Multinational Financial Management, Study Guide, 6th Edition Solution Manual

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CHAPTER 1: INTRODUCTION1CHAPTER 1INTRODUCTIONChapter 1 emphasizes the internationalization of business and economic activity that has occurred sincethe end of World War II. Although international business activities have existed for centuries, primarily inthe form of exporting and importing, only in the postwar periodhavemultinational firms becomepreeminent. The distinguishing characteristic of the MNC is its emphasis on global, rather than affiliate,performance. Specifically, MNCs ask,“Where in the world should we build our plants, sell our products,raise capital, and hire personnel?”Thus the trueMNCis characterized more by attitude than the physicalreality of an integrated, globalsystem of marketing and production activities. It involves looking beyondtheboundaries of the home countryand treating the world as“our oyster.”After stimulating student interest with this vision of the MNC, I then introduce the financial decisionsthatMNCsmust make. I begin by discussing the key concepts and lessons from domestic finance thatapply directly to international corporate finance. The lessons include the emphasis on cash flow ratherthan accounting earnings, the time value of money, the importance of taxes, and the unwillingness ofinvestors to reward companies for activities (like corporate diversification)thatinvestors could replicatefor themselves at no greater cost.The key concepts, which I point out will arise time and again in the course, are arbitrage, marketefficiency, and the separation of risk into systematic risk, which must be rewarded, and unsystematic risk,which is not rewarded. The latter concept, of course, is the intuition underlying both the capital assetpricing model (CAPM) and the arbitrage pricing theory (APT). Although imperfect, the theoreticalframework of domestic corporate finance provides a useful frame of reference, and understanding it isessential before proceeding with the more complex aspects of international financial management. Idevote some time to explaining that total risk matters, even if the CAPM or APT holds. Otherwise,theastute student will see a conflict between the irrelevance of unsystematic risk and hedging activities.I then outline the key decision areas in international financial management: foreign exchange riskmanagement, managing working capital and the internal financial system, financing foreign units, capitalbudgeting, and evaluation and control. I emphasize the additional parameters that MNC financialexecutives must cope with, including multiple currencies, rates of inflation, tax systems, and capitalmarkets, as well as foreign exchange and political risks.

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