INTERNATIONAL

BUSINESS FINANCE
FINS3616

BY: MISHAL MANZOOR

m.manzoor@unsw.edu.au
Attendance and participation will only be recorded in your enrolled
Tutorial!

Assessment Structure

ASSESSMENT DUE DATE PERCENTAGE

Tutorial Ongoing 15%
Participation &
Homework
Online Ongoing 5%
Contributions
Online Tests Week 4 & 7 40%
Final Exam Exam Period 40%
❑ In each regular tutorial session, I will be preparing tutorial
slides for you and will create opportunities for you to
participate.

❑ We will discuss assigned Textbook Questions in each week.

❑ By the end of each week, I will share my Tutorial Discussion

Slides with you all via your emails (before Saturday 5pm).

❑ Your attendance & participation will only be recorded in your

ENROLLED tutorial, unless by PRIOR email arrangement with
your tutor. You cannot just show up to another tutorial
session.
❑ Come well prepared before your tutorial session;

❑ Don’t guess answers while participating in tutorial session;

❑ Give a reasonable and thoughtful explanation while

answering if you want to secure your marks for participation;

❑ The only real guaranteed way to maximize your participation

grade is to participate in Every tutorial week across the
semester;
❑ My job as a tutor is to make as many opportunities for you
students to participate in class as possible while teaching
you the course material through the assigned homework
questions;

❑ And of course to record your participation and attendance

accurately each week; and plus
❑ In case you have any questions regarding anything, you may
send me an email on this address:
“m.manzoor@unsw.edu.au”

❑ When you email me PLEASE include the following

information so that I can properly locate you:

❑ Correct Tutorial Class in which you are officially enrolled

❑ Your Full Name

❑ Your Student Number

❑ Please use professional email address for correspondence

Q1(a): What are the various categories of multinational firms?

ANSWER:

1. Raw materials seekers

2. Market seekers
3. Cost minimizers
Q1(b): What is the motivation for international expansion of firms
within each category?

ANSWER:

❑ The raw materials seekers go abroad to explore raw materials

over there e.g. the multinational oil and mining companies

❑ Market seekers go overseas to produce and sell in foreign

markets e.g. Unilever, Proctor & Gamble

❑ The cost minimizers invest in lower cost production sites or

production technologies overseas in order to remain cost
competitive e.g. Apple, Zara
Other Motivations:

❑ Knowledge seeking: gain information e.g. production

processes in terms of technology, foreign innovation
❑ Following Domestic customers: trying to deliver services to
customers abroad
❑ Exploiting financial market imperfections: reduce taxes
Q10: Is there any reason to believe that MNCs may be less risky
than purely domestic firms? Explain.

ANSWER:

❑ Yes. International diversification may actually allow firms to

reduce the total risk they face.

❑ Much of the general market risk facing a company is related

to the cyclical nature of the domestic economy of the home
country.

❑ Operating in a number of nations whose economic cycles are

not perfectly in phase may, therefore, reduce the overall
variability of the firm's earnings.
Q2(a): How does foreign competition limit the prices that
domestic companies can charge and the wages and benefits
that workers can demand?

ANSWER:

❑ As domestic producers raise their prices, customers begin

substituting less expensive goods and services supplied by
foreign producers. The likelihood of losing sales limits the
prices that domestic firms can charge.

❑ Foreign competition also acts to limit the wages and benefits

that workers can demand.

❑ If workers demand more money, firms have two choices.

Accept or fight worker demands.
❑ If no foreign competition, the cost of accepting the demand is
relatively low. Since all firms will face the same higher costs,
they can cover these higher costs by raising prices.

❑ Foreign competition changes the picture since foreign firms'

costs will be unaffected by higher domestic wages and
benefits. If domestic firms accept workers demand, foreign
firms will underprice them in the market and take market
share away.

❑ Recognizing this, domestic firms facing foreign competition

are more likely to fight worker demands for higher wages and
benefits.
Q2(b): What political solutions can help companies and unions
avoid the limitations imposed by foreign competition?

ANSWER:

❑ The classic political solution is protectionism. By limiting

foreign competition, either through tariffs or quotas,
companies and workers limit the ability of foreign goods to
restrain domestic price increases.

❑ The government can also subsidize domestic firms in

competing against foreign firms.
Q2(c): Who pays for these political solutions? Explain.

