Expert answer:Assignment 2: Financial Markets and Institutions
Solved by verified expert:Assignment 2: Financial Markets and Institutions, Part 2Choose three (3) types of securities from any of the financial markets covered in the textbook during Weeks 1 through 7. Pick securities you would enjoy researching for this assignment. I attached week 1-4 for your reference. Write a five to six (5-6) page paper in which you:1. Analyze the role financial markets play in creating economic wealth in the U.S. 2. Provide a general overview of each of the three (3) securities you chose. Be sure to include such information as name, company it represents (if applicable), pricing, and historical performance. 3. Assess the current risk return relationship of each of the three (3) securities. 4. Recommend one (1) strategy for maximizing return for the current risk return relationship identified for each of the three (3) securities. 5. Suggest how the Federal Reserve and its monetary policy affect each of the three (3) securities today. 6. Determine whether each of the three (3) securities is a good investment in the next twelve (12) months, five (5) years, and ten (10) years. Provide a rationale for each security with your determination. 7. Use at least six (6) quality academic resources in this assignment. Note: Wikipedia and other Websites do not qualify as academic resources. Your assignment must follow these formatting requirements:Be typed, double spaced, using Times New Roman font (size 12), with one-inch margins on all sides; citations and references must follow APA or school-specific format. Check with your professor for any additional instructions.Include a cover page containing the title of the assignment, the student’s name, the professor’s name, the course title, and the date. The cover page and the reference page are not included in the required page length. The specific course learning outcomes associated with this assignment are:Describe the various types of financial markets and the types of transactions supported by each market in the U.S. and globally.Explain the operation of the Federal Reserve and describe how monetary policy is used in the U.S. and other countries to manage the economyDetermine the valuation of various types of securities.Assess the risks in the various types of financial markets and develop strategies to manage the risks.Use technology and information resources to research issues in financial markets and institutions.Write clearly and concisely about financial markets and institutions using proper writing mechanics.The following additional outcomes may apply depending upon the student’s choice of securities:Develop strategies for the use of equity markets by investors and firms to meet stated financial objectives.Analyze the factors that affect interest rates and forecast interest rate changes.
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PART 1
The International Financial
Environment
Part 1 (Chapters 1 through 5) provides an overview of the multinational corporation
(MNC) and the environment in which it operates. Chapter 1 explains the goals of the
MNC, along with the motives and risks of international business. Chapter 2 describes
the international flow of funds between countries. Chapter 3 describes the international financial markets and how these markets facilitate ongoing operations.
Chapter 4 explains how exchange rates are determined, and Chapter 5 provides background on the currency futures and options markets. Managers of MNCs must
understand the international environment described in these chapters in order to
make proper decisions.
Multinational
Corporation (MNC)
Foreign Exchange Markets
Dividend
Remittance
and
Financing
Exporting and Importing
Product Markets
Investing and Financing
Subsidiaries
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International
Financial Markets
1
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1
Multinational Financial
Management: An Overview
CHAPTER
OBJECTIVES
The specific objectives
of this chapter are to:
■ identify the
management goal
and organizational
structure of the MNC,
■ describe the key
theories about why
MNCs engage in
international
business,
■ explain the common
methods used to
conduct
international
business, and
■ provide a model for
valuing the MNC.
Multinational corporations (MNCs) are defined as firms that engage in
some form of international business. Their managers conduct international
financial management, which involves international investing and financing
decisions that are intended to maximize the value of the MNC. The goal of
these managers is to maximize their firm’s value, which is the same goal
pursued by managers employed by strictly domestic companies.
Initially, firms may merely attempt to export products to a certain country
or import supplies from a foreign manufacturer. Over time, however, many
of these firms recognize additional foreign opportunities and eventually
establish subsidiaries in foreign countries. Dow Chemical, IBM, Nike, and
many other firms have more than half of their assets in foreign countries.
Some businesses, such as ExxonMobil, Fortune Brands, and ColgatePalmolive, commonly generate more than half of their sales in foreign
countries. It is typical also for smaller U.S. firms to generate more than 20
percent of their sales in foreign markets; examples include Ferro (Ohio) and
Medtronic (Minnesota). Many technology firms, such as Apple, Facebook,
and Twitter, expand overseas in order to capitalize on their technology
advantages. Many smaller private U.S. firms such as Republic of Tea
(California) and Magic Seasoning Blends (Louisiana) generate a substantial
percentage of their sales in foreign markets. Seventy-five percent of U.S.
firms that export have fewer than 100 employees.
