International Financial Management, 6th Edition
By Jeff Madura and Roland Fox
Contents:
About the authors iv
Preface xiv
PART I The international
financial environment 1
1 Multinational
financial management:
an overview 2
Understanding the context 2
Goal of the MNC 3
Conflicts with the MNC goal 3
Agency theory 3
External influences 7
Constraints interfering with the MNC’s goal 9
International business methods 10
International trade 10
Licensing 10
Franchising 11
Joint ventures 11
Acquisitions of existing operations 11
Establishing new foreign subsidiaries 12
Special Purpose Vehicles 12
Summary of methods 13
Exposure to international risk 13
Exposure to exchange rate movements 13
Exposure to foreign economies 14
Exposure to regulatory risk 14
Overview of an MNC’s cash flows 16
Host country MNC relationships 18
MNC valuation 19
Stock market valuation 19
Valuation in the accounts 19
Financial academic models 20
Organization of the text 21
Summary 22
Critical debate 23
Self test 23
Questions and exercises 23
Endnotes 25
BLADES PLC CASE STUDY: Decision to
expand internationally 26
SMALL BUSINESS DILEMMA: Developing
a multinational sporting goods industry 27
2 International trade and investment:
measurement and theories 29
Balance of payments 30
Why the balance of payments balances 31
The IMF presentation of the balance of payments 32
Understanding the balance of payments 34
International trade and investment flows 36
Direction of trade 37
Trade and investment agreements 37
Trade disputes 39
Factors affecting international trade flows 42
Impact of inflation 42
Impact of national income 42
Impact of government restrictions 42
Impact of exchange rates on MNCs 44
The Marshall Lerner conditions* 44
Interaction of factors 48
Correcting a balance of trade deficit 48
Why a weak home currency is not a perfect
solution 49
International capital flows 50
Factors affecting foreign direct investment 52
Factors affecting international portfolio investment 53
Economic theories of international trade and
investment 54
Agencies that facilitate international flows 58
International Monetary Fund 58
World Bank 60
World Trade Organization 61
International Financial Corporation 61
International Development Association 61
Bank for International Settlements 61
Regional development agencies 62
BRICS 62
Summary 62
Critical debate 63
Self test 63
Questions and exercises 64
Endnotes 64
BLADES PLC CASE STUDY: Exposure to
international flow of funds 66
SMALL BUSINESS DILEMMA: Developing
a multinational sporting goods industry 67
3 International financial markets
and portfolio investment 68
Functions of a financial market 69
Motives for using international financial markets 69
Motives for investing in foreign markets 69
Motives for providing credit in foreign markets 70
Motives for borrowing in foreign markets 70
Foreign exchange market 71
Foreign exchange transactions 71
Understanding the exchange rate 74
Currency pairs quote – standard notation 75
Avoiding currency conversion errors 75
Direct and indirect quotations 76
Currency futures and options markets 81
International money market 82
Origins and development 83
The rise of the Eurodollar 85
Central Bank Digital Currency (CBDC) and MNC
payments 85
Standardizing global bank regulations 87
International credit market 88
Syndicated loans 89
International bond market 89
Eurobond market 89
Development of other bond markets 90
Comparing interest rates between currencies 91
International stock markets 92
Issuance of foreign shares in the US 92
Issuance of shares in foreign markets 93
International financial markets and the MNC 94
Market efficiency and the efficient markets
hypothesis 95
Summary 102
Critical debate 102
Self test 103
Questions and exercises 103
Endnotes 105
BLADES PLC CASE STUDY: Decisions to
use international financial markets 106
SMALL BUSINESS DILEMMA: Developing
a multinational sporting goods industry 107
APPENDIX 3: Portfolio investment 108
4 International ethical concerns:
the Green movement, Islamic
finance and globalization 123
What are ethics? 124
The importance of ethical issues 124
Poor regulation of markets 127
The Green movement 128
Islamic finance 131