ANSWER:

❑ Consumers pay for protectionism in the form of higher prices

for their goods and service, fewer choices, and lower quality.

❑ These consumers include firms that use imports to produce

their own goods and services for sale.

❑ Taxpayers pay for subsidies in the form of higher taxes or

fewer of the other services provided by government.
Q7: A memorandum by Labor Secretary Robert Riech to
President Bill Clinton suggested that the government
penalize U.S. companies that invest overseas rather than at
home. According to Reich, this kind of investment hurts
exports and destroys well-paying jobs. Comment on this
argument.

ANSWER:

❑ The assumption underlying Secretary Reich's memo is

inconsistent with the empirical evidence.

❑ According to this evidence, U.S. companies that invest

abroad tend to expand their exports from the United States.
❑ The jump in exports stems from the fact that by investing
abroad, companies are able to expand their presence in
foreign markets as well as protect foreign markets that would
otherwise be lost to competitors.

❑ This enables them to sell more product, most of which is

made in the United States. In addition, the foreign plants tend
to use components and capital equipment that are mostly
made in and exported from U.S. plants.

❑ Penalizing U.S. companies that invest abroad as Secretary

Reich suggests would most likely lead to the loss of foreign
markets as well as the additional exports that such markets
generate.
Q3: Given the resources available to them, countries A and B can
produce the following combinations of steel and corn.

COUNTRY A COUNTRY B
Steel (tons) Corn Steel (tons) Corn
(bushels) (bushels)
36 0 54 0
30 3 45 9
24 6 36 18
18 9 27 27
15 12 18 36
6 15 9 45
0 18 0 54
3(a): Do you expect trade to take place between countries A and
B? Why?

ANSWER: YES.

For country A, the opportunity cost of producing 1 steel:

36 Steel (tons) = 18 Corn (bushels)

1 Steel (tons) = 18/36 Corn (bushels)
1 Steel (tons) = 1/2 Corn (bushels)

For country A, the opportunity cost of producing 1 corn:

18 Corn (bushels) = 36 Steel (tons)

1 Corn (bushels) = 36/18 Steel (tons)
1 Corn (bushels) = 2 Steel (tons)
For country B, the opportunity cost of producing 1 steel:

54 Steel (tons) = 54 Corn (bushels)

1 Steel (tons) = 54/54 Corn (bushels)
1 Steel (tons) = 1 Corn (bushels)

For country B, the opportunity cost of producing 1 corn:

54 Corn (bushels) = 54 Steel (tons)

1 Corn (bushels) = 54/54 Steel (tons)
1 Corn (bushels) = 1 Steel (tons)

These relative prices indicate that country A has a comparative

advantage in the production of steel, whereas country B has a
comparative advantage in the production of corn.
❑ High Opportunity cost is unfavourable

❑ Low Opportunity cost is favourable

3(b): Which country will export steel? Which will export corn?

ANSWER:

Given these comparative advantages:

A will export steel
B will export corn
Q1(A): What are the five basic mechanisms for establishing
exchange rates?

ANSWER:

The five basic mechanisms for establishing exchange rates are:

❑ free float
❑ managed float
❑ target-zone arrangement
❑ fixed-rate system
❑ current hybrid system
Q1(B): How does each work?

ANSWER:

❑ In a free float (clean float), exchange rates are determined by

the interaction of currency supplies and demands.

❑ In a managed float (dirty float), exchange rates are

determined by market forces with some central bank
intervention to reduce the economic uncertainty associated
with a free float.

❑ Under a target-zone arrangement, countries adjust their

national economic policies to maintain their exchange rates
within a specific margin around agreed-upon, fixed central
exchange rates.
❑ Under a fixed-rate system, such as the Bretton Woods
system, governments are committed to maintaining target
exchange rates. Each central bank actively buys or sells its
currency in the foreign exchange market whenever its
exchange rate threatens to deviate from its stated par value
by more than an agreed-on percentage.

❑ Currently, the international monetary system is a hybrid

system, with major currencies floating on a managed basis,
some currencies freely floating, and other currencies moving
in and out of various types of pegged exchange rate
relationships.
Q1(C): What costs and benefits are associated with each
mechanism?