International financial management is important even to companies that
have no international business. The reason is that these companies must
recognize how their foreign competitors will be influenced by movements
in exchange rates, foreign interest rates, labor costs, and inflation. Such
economic characteristics can affect the foreign competitors’ costs of
production and pricing policies.
This chapter provides background on the goals, motives, and valuation of
a multinational corporation.
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Part 1: The International Financial Environment
1-1 Managing the MNC
The commonly accepted goal of an MNC is to maximize shareholder wealth. Managers
employed by the MNC are expected to make decisions that will maximize the stock price
and thereby serve the shareholders’ interests. Some publicly traded MNCs based outside
the United States may have additional goals, such as satisfying their respective governments, creditors, or employees. However, these MNCs now place greater emphasis on
satisfying shareholders; that way, the firm can more easily obtain funds from them to
support its operations. Even in developing countries (e.g., Bulgaria and Vietnam) that
have just recently encouraged the development of business enterprise, managers of
firms must serve shareholder interests in order to secure their funding. There would be
little demand for the stock of a firm that announced the proceeds would be used to overpay managers or invest in unprofitable projects.
The focus of this text is on MNCs whose parents wholly own any foreign subsidiaries,
which means that the U.S. parent is the sole owner of the subsidiaries. This is the most
common form of ownership of U.S.-based MNCs, and it gives financial managers
throughout the firm the single goal of maximizing the entire MNC’s value (rather than
the value of any particular subsidiary). The concepts in this text apply generally also to
MNCs based in countries other than the United States.
1-1a How Business Disciplines Are Used to Manage the MNC
Various business disciplines are integrated to manage the MNC in a manner that maximizes shareholder wealth. Management is used to develop strategies that will motivate
and guide employees who work in an MNC and to organize resources so that they can
efficiently produce products or services. Marketing is used to increase consumer awareness about the products and to monitor changes in consumer preferences. Accounting
and information systems are used to record financial information about revenue and
expenses of the MNC, which can be used to report financial information to investors
and to evaluate the outcomes of various strategies implemented by the MNC. Finance
is used to make investment and financing decisions for the MNC. Common finance
decisions include:
■
■
■
■
whether to discontinue operations in a particular country,
whether to pursue new business in a particular country,
whether to expand business in a particular country, and
how to finance expansion in a particular country.
These finance decisions for each MNC are partially influenced by the other business
discipline functions. The decision to pursue new business in a particular country is based
on comparing the costs and potential benefits of expansion. The potential benefits of
such new business depend on expected consumer interest in the products to be sold
(marketing function) and expected cost of the resources needed to pursue the new business (management function). Financial managers rely on financial data provided by the
accounting and information systems functions.
1-1b Agency Problems
Managers of an MNC may make decisions that conflict with the firm’s goal of maximizing shareholder wealth. For example, a decision to establish a subsidiary in one location
versus another may be based on the location’s appeal to a particular manager rather than
on its potential benefits to shareholders. A decision to expand a subsidiary may be
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does not guarantee this page will contain current material or match the published product.
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does not guarantee this page will contain current material or match the published product.
Chapter 1: Multinational Financial Management: An Overview
5
motivated by a manager’s desire to receive more compensation rather than to enhance
the value of the MNC. This conflict of goals between a firm’s managers and shareholders
is often referred to as the agency problem.
The costs of ensuring that managers maximize shareholder wealth (referred to as
agency costs) are normally larger for MNCs than for purely domestic firms for several
reasons. First, MNCs with subsidiaries scattered around the world may experience larger
agency problems because monitoring the managers of distant subsidiaries in foreign
countries is more difficult. Second, foreign subsidiary managers who are raised in different cultures may not follow uniform goals. Some of them may believe that the first priority should be to serve their respective employees. Third, the sheer size of the larger
MNCs can also create significant agency problems, because it complicates the monitoring
of managers.