The ethical arguments of capitalist interest
rates 132
Islamic finance principles 132
Prohibitions and encouraged practices 133
Islamic financial transactions 134
Globalization and its discontents 135
Globalization 135
Discontent 136
Corporate Social Responsibility (CSR) and Socially
Responsible Investment (SRI) 138
International corporate governance 139
Corporate governance and outside parties 139
Differing control structures 140
Why do governance structures differ? 140
Summary 141
Critical debate 141
Self test 142
Questions and exercises 142
Endnotes 143
BLADES PLC CASE STUDY: Ethical debate 144
SMALL BUSINESS DILEMMA: Obtaining
finance 145
Part I: Integrative problem 146
Part I: Essays/discussion and academic
articles 147
PART II Exchange rate
behaviour 149
5 Exchange rate changes 150
Measuring exchange rate movements 151
Exchange rate movements – an overview 152
Demand for a currency 153
Supply of a currency for sale 153
Equilibrium 154
Factors that influence exchange rates 155
Relative inflation rates 155
Relative interest rates 156
Relative income levels 158
Government controls 159
Expectations 160
Speculation 161
Order flow models 161
Interaction of factors 162
Speculating on anticipated exchange rates 164
Summary 166
Critical debate 167
Self test 167
Questions and exercises 167
Endnotes 169
BLADES PLC CASE STUDY: Assessment
of future exchange rate movements 170
SMALL BUSINESS DILEMMA: Assessment
by the Sports Exports Company of factors
that affect the British pound’s value 171
6 Exchange rate
history and the role
of governments 172
Exchange rate systems 173
Fixed exchange rate system 173
Managed float exchange rate system 175
Pegged exchange rate system 176
Currency boards 176
Dollarization 178
Freely floating exchange rate system 178
The concept of an optimal currency area* 180
Classification of exchange rate arrangements 181
Government intervention – the process 183
Reasons for government intervention 183
Direct intervention 184
Indirect intervention 187
Exchange rate target zones 188
Intervention as a policy tool 189
Influence of a weak (relatively low value) home
currency on the economy 189
Influence of a strong home currency on the
economy 189
Balassa Samuelson effect 190
The law of comparative advantage? 191
The trilemma of government policy choice 191
A brief history of exchange rates 192
Summary 207
Critical debate 207
Self test 208
Questions and exercises 208
Endnotes 209
BLADES PLC CASE STUDY: Assessment of
government influence on exchange rates 211
SMALL BUSINESS DILEMMA: Assessment
of central bank intervention by the Sports
Exports Company 212
7 Forecasting exchange rates 213
Why firms forecast exchange rates 214
Forecasting techniques 217
Market efficiency 217
Fundamental forecasting 221
Market-based forecasting 226
Mixed forecasting 228
Forecasting services 229
Performance of forecasting services 229
Evaluation of forecast performance 229
Forecast accuracy over time 230
Statistical test of forecasts – the de-trending
problem 231
Should MNCs make exchange rate forecasts? 232
Methods of forecasting exchange rate volatility 235
Summary 236
Critical debate 237
Self test 237
Questions and exercises 238
Endnotes 239
BLADES PLC CASE STUDY: Forecasting
exchange rates 240
SMALL BUSINESS DILEMMA: Exchange
rate forecasting by the Sports
Exports Company 241
8 International arbitrage and
covered interest rate parity 242
International arbitrage 243
Locational arbitrage 243
Triangular arbitrage 246
Covered interest arbitrage 249
Summary of arbitrage effects 250
Interest rate parity (IRP) 251
Derivation of interest rate parity 251
Determining the forward premium 251
The approximate relationship between forward
premium and interest rate differential 252
Graphic analysis of interest rate parity 253
Interpretation of interest rate parity 254
Does interest rate parity hold? 255
Considerations when assessing interest rate parity 256
Summary 258
Critical debate 258
Self test 259
Questions and exercises 259
Endnote 261
BLADES PLC CASE STUDY: Assessment
of potential arbitrage opportunities 262
SMALL BUSINESS DILEMMA: Assessment
of prevailing spot and forward rates by the