ANSWER:

Benefits of a Floating Rate System:

❑ Helps to stabilize the economy and facilitate free trade;

❑ A negative shock in the economy leads to lower exchange
rate. A depreciation in currency will boost exports.
❑ Allow independent monetary policy.
❑ a floating rate system can also act as a shock absorber to
cushion real economic shocks that change the equilibrium
exchange rate.
Costs of a Floating Rate System:

❑ many economists point to excessive volatility as a major cost

of a floating rate system;
❑ More economic volatility and more risky business decisions
❑ the experience to date is that the dollar value fluctuation have
had little to do with actual inflation and a lot to do with
expectations of future government policies and economic
conditions;
Benefits of a Managed Float:

❑ the potential benefit of a managed float is that governments

intervene actively in the foreign exchange market to smooth
out exchange rate fluctuations in order to reduce the
economic uncertainty associated with a freely floating
exchange rate. (Countries intervene in the foreign exchange
market to smooth out temporary fluctuations by buying or
selling currency on the open market.)

Costs of a Managed Float:

❑ the costs of a managed float stem from the demonstrated

inability of governments to recognize the difference between
a temporary exchange rate disequilibrium and a permanent
one;
Costs of a Managed Float: CONT…..

❑ by trying to manage exchange rates when a permanent shift

in the equilibrium exchange rate has occurred, governments
run the risk of creating an exchange rate crisis and wasting
reserves.

Benefits of a Target Zone Arrangement:

❑ the experience with the European Monetary System is that the

target zone arrangement in effect forced convergence of
monetary policy to that of the country–Germany–with the most
disciplined anti-inflation policy and led to low inflation.
Costs of a Target Zone Arrangement:

❑ Allows for some exchange rate fluctuation (but intervention to

maintain rates within margins)
❑ maintaining a genuinely stable target zone arrangement
requires the political will to direct fiscal and monetary policies
at that goal and not at purely national ones;
❑ this turns out to be difficult for countries to achieve.
❑ In the case of the European Monetary System, the result was
periodic currency crises;
❑ Changing the target-zone or margin destroys credibility
Benefits of a Fixed Rate System:

❑ a permanently fixed exchange rate system–such as that

achieved by a currency board, dollarization, or euroization–
results in currency stability and the absence of currency
crises;
❑ Reduces economic volatility, benefits trade and investment
❑ in a system such as existed under Bretton Woods, where there
is a commitment to a fixed exchange rate system, but no
mechanism to bind that commitment, you will have more
monetary discipline than in a freely floating system and hence
lower inflation than might otherwise be the case.
Costs of a Fixed Rate System:

❑ No monetary independence – requires coordinated monetary

policies
❑ All members of the system must have same inflation rate;
❑ in a permanently fixed system, the exchange rate cannot
cushion the effects of real economic shocks, such as
devaluation of a major competitor’s currency;
❑ instead, prices must adjust;
❑ given the lack of flexibility of many prices–because of
government regulations or union restrictions–the result of
these economic shocks can be higher unemployment and less
economic growth;
Benefits of a Hybrid System:

❑ The current system gives countries the option to select the

system that best meets their needs. However, all too often, the
decision is based on political rather than economic
calculations. (Monetary independence)

Costs of a Hybrid System:

❑ The costs of a hybrid system, such as the one currently in

place, is that there is no constraint on the choices that
governments can make. The resulting choices can be good
ones or bad ones.
Q5:The experiences of fixed exchange-rate systems and target
zone arrangements have not been entirely satisfactory.

(A): What lessons can economists draw from the breakdown of

the Bretton Woods system?

ANSWER:

❑ Adjusting monetary growth rates is the principal way to

stabilize exchange rates. For example, raising the value of the
dollar relative to the yen requires tightening U.S. monetary
policy relative to Japanese monetary policy.

❑ The experience of Bretton Woods and similar experiments

demonstrates that conscious and explicit coordination of
monetary policies among sovereign authorities is difficult.
❑ The problem stems from the inability of sovereign authorities
to coordinate their monetary growth rates as each sovereign
country has its own targets for growth and inflation.
Therefore, their own independent assessment of the
macroeconomic policies is required to attain those targets.
(B): What lessons can economists draw from the exchange rate
experiences of the European Monetary System?

ANSWER:

❑ Exchange rate stability requires that monetary policies be

coordinated.