EXAMPLE
Two years ago, Seattle Co. (based in the United States) established a subsidiary in Singapore so that it
could expand its business there. It hired a manager in Singapore to manage the subsidiary. During the
last two years, sales generated by the subsidiary have not grown. Even so, the manager hired several
employees to do the work that he was assigned to do. The managers of the parent company in the
United States have not closely monitored the subsidiary because it is so far away and because they
trusted the manager there. Now they realize that there is an agency problem. The subsidiary is experiencing losses every quarter, so its management must be more closely monitored. l
Lack of monitoring can lead to substantial losses for MNCs. The large New
York–based bank JPMorgan Chase & Co. lost at least $6.2 billion and had to pay
more than $1 billion in fines and penalties after a trader in its office in London,
England, made extremely risky trades. The subsequent investigation revealed that
the bank had maintained poor internal control and failed to provide proper oversight
of its employees.
Parent Control of Agency Problems The parent corporation of an MNC may
be able to prevent most agency problems with proper governance. The parent should
clearly communicate the goals for each subsidiary to ensure that all of them focus on
maximizing the value of the MNC and not of their respective subsidiaries. The parent
can oversee subsidiary decisions to check whether each subsidiary’s managers are satisfying the MNC’s goals. The parent also can implement compensation plans that reward
those managers who satisfy the MNC’s goals. A common incentive is to provide managers with the MNC’s stock (or options to buy that stock at a fixed price) as part of
their compensation; thus the subsidiary managers benefit directly from a higher stock
price when they make decisions that enhance the MNC’s value.
EXAMPLE
When Seattle Co. (from the previous example) recognized the agency problems with its Singapore subsidiary, it created incentives for the manager of the subsidiary that aligned with the parent’s goal of maximizing shareholder wealth. Specifically, it set up a compensation system whereby the manager’s annual
bonus is based on the subsidiary’s earnings. l
Corporate Control of Agency Problems In some cases, agency problems can
occur because the goals of the entire management of the MNC are not focused on maximizing shareholder wealth. Various forms of corporate control can help prevent these
agency problems and thus induce managers to make decisions that satisfy the MNC’s
shareholders. If these managers make poor decisions that reduce the MNC’s value, then
another firm might acquire it at the lower price and hence would probably remove the
weak managers. Moreover, institutional investors (e.g., mutual and pension funds) with
large holdings of an MNC’s stock have some influence over management because they
will complain to the board of directors if managers are making poor decisions.
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Part 1: The International Financial Environment
Institutional investors may seek to enact changes, including removal of high-level managers or even board members, in a poorly performing MNC. Such investors may also
band together to demand changes in an MNC, as they know that the firm would not
want to lose all of its major shareholders.
How SOX Improved Corporate Governance of MNCs One limitation of the
corporate control process is that investors rely on reports by the firm’s own managers for
information. If managers are serving themselves rather than the investors, they may
exaggerate their performance. There are many well-known examples (such as Enron
and WorldCom) in which large MNCs were able to alter their financial reporting and
hide problems from investors.
Enacted in 2002, the Sarbanes-Oxley Act (SOX) ensures a more transparent process
for managers to report on the productivity and financial condition of their firm. It
requires firms to implement an internal reporting process that can be easily monitored
by executives and the board of directors. Some of the common methods used by MNCs
to improve their internal control process are:
■
■
■
■
■
establishing a centralized database of information,
ensuring that all data are reported consistently among subsidiaries,
implementing a system that automatically checks data for unusual discrepancies
relative to norms,
speeding the process by which all departments and subsidiaries access needed data,
and
making executives more accountable for financial statements by personally verifying
their accuracy.
These systems make it easier for a firm’s board members to monitor the financial
reporting process. In this way, SOX reduced the likelihood that managers of a firm can
manipulate the reporting process and therefore improved the accuracy of financial information for existing and prospective investors.
1-1c Management Structure of an MNC
The magnitude of agency costs can vary with the MNC’s management style. A centralized management style, as illustrated in the top section of Exhibit 1.1, can reduce agency
costs because it allows managers of the parent to control foreign subsidiaries and thus
reduces the power of subsidiary managers. However, the parent’s managers may make
poor decisions for the subsidiary if they are less informed than the subsidiary’s managers
about its setting and financial characteristics.
