fixed exchange rates were abandoned in the early 1970s?

To allow greater flexibility against market fluctuations Signup and view all the answers

Political risks in international finance primarily refer to which of the following?

The impact of governmental policies on business operations Signup and view all the answers

What is one consequence of appreciating a domestic currency against a foreign currency?

Foreign investments yield lower returns when repatriated Signup and view all the answers

How do market imperfections influence international finance?

They lead to inefficiencies in the allocation of resources Signup and view all the answers

How do MNCs typically benefit from economy of scale?

By pooling their global purchasing power over suppliers Signup and view all the answers

What is the primary effect of privatization on state-owned enterprises?

It improves efficiency and reduces operating costs Signup and view all the answers

What do 'A-shares' on Chinese stock exchanges primarily represent?

Shares reserved for Chinese citizens Signup and view all the answers

In terms of international trade, what is the theory of comparative advantage primarily concerned with?

Mutual benefit from specialization and trade Signup and view all the answers

What impact did China’s issuance of stock for state-owned enterprises have on privatization?

It marked a significant step toward private ownership Signup and view all the answers

What is often associated with the privatization of state-owned businesses?

Increased hard-currency foreign reserves Signup and view all the answers

How does trade liberalization enhance the welfare of world citizens?

By promoting specialization and comparative advantage Signup and view all the answers

Which of the following statements about MNCs is incorrect?

They often operate only in developing countries. Signup and view all the answers

Study Notes

Globalization and the Multinational Firm

International Finance is crucial to understand globalized markets
The global economy is highly integrated in markets for goods and services, as well as financial markets
Major economic functions (consumption, production, investment) are globalized
International finance differs from domestic finance due to four main factors:
- Foreign exchange risk: profits in a foreign currency can be lost due to unpredictable exchange rate movements
- Political risk: sovereign countries can change the "rules of the game" affecting businesses and investors
- Market imperfections: frictions like legal restrictions, transaction/transport costs, information asymmetry, and discriminatory taxation prevent free movements of people, goods, services, and capital
- Expanded opportunity set: enables firms to locate production globally to maximize performance, benefit from economies of scale, and raise funds in any market to lower capital costs; also allows investors to diversify internationally to potentially reduce risk or increase return
Fixed exchange rates were abandoned in the early 1970s
Goals of international financial management are similar across many countries, but sometimes shareholder wealth maximization isn't the only concern worldwide

Overview of International Financial Management

The goal of sound financial management is to maximize shareholder wealth
Different countries have different perspectives.
- Continental Europe: shareholders are viewed as one stakeholder among many (and this includes employees, suppliers, customers, and banks)
- Japan: maximizing value and growth of keiretsu firms

Corporate Governance

Managers may pursue their own private interests
Agency problems can be a weakness, particularly where legal protection of shareholders is weak or nonexistent
Governance is the financial and legal framework regulating the relationship between a firm's management and its shareholders

Globalization of the World Economy

Major Trends & Developments:
- Emergence of globalized financial markets
- Rise of multinational corporations
- Privatization
- Trade liberalization and economic integration
- Global financial crisis of 2008-2009

Emergence of Globalized Financial Markets

Factors contributing to globalized financial markets:
- Deregulation of financial markets
- Financial innovations (currency futures & options, multi-currency bonds, cross-border stock listings, international mutual funds)
- Advances in technology

Multinational Corporations

A MNC is a firm incorporated in one country with production and sales operations in others
MNCs gain several advantages from economies of scale
- Spreading R&D, advertising costs over global sales
- Pooling global purchasing power
- Utilizing technology/management globally
- Access to underpriced labor or special R&D in certain countries

Privatization

Privatization is when a country divests itself of business ventures to the free market
May be seen as denationalization
Selling state-owned businesses helps bring in foreign currency reserves
Generally seen as reducing bureaucratic inefficiency and waste
May improve efficiency by up to 20%

Trade Liberalization and Economic Integration

At the Global Level:
- General Agreement on Tariffs and Trade (GATT), founded in 1947, reduced trade barriers
- The World Trade Organization (WTO) replaced GATT, having stronger enforcement power
- China joined WTO in 2001
- Doha Round (WTO talks) stalled amid developed-developing country disagreements
At the Regional Level:
- European Union (EU) eliminated barriers to free flow of goods, capital, and people
- North American Free Trade Agreement (NAFTA) phased out trading impediments between Canada, Mexico, and the US, later replaced by the USMCA

Global Financial Crisis of 2008-2009

Started from the subprime mortgage crisis in the US
Factors that drove the crisis include excessive borrowing and risk-taking by households and financial institutions
Securitization (transferring risk to parties other than originators by converting ownership of financial assets into securities) amplified the global crisis
Led to poor lending standards, increasing moral hazard

Optional Reading

Cheol Eun, Bruce Resnick, and Tuugi Chuluun, "International Financial Management," 10th edition, 2024, Chapter 1

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Description

This quiz explores the key concepts of international finance and the factors that differentiate it from domestic finance. Understand the major aspects of globalization that impact multinational firms, including foreign exchange risk, political risk, and market imperfections. Test your knowledge on how these factors influence global economic functions.