Sports Exports Company 263
9 Relationships between
inflation, interest rates and
exchange rates 264
Purchasing power parity (PPP) 265
Interpretations of purchasing power parity 265
Power parity theory – an informal approach 266
Derivation of purchasing power
parity – a more formal approach 267
Using PPP to estimate exchange rate effects 269
Graphic analysis of purchasing power parity 270
Testing the purchasing power parity theory 271
Why purchasing power parity does not occur 272
The real exchange rate 273
Purchasing power parity in the long and short run 275
Commodity currencies 277
International Fisher effect (IFE) 278
Relationship with purchasing power parity 278
Implications of the IFE for the foreign investment
market 279
Derivation of the international Fisher effect 281
Tests of the international Fisher effect 282
Comparison of the IRP, PPP and IFE theories 283
Summary 284
Critical debate 285
Self test 285
Questions and exercises 286
Endnotes 287
BLADES PLC CASE STUDY: Assessment
of purchasing power parity 288
SMALL BUSINESS DILEMMA: Assessment
of the IFE by the Sports Exports Company 289
APPENDIX 9*: Further notes on exchange rate
models 290
Part II: Integrative problem 293
Part II: Essays/discussion and academic
articles 294
PART III Exchange rate
risk management 295
10 Measuring exposure to exchange
rate fluctuations 296
Is exchange rate risk relevant? 297
Purchasing power parity argument 297
The investor/stakeholder hedge argument 297
Currency diversification argument 297
Creditor argument 298
The size argument 298
MNC response 298
Types of exposure 299
Transaction exposure 299
Estimating ‘net’ cash flows in each currency 299
Measuring the potential impact of the currency
exposure 301
Assessing transaction exposure based on
value-at-risk* 306
Economic exposure 309
Economic exposure of domestic firms 311
Measuring economic exposure 311
Translation exposure 315
Does translation exposure matter? 316
Determinants of translation exposure 316
Summary 318
Critical debate 318
Self test 318
Questions and exercises 319
BLADES PLC CASE STUDY: Assessment
of exchange rate exposure 321
SMALL BUSINESS DILEMMA: Assessment
of exchange rate exposure by the Sports
Exports Company 322
11 Market insurance: currency
derivatives 323
Overview 324
Forward market 324
How MNCs use forward contracts 324
Non-deliverable forward contracts 331
Currency futures market 332
Contract specifications 333
Trading futures 334
Pricing currency futures 338
How firms use currency futures 338
Currency swap market 339
Currency options market 342
Option exchanges 343
Over-the-counter market 343
Currency call options 344
Factors affecting currency call option premiums 345
How firms can use plain vanilla currency
call options 347
Speculating with currency call options 349
Further points 350
Currency put options 351
Factors affecting currency put option premiums 352
Hedging with currency put options 353
Speculating with currency put options 353
Contingency graphs for currency options 356
Contingency graphs for call options 356
Contingency graphs for put options 357
Lowering the cost of options: conditional
and barrier options and collars* 359
Conditional currency options 359
Barrier options 360
Collars 361
Option types 363
European and American currency options 363
Asian options 363
Options in emerging market economies 363
Cross-hedging 363
Financial management of derivatives for
non-financial companies 364
Summary 365
Critical debate 365
Self test 365
Questions and exercises 366
Endnotes 368
BLADES PLC CASE STUDY: Use of currency
derivative instruments 369
SMALL BUSINESS DILEMMA: Use of currency
futures and options by the Sports Exports
Company 370
APPENDIX 11A*: Currency option pricing 371
APPENDIX 11B: Currency option
combinations 373
12 Non-market methods of
transaction management 377
Transaction exposure 378
Identifying net transaction exposure 378
Non-market methods for reducing transaction
exposure 378
Market methods for reducing transaction
exposure 383
Futures hedge 384
Forward hedge 384
Currency option hedge 387
Comparison of hedging techniques 389
Hedging policies of MNCs 397
Limitations of hedging 398