Alternatively, an MNC can use a decentralized management style, as illustrated in the
bottom section of Exhibit 1.1. This style is more likely to result in higher agency costs
because subsidiary managers may make decisions that fail to maximize the value of the
entire MNC. Yet this management style gives more control to those managers who are
closer to the subsidiary’s operations and environment. To the extent that subsidiary
managers recognize the goal of maximizing the value of the overall MNC and are compensated in accordance with that goal, the decentralized management style may be more
effective.
Given the clear trade-offs between centralized and decentralized management styles,
some MNCs attempt to achieve the advantages of both. That is, they allow subsidiary
managers to make the key decisions about their respective operations while the parent’s management monitors those decisions to ensure they are in the MNC’s best
interests.
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does not guarantee this page will contain current material or match the published product.
6
© 2014 Cengage Learning. All Rights Reserved. This content is not yet final and Cengage Learning
does not guarantee this page will contain current material or match the published product.
Chapter 1: Multinational Financial Management: An Overview
Exhibit 1.1 Management Styles of MNCs
Centralized Multinational
Financial Management
Cash Management
at Subsidiary A
Financial Managers
of Parent
Inventory and
Accounts Receivable
Management at
Subsidiary A
Financing at
Subsidiary A
Cash Management
at Subsidiary B
Inventory and
Accounts Receivable
Management at
Subsidiary B
Capital
Expenditures
at Subsidiary A
Capital
Expenditures
at Subsidiary B
Financing at
Subsidiary B
Decentralized Multinational
Financial Management
Cash Management
at Subsidiary A
Financial Managers
of Subsidiary A
Financial Managers
of Subsidiary B
Inventory and
Accounts Receivable
Management at
Subsidiary A
Financing at
Subsidiary A
Cash Management
at Subsidiary B
Inventory and
Accounts Receivable
Management at
Subsidiary B
Capital
Expenditures
at Subsidiary A
Capital
Expenditures
at Subsidiary B
Financing at
Subsidiary B
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Part 1: The International Financial Environment
How the Internet Facilitates Management Control The Internet simplifies the
process for the parent to monitor the actions and performance of its foreign subsidiaries.
EXAMPLE
Recall the example of Seattle Co., which has a subsidiary in Singapore. Using the Internet, the foreign subsidiary can e-mail updated information in a standardized format that reduces language problems and also
send images of financial reports and product designs. The parent can then easily track the inventory,
sales, expenses, and earnings of each subsidiary on a weekly or monthly basis. Thus using the Internet
can reduce agency costs due to international aspects of an MNC’s business. l
1-2 Why MNCs Pursue International Business
Multinational business has generally increased over time. Three commonly held theories
to explain why MNCs are motivated to expand their business internationally are the
(1) theory of comparative advantage, (2) imperfect markets theory, and (3) product
cycle theory. These theories overlap to some extent and can complement each other in
developing a rationale for the evolution of international business.
1-2a Theory of Comparative Advantage
Specialization by countries can increase production efficiency. Some countries, such as
Japan and the United States, have a technology advantage, whereas others, such as
China and Malaysia, have an advantage in the cost of basic labor. Because these advantages cannot easily be transported, countries tend to use their advantages to specialize in
the production of goods that can be produced with relative efficiency. This explains why
countries such as Japan and the United States are large producers of electronic products
while countries such as Jamaica and Mexico are large producers of agricultural and
handmade goods. Multinational corporations such as Oracle, Intel, and IBM have
grown substantially in foreign countries because of their technology advantage.
A country that specializes in some products may not produce other products, so trade
between countries is essential. This is the argument made by the classical theory of comparative advantage. Comparative advantages allow firms to penetrate foreign markets.
Many of the Virgin Islands, for example, specialize in tourism and rely completely on
international trade for most products. Although these islands could produce some
goods, it is more efficient for them to specialize in tourism. That is, the islands are better
off using some revenues earned from tourism to import products than attempting to
produce all the products they need.
1-2b Imperfect Markets Theory
If each country’s markets were closed to all other countries, then there would be no international business. At the other extreme, if markets were perfect and thus the factors of production
(such as labor) easily transferable, then labor and other resources would flow wherever they
were in demand. Such unrestricted mobility of factors would create equality in both costs and
returns and thus would remove the comparative cost advantage, which is the rationale for
international trade and investment. However, the real world suffers from imperfect market
conditions where factors of production are somewhat immobile. There are costs and often
restrictions related to the transfer of labor and other resources used for production. There also
may be restrictions on …
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