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Global Financial Management

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  1. Global Financial Management UNIT 2: The Global Financial Environment TouchText • Financial Management Overview • Globalization • Monetary Systems • Balance of Payments Problems and Exercises Next

  2. Financial Management Financial Management = How to make best financial decisions for a business. Mostly related to Investing (“Capital Budgeting”) Dividend Policy Raising Necessary $$$ (“Capital Structure”) Working Capital Management Dictionary Why Global Financial Management? Multinational Corporations (MNCs) face unique challenges. Foreign Exchange (FX) Risk Country Risk Market Imperfections (e.g. trade barriers) Cultural and legal challenges Greater Opportunity Set Take Notes Back Next

  3. Financial Management: Main Areas of Decision-Making Dictionary 4. Working Capital Management Operating Activities: Cash to/from regular business operations. 4. Dividend Policy Capital Budgeting Investing Activities: Cash for the purchase of fixed assets. 3. Capital structure Financing Activities: Cash from raising money and paying back banks and investors. Take Notes Back Next

  4. Goal of “Business” In making financial management decisions, whose interests are/should be served? Dictionary Stakeholders (banks, employees, community, etc.) Business Groups (e.g. Japanese keiretsu). Shareholders (business owners). Inside Owners (e.g. family businesses). What should be their objective? Welfare Maximization. Wealth Maximization. Strategic Objectives (e.g. Market Share). Businesses don’t make decisions. People do! Take Notes Back Next

  5. Globalization: Trends Several trends are facilitating globalization. Dictionary • Financial liberalization (e.g. London’s “Big Bang”). • Monetary liberalization (e.g. Thai baht float). • Global trade liberalization (negotiated through the WTO). • Regional trade blocks (e.g. ASEAN, NAFTA, the EU) • Privatization of state enterprises. • Technological improvements (e.g. internet) facilitating globalization. New Investment Policy Rules Liberalization (78%) Regulation (22%) Take Notes Back Next

  6. Multinational Corporations (MNCs) Most of the world’s largest corporations are Multi-National Corporations (MNCs), which are incorporated in one (“home”) country, but have production facilities and sales in several foreign countries. As MNCs expand abroad, they provide foreign direct investment (FDI) to host foreign countries. Dictionary Take Notes Back Next

  7. MNCs: Sales and Profitability Dictionary * The UNCTAD report refers to MNCs as Trans-National Corporations (TNCs). Take Notes Back Next

  8. Global Monetary Systems: Historical Eras Though any country can adopt their own monetary policy, there have been broad historical eras of monetary policies. Dictionary • Metalism(pre-1870)– silver and/or gold coinage. • Gold Standard (to 1914) – currencies pegged to gold. • Inter-War Period (to 1944) – disparate policies to stabilize economies. • Bretton Woods (to 1972) – European currencies pegged to US$; and US$ fixed to gold. • Flexible Exchange Rates (post-1972) – Currencies not backed by gold or silver; float in value against one another. Take Notes Back Next

  9. Bretton Woods Problem: USA imports -> gold reserve exports; Gold reserve exports -> weak US$; Weak US$ -> collapse of system. German d-mark Dictionary French franc Par DM/US$ Par Ffr/US$ USA US$35 = 1 oz. Gold Though this system failed, the USA dollar (US$) emerged as the #1 global reserve currency. Take Notes Back Next

  10. Exchange Rate Regimes Within a global flexible exchange rate system, individual countries can establish their own regime. Regime types comprise: Dictionary • No home currency (e.g. Panama uses US$). • Fixed exchange rate (e.g. China against US$). • Peg with bands (fixed against another currency, + or – a certain percent). • Crawling peg (peg adjusted periodically). • Managed float (flexible fx rate, but government periodically intervenes). • Free float (fx rate determined by market forces). Take Notes Back Next

  11. Balance of Payments The Balance of Payments (BoP) represents international monetary flows. It consists of 3 main components. Dictionary • The Current Account (CA) – International trade in goods and services. • The Capital Account (KA) – international financial flows (e.g. investments, loans, etc.) • Official Reserves – international currency held by the central bank. CA surplus = net exporter (foreign currency in) CA deficit = net importer (foreign currency out) (CA balance + KA balance) = Δ in official reserves. Take Notes Back Next

  12. Balance of Payments and FX Rates The Balance of Payments Identity: (CA balance + KA balance) = Δ in official reserves. Dictionary • Under a flexible exchange rate regime, • Δ in official reserves = 0 • FX rate adjusts so that CA balance = KA balance • Under a fixed exchange rate regime, • Δ in official reserves adjust to = (CA + KA) Under a fixed regime, if (CA + KA) < 0 (i.e. in deficit), the Δ in official reserves will be negative. If reserves fall too low, the central bank will have to devalue (or float) the currency. FX currency restrictions may also be imposed. Take Notes Back Next

  13. Importance of the Capital Account (KA) In some countries, financial flows through the capital account may be larger than trade flows through the current account. Dictionary Capital Account (financial), investing, banking, etc. > Current Account (trade), exports, imports Financial flows through the capital account can be short-term (so-called “hot” money) and can change quickly. This can create pressure on FX rate stability. Take Notes Back Next

  14. Fixed FX Rates: Supply and Demand In Thailand, the fixed FX rate was too high, causing official reserves to leave the country to support the BoP deficit. This can be displayed in a standard economic supply-demand diagram. Dictionary Take Notes Back Next

  15. FX Rates: Supply and Demand In Thailand, after the baht was floated, it fell in value to 41 THB/$, and the BoP deficit reversed itself. Dictionary Take Notes Back Next

  16. End of Unit 2 Questions and Problems The following problems require the calculation of various statistics using MS Excel. The problems are linked to actual Excel spreadsheets, where students should do their work. Dictionary Dictionary www. Directions: Write a one or two paragraph story explaining what happened during the “Tom Yum Kung Crisis” of 1997. Data courtesy of the Bank of Thailand ( Take Notes Back Next