❑ Implementing target zones on a wider scale would be all the

more difficult.

❑ Differences in preferences, policy objectives, and economic

structures account in part for these difficulties.
❑ More fundamentally, however, coordination of macroeconomic
policies will not necessarily benefit all participant countries
equally, and those that benefit the most may not be willing to
compensate those that benefit least.

❑ Countries with appreciating currencies, trade surpluses, and

increasing reserves are less prone to adjust than countries
with depreciating currencies, trade deficits, or reserve losses.

❑ Germany has maintained a domestic monetary target of low

or zero inflation, and often has refused to alter domestic
monetary policy because of exchange rate considerations.

❑ Because of Germany's economic importance, the other

member countries have had to adjust their domestic policies.
Q1: During the currency crisis of September 1992, the Bank of
England borrowed DM 33 billion from the Bundesbank when
a pound was worth DM 2.78 or $1.912. It sold these DM in the
foreign exchange market for pounds in a futile attempt to
prevent a devaluation of the pound. It repaid these DM at the
post-crisis rate of DM 2.50:£1. By then, the dollar:pound
exchange rate was $1.782:£1.

(A): By what percentage had the pound sterling devalued in the

interim against the Deutsche mark? Against the dollar?

ANSWER:

During this period, the pound depreciated by:

ANSWER:

❑ 10.1% against the pound

❑ 6.8% against the dollar

(B): What was the cost of intervention to the Bank of England in
pounds? In dollars?

ANSWER:

❑ The Bank of England borrowed DM 33 billion and must repay

DM 33 billion. When it borrowed these DM, the DM was worth
£0.3597, valuing the loan at £11.87 billion (DM 33 billion x
0.3597).

❑ After devaluation, the DM was worth £0.4000. Hence, the Bank

of England's cost of repaying the DM loan was £13.20 billion
(DM 33 billion x 0.4), a rise of £1.33 billion.

❑ Thus, the cost to the Bank of England of this DM borrowing

and intervention was £1.33 billion.
❑ In dollar terms, intervention cost the Bank of England $825
million.

❑ This estimate is based on the difference of $0.025 between the

DM's initial value of $0.6878 (1.912/2.78) and its ending value
of $0.7128 (1.782/2.50) times the DM 33 billion borrowed and
spent defending the pound.

❑ Specifically, the cost calculation is $0.025 x 33,000,000,000 =

$825 million.
Q2: Suppose the central rates within the ERM for the French
franc and DM are FF 6.90403:ECU 1 and DM 2.05853:ECU 1,
respectively.

(A): What is the cross-exchange rate between the franc and the
mark?

ANSWER:

❑ Since things equal to the same thing are equal to each other,
we have FF 6.90403 = DM 2.05853.

❑ Hence, FF1 = DM 2.05853/6.90403 = DM 0.298164.

❑ Equivalently, DM 1 = FF 6.90403/2.05853 = FF 3.35386.

(B): Under the original 2.25% margin on either side of the central
rate, what were the approximate upper and lower intervention
limits for France and Germany?

ANSWER:

❑ Given the answer to part a, the French franc could rise to

approximately DM 0.298164 x 1.0225 = DM 0.304872 or fall as
far as DM 0.298164 x 0.9775 = DM 0.291455.

❑ Similarly, the upper limit for the DM is FF 3.42933 and the

lower limit is FF 3.27840.
(C): Under the revised 15% margin on either side of the central
rate, what are the current approximate upper and lower
intervention limits for France and Germany?

ANSWER:

❑ Given the answer to part a, the French franc could rise to

approximately DM 0.298164 x 1.15 = DM 0.342888 or fall as far
as DM 2.98164 x 0.85 = DM 0.253439.

❑ Similarly, the upper limit for the DM is FF 3.85694 and the

lower limit is FF 2.85078.
Q3: A Dutch company exporting to France had FF 3 million due in
90 days. Suppose that the current exchange rate was FF 1 =
Dfl 0.3291.

(A): Under the exchange rate mechanism, and assuming central

rates of FF 6.45863/ECU and Dfl 2.16979/ECU, what was the
central cross-exchange rate between the two currencies?

ANSWER:

❑ Given central rates of DFl 2.16979:ECU and FF 6.45863:ECU

for the Dutch guilder and French franc, respectively, the
central cross rate between the two currencies is DFl 1 = FF
2.97662 (6.45863/2.16979).