Limitation of hedging an uncertain amount 398
Limitation of repeated short-term hedging 399
Hedging long-term transaction exposure 400
Long-term forward contract 401
Currency swap 401
Parallel loan 402
Borrowing policy 402
Cross-hedging 402
Summary 403
Critical debate 403
Self test 404
Questions and exercises 404
BLADES PLC CASE STUDY: Management of
transaction exposure 410
SMALL BUSINESS DILEMMA: Hedging
decisions by the Sports Exports Company 411
APPENDIX 12: Calculating the optimal size
of a cross-currency hedge: the hedge ratio 412
13 Economic and translation
exposure management 414
Economic exposure 415
Use of the income statement to assess economic
exposure 416
How restructuring can reduce economic exposure 418
Issues involved in the restructuring decision 420
A case study in hedging economic exposure 421
Silverton Ltd’s dilemma 422
Assessment of economic exposure 422
Assessment of each unit’s exposure 423
Identifying the source of the unit’s exposure 423
Possible strategies to hedge economic exposure 424
Silverton’s hedging solution 425
Limitations of Silverton’s optimal hedging
strategy 426
Hedging exposure to fixed assets 426
Managing translation exposure 426
Limitations of hedging translation exposure 428
Summary 429
Critical debate 429
Self test 429
Questions and exercises 430
Endnote 431
BLADES PLC CASE STUDY: Assessment of
economic exposure 432
SMALL BUSINESS DILEMMA: Hedging the
Sports Exports Company’s economic
exposure to exchange rate risk 433
Part III: Integrative problem 434
Part III: Essays/discussion and academic
articles 435
PART IV Long-term asset
and liability management 437
14 Foreign direct investment 438
The big picture 439
Investment appraisal – the modern approach 439
Net present value 440
Real options 442
Game theory and strategy 443
A combined view 444
Motives for foreign direct investment 445
Firm-specific advantages (ownership) 445
Internalization advantages 445
Country-specific advantages 446
Benefits of international diversification 448
Diversification analysis of international projects 449
Diversification among countries 451
Host government views of foreign direct
investment 452
The bargaining model 453
Investment agreements 455
The Multilateral Agreement on Investment (MAI) 455
Subsidiary versus parent perspective 459
Tax differentials 459
Restricted remittances 459
Excessive remittances 459
Exchange rate movements 459
Summary of factors 460
Empirical studies 461
Internalization 461
Exchange rates 461
Taxes 461
Institutions 462
Tariffs 462
Trade effects 462
Summary 462
Critical debate 463
Self test 463
Questions and exercises 463
Endnotes 465
BLADES PLC CASE STUDY: Consideration
of foreign direct investment 466
SMALL BUSINESS DILEMMA: Foreign direct
investment decision by the Sports Exports
Company 467
APPENDIX 14: Incorporating international
tax laws in the investment decision 468
15 Country risk analysis 475
Why country risk analysis is important 476
Political risk factors 476
Attitude of consumers in the host country 477
Actions of host government 477
Blockage of fund transfers 479
Currency inconvertibility 479
War 479
Bureaucracy 480
Corruption 480
Financial risk factors 481
Indicators of economic growth 482
Types of country risk assessment 482
Macroassessment of country risk 482
Microassessment of country risk 483
Techniques to assess country risk 484
Checklist approach 485
Delphi technique 485
Quantitative analysis 485
Inspection visits 485
Combination of techniques 485
Measuring country risk 486
Variation in methods of measuring country risk 487
Using the country risk rating for
decision-making 489
Comparing risk ratings among countries 489
Market approach to country risk rating 489
Incorporating country risk in capital
budgeting 490
Adjustment of the discount rate 490
Adjustment of the estimated cash flows 490
How country risk affects financial decisions 491
Reducing exposure to host government
takeovers 492
Use a short-term horizon 492
Rely on unique supplies or technology 493
Hire local labour 493
Borrow local funds 493
Purchase insurance 493
Summary 494
Critical debate 494
Self test 494
Questions and exercises 495
Endnotes 496
