Course introduction for 723G33 Risk Management and derivatives

1. Course introduction for 723G33Risk Management and derivatives (former 723g14 International Finance) Yinghong.chen@liu.se YH Chen, Doctor in Financial Economics yinghong.chen@liu.se

2. Contents • Couse introduction for 723G33 • Main Book, Other Reference books, chapters • Detailed schedule • Theories of international trade: comparative advantage and competitive advantage • Homework 1 • Assignment: preparation of Case Porsche changes tack yinghong.chen@liu.se

3. LiU: Campus Valla Library Classlocation Exam place yinghong.chen@liu.se

4. Main book: Multinational Business Finance by Eiteman, Stonehill and Moffett yinghong.chen@liu.se

5. Other Reference books, chapters • International Business: Environment and Operations, John D. Daniels, Lee H. Radebaugh & Daniel P. Sullivan; 12th edition, for cultural aspect of International business of MNEs • Corporate Finance Foundations: Global Edition, by Hirt, Block and Danielsen, 14E, McGraw-Hill. Chapter 19 and 21 yinghong.chen@liu.se

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8. Obligatory • Obligatory lectures and seminars. • Obligatory Lab exercise on testing the Equilibrium Theory of Exchange Rate (exercise to be handed in before 25 of May, according to lab instructions) • Group presentation is obligatory on 29th of may. Discussant group will be picked later. Topics can be chosen from major areas of the course. Deadline, 27th of May. Send to both your discussant group and yinghong.chen@liu.se Instructions on website. • The exam is set preliminarily on the 4thof June. (account for 80% of the total points) yinghong.chen@liu.se

9. Introduction: importance of risk management ofMNEs • Globalization is a fact of life. I define globalization as producing where it is most cost-effective, selling where it is most profitable, and sourcing capital where it is cheapest, without worrying about national boundaries. —Narayana Murthy, President and CEO, Infosys yinghong.chen@liu.se

10. Importanceof risk management ofMNEs • There are unique risks and opportunities involved in running international firms compared to purely domestic firms. They are foreign exchange risk, operating risk, country specific risk, laws and regulations, cultural aspect of multinational firms, etc. • Derivative securities such as options and futures are used by corporate financial managers of MNEs for hedging activities. Case in point: Porsche yinghong.chen@liu.se

11. Variousaspectsof International Business • The Cultural Environments Facing Business • The Political and Legal Environments Facing Business • The Economic Environments Facing Businesses • Globalization and Society yinghong.chen@liu.se

12. Theoriesof international trade • Theory of Comparative advantage (Factor Endowment: land, labor, location, natural resources, population) • International Trade and Factor-Mobility Theory • Porter´s theory of competitive advantages of nations of International trade (chapter 17) • Rationales of Foreign direct investment, FDIs yinghong.chen@liu.se

13. The theory of comparative advantage • The theory of comparative advantage provides a basis for explaining and justifying international trade in a model world assumed to enjoy: • free trade; • perfect competition; • no uncertainty; • costless information; and • no government interference. yinghong.chen@liu.se

14. The theory of comparative advantage • Absolute advantage and comparative advantage, opportunity costs • Firms in Country A specialize in making products that can be produced relatively efficiently, given Country A’s endowment of factors of production, that is, land, labor, capital, and technology • Firms in Country B do likewise, given the factors of production found in Country B • In this way the total combined output of A and B is maximized yinghong.chen@liu.se

15. Exhibit 1.3 Global Outsourcing of Comparative Advantage yinghong.chen@liu.se

16. Comparativeadvantage vs. Competitiveadvantage • Although international trade might have approached the comparative advantage model during the nineteenth century, it certainly does not today, for the following reasons: • Countries do not appear to specialize only in those products that could be most efficiently produced by that country’s particular factors of production (as a result of government interference and ulterior motivations) • At least two factors of production – capital and technology – now flow directly and easily between countries yinghong.chen@liu.se

17. The Porter's Diamond model for the competitive advantage of nations (chapter 17) Sources of competitive advantage: • Factor Conditions: nation's position in factors of production, such as natural resources, climate, skilled labors, infrastructure, technology, etc • Demand Conditions: of home buyers needs - their sophistication • Suppliers and Related Industries: clusters of related/supervising industries. • Firm Strategy, Structure and Rivalry: attitude, willingness to succeed, domestic rivary. yinghong.chen@liu.se

18. Four Determinants of National Competitive Advantage yinghong.chen@liu.se

19. Pricingofforeignexchange • International parity conditions: Relationship between Interest Rates and, spot and forward exchange rates, inflation, changes in spot rate • Arbitrage principle: The law of one price, normally we use home currency value per dollar, direct quote. • Indirect quote: 1 £= 1,5 $ yinghong.chen@liu.se

20. 0 The law of one price and Exchange Rates • If the identical product or service can be: • sold in two different markets; and • no restrictions exist on the sale; and • transportation costs of moving the product between markets are equal, then • the products price should be the same in both markets. • This is called the law of one price.