❑ Equivalently, FF 1 = DFl 0.335952 (2.16979/6.45863).

(B): Based on the answer to part A, what was the most the Dutch
company could lose on its French franc receivable, assuming
that France and the Netherlands stuck to the ERM with a 15%
band on either side of their central cross rate?
ANSWER:

❑ At worst, the French franc can fall by 15% relative to its

central guilder cross rate, to a cross-exchange rate of FF 1 =
DFl 0.285559 (0.335952 x 0.85).

❑ Since the current exchange rate is FF 1 = DFl 0.3291, the most

the Dutch company can lose on its FF 3 million receivable is
3,000,000 x (0.3291 - 0.285559) = DFl 130,622.
❑ worst that could happen is that the cross rate would be at its
upper bound of DFl 0.386345 (0.335952 x 1.15) and it falls to its
lower bound of 0.285559 (established in the answer to part B).

❑ In this case, the maximum possible loss is 3,000,000 x

(0.386345 - 0. 285559) = DFl 302,357.
Q1: Define Globalization. How has it proceeded in trade in goods
and services versus capital markets?

ANSWER:

Globalization refers to the increasing connectivity and integration

of countries and corporations and the people within them in
terms of their economic, political, and social activities.

Because of Globalization, multinational corporations dominate

the corporate landscape.
Q2: Describe four ways that a company can supply its products
to a foreign country. How do they differ?

ANSWER:

An MNC can supply a foreign market through:

❑ Exports
❑ Licensing local firms abroad to manufacture the company’s
product
❑ Setting up a joint venture with a foreign company
❑ Or by foreign direct investment
Q3: What is the IMF? What is its role in the world economy?

ANSWER:

❑ The International Monetary Fund (IMF) is an international

organization of 187 member countries, based in Washington,
DC, which was conceived at a United Nations conference
convened in Bretton Woods, New Hampshire, in 1944.

❑ The main goal of the IMF is to ensure the stability of the

international monetary and financial system—the system of
international payments and exchange rates among national
currencies that enables trade to take place between
countries, to help resolve crises when they occur, and to
promote growth and alleviate poverty.
❑ To meet these objectives, the IMF offers surveillance and
technical assistance.

❑ Surveillance is the regular dialogue about a country’s

economic condition and policy advice that the IMF offers to
each of its members.

❑ Technical assistance and training are offered to help member

countries strengthen their capacity to design and implement
effective policies, including fiscal policy, monetary and
exchange rate policies, banking and financial system
supervision and regulation, and statistics.
Q4: What is the World Bank? What is its role in the world
economy?

ANSWER:

❑ The World Bank is an international institution created in 1944,

as the International Bank for Reconstruction and
Development (IBRD) to facilitate postwar reconstruction and
development.

❑ Over time, the IBRD’s focus shifted toward poverty reduction,

and in 1960, the International Development Association (IDA)
was established as an integral part of the World Bank.
❑ Whereas the IBRD focuses on middle-income countries, the
IDA focuses on the poorest countries in the world.

❑ Together they provide low-interest loans, interest-free credits,

and grants to developing countries for investments in
education, health, infrastructure, communications, and other
activities.

❑ The World Bank also provides advisory services to

developing countries and is actively involved with efforts to
reduce and cancel the international debt of the poorest
countries.
Q 5: What is the difference between a target zone and a crawling
peg?

ANSWER:

❑ In a target zone, the currency is allowed to fluctuate in a

percentage band around a “central value”.

❑ One can view a pegged system as a target zone system with

a very narrow band.

❑ In a crawling peg system, the fixed rate or band is adjusted

over time, typically in a pre-determined way as a function of
the inflation differential between the crawling peg country
and the country to whose currency the peg is set.
❑ Such a system is often used in developing countries, where
the “crawl” of the band prevents the country from losing too
much competitiveness when its inflation rate is higher than
that of the benchmark country.
Q 6: What was the EMS?

ANSWER:

❑ EMS stands for European Monetary System, a target zone

system that operated in Europe between 1979 and 1999.

❑ Exchange rates were, for most of the time, maintained

between bands of 2.25% around central rates.

❑ The countries participating in the EMS were a gradually

increasing number of European Union countries.