BLADES PLC CASE STUDY: Country risk
assessment 497
SMALL BUSINESS DILEMMA: Country risk
analysis at the Sports Exports Company 498
16 Long-term financing 499
Long-term financing decision 500
Sources of equity 500
Sources of debt 500
Cost of debt financing 501
Measuring the cost of financing 502
Assessing the exchange rate risk of debt
financing 503
Use of exchange rate probabilities 503
Use of simulation 504
Reducing exchange rate risk 504
Offsetting cash inflows 504
Market methods 505
Currency swaps 505
Parallel loans 507
Diversifying among currencies 508
Interest rate risk from debt financing 509
The debt maturity decision 509
The fixed versus floating rate decision 511
Hedging with interest rate swaps 511
Plain vanilla swap 512
Project finance 515
Summary 516
Critical debate 516
Self test 517
Questions and exercises 517
BLADES PLC CASE STUDY: Use of long-term
foreign financing 519
SMALL BUSINESS DILEMMA: Long-term
financing decision by the Sports
Exports Company 520
Part IV: Integrative problem 521
Part IV: Essays/discussion and academic
articles 523
PART V Short-term asset
and liability management 525
17 Financing international trade 526
Payment methods for international trade 527
Prepayment 527
Letters of credit (L/C) 528
Drafts 528
Consignment 528
Open account 528
Trade finance methods 529
Accounts receivable financing 529
Factoring 529
Letters of credit (L/C) 529
Banker’s acceptance 533
Working capital financing 536
Medium-term capital goods financing (forfaiting) 537
Countertrade 537
Government agencies for international trade 538
Summary 539
Critical debate 539
Self test 540
Questions and exercises 540
BLADES PLC CASE STUDY: Assessment
of international trade financing in Thailand 542
SMALL BUSINESS DILEMMA: Ensuring
payment for products exported by the
Sports Exports Company 543
18 Short-term financing 544
Sources of short-term financing 545
Euronotes 545
Euro-commercial paper 545
Eurobank loans 545
Trade credit 545
Internal financing by MNCs 545
Why MNCs consider foreign financing 546
Foreign financing to offset foreign currency
inflows 546
Foreign financing to reduce costs 547
Determining the effective financing rate 548
The variance of the rate divided into currency
and exchange rate movements* 552
Criteria considered for foreign financing 552
Interest rates 552
Interest rate parity (IRP) 552
Exchange rate variation 552
Term, roll over risk and regulatory risk 553
Exchange rate forecasts 553
Actual foreign financing 555
Financing with a portfolio of currencies 556
Summary 558
Critical debate 558
Self test 558
Questions and exercises 559
BLADES PLC CASE STUDY: Use of foreign
short-term financing 561
SMALL BUSINESS DILEMMA: Short-term
financing by the Sports Exports Company 562
19 International cash management 563
Cash flow analysis – subsidiary perspective 564
Subsidiary expenses 564
Subsidiary revenue 564
Subsidiary dividend payments 564
Subsidiary liquidity management 565
Centralized cash management 565
Techniques to optimize cash flows 567
Accelerating cash inflows 567
Minimizing currency conversion costs 567
Managing blocked funds 570
Managing intersubsidiary cash transfers 570
Complications in optimizing cash flow 571
Company-related characteristics 571
Government restrictions 571
Characteristics of banking systems 571
Investing excess cash 571
How to invest excess cash 572
Centralized cash management 572
Diversifying cash across currencies 574
Dynamic hedging 574
Summary 575
Critical debate 575
Self test 576
Questions and exercises 576
BLADES PLC CASE STUDY: International
cash management 578
SMALL BUSINESS DILEMMA: Cash
management at the Sports
Exports Company 579
Part V: Integrative problem 580
Part V: Essays/discussion and academic
articles 582
20 Concluding comments 583
The significance of international financial
management 584
Summary of the book 584
Advances 584
Remaining issues 585
Endnotes 586
APPENDIX A: Answers to self-test questions 587
APPENDIX B: Statistics and project support 598
Glossary 610
Index 621
Online additional reading
1 Multinational restructuring
2 Multinational cost of capital and capital structure
3 Multinational capital budgeting
See the online resources