21. Exhibit 7.11 International Parity Conditions in Equilibrium (Approximate Form)

22. Exhibit 1.1 Global Capital Markets yinghong.chen@liu.se

23. What is Different About International Financial Management of MNEs? • Exhibit 1.4 summarizes the differences. • Culture and history differ among countries • Corporate governance • Greater levels of foreign exchange and political risks • Financial theory and applications are modified in the global versus domestic marketplace • Specialized and complicated financial instruments become tools of the trade yinghong.chen@liu.se

24. Exhibit 1.4 What Is Different About International Financial Management? ESM: 13th edition

25. Market Imperfections: A Rationale for the Existence of the Multinational Firm • MNEs strive to take advantage of imperfections in national markets for products, factors of production, and financial assets. • Imperfections in the market for products translate into market opportunities for MNEs. • Large international firms are better able to exploit such competitive factors as economies of scale, managerial and technological expertise, product differentiation, and financial strength than their local competitors. yinghong.chen@liu.se

26. Market Imperfections: A Rationale for the Existence of the Multinational Firm • Strategic motives drive the decision to invest abroad and become a MNE and can be summarized under the following categories: • Market seekers • Raw material seekers • Production efficiency seekers • Knowledge seekers • Political safety seekers • These categories are not mutually exclusive. yinghong.chen@liu.se

27. The Globalization Process • Stage I: early domestic phase growing into the international trade phase (Exhibit 1.5) • Stage II: A successful firm will continue to grow from simple international trade to the multinational phase characterized by production and investment both at home and abroad (Exhibit 1.6) • Growth may be limited by the twin agency problems of corporate insiders and the rulers of sovereign states (Exhibit 1.7) yinghong.chen@liu.se

28. Exhibit 1.5 Trident Corp: Initiation of the Globalization Process ESM: 13th edition

29. Exhibit 1.6 Trident’s Foreign Direct Investment Sequence ESM 13th edition

30. Exhibit 1.7 Potential Limits of Financial Globalization ESM: 13th edition

31. Homework • Chapter 1: problems 1 to 5. RecardiantheoryofComparativeadvantages . China and France, due on Tuesday, 14th. Hand in by group or individually yinghong.chen@liu.se

32. Assignment: Prepare the Porsche case before Wednesday’s workshop • Form two groups A and B: one will present the Porsche Changes Tack case. The other asks questions, Preparation needed. • The Case is to be found on course homepage under course notes. http://www.iei.liu.se/fek/frist/723G33?l=en • Discussion of the class follows: various risk management aspects of Porsche. Ownership, management style, synergies, financial risks, performance, etc. • Other info: Porsche Homepage http://www.porsche-se.com/pho/en/ yinghong.chen@liu.se

33. The holding structure of Porsche SE as of May 3rd, 2012. ¹ votingrights yinghong.chen@liu.se

34. Some concepts before the case of Porsche Changes Tack • Ownership structure and corporate governance Owner control vs. Management control • Family ownership (concentrated ownership: common in Continental Europe • Shareholder oriented governance structure, or stakeholder oriented governance structure • The conflicts of interests: shareholders verses other constituents (stakeholders: debt holders, labor unions, governments, etc), • Performance measures, ROA, ROE yinghong.chen@liu.se

35. Mini-Case Questions: Porsche Changes Tack • What strategic decisions made by Porsche over the years 1999 to 2004 had given rise to its extremely high return on invested capital? • Vesilina D. wondered if she might have to distinguish between the Porsche’s ability to generate results for stockholders versus its willingness to do so. What do you think? • Is pursuing the interest of Porsche’s controlling families different from maximizing the returns to its public share owners? yinghong.chen@liu.se

36. Exhibit 1 Porsche’s Growth in Sales, Income, and Operating Margin yinghong.chen@liu.se

37. Exhibit 2 Return on Invested Capital (ROIC) for European Automakers, 2004 yinghong.chen@liu.se

38. Exhibit 3 Porsche’s Velocity (capital turnover), Margin, and ROIC yinghong.chen@liu.se

39. Useful links for today Main Book homepage for Multinational Business Finance , 13th, 12th ed. Both are ok. http://wps.pearsoned.co.uk/ema_ge_eiteman_mbf_13/ http://wps.pearsoned.co.uk/ema_ge_eiteman_mbf_12/ Corporate Finance Foundations: Global Edition, by Hirt, Block and Danielsen, 14E, McGraw-Hill. Chapter 19 and 21 http://highered.mcgraw-hill.com/sites/0073530727/student_view0/index.html http://highered.mcgraw-hill.com/sites/0073530727/student_view0/video_clips.html yinghong.chen@liu.se

40. Practical help How to get around Linköping University? • English version of the University: http://www.liu.se/?l=en • Need help? book a Librarian for information searching and database, etc. http://www.bibl.liu.se/?l=en 3. School map: http://www.liu.se/om-liu/till-liu/kartor?l=en Search a location, reserve a room etc. yinghong.chen@liu.se