The Key Themes of Finance for a Multi-National Corporation

ENVIRONMENT OF INTERNATIONAL FINANCIAL MANAGEMENT

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This section consists of the following subsections:

пЃ¶ Determination of Exchange Rates

пЃ¶ The International Monetary System

пЃ¶ The Balance of Payments

пЃ¶ Foreign Exchange Market

пЃ¶ International Parity Conditions

These five themes basically define the environment in which a MNC functions.

Determination of Exchange Rates

One of the basic issues which a company should consider when stepping on a foreign market are the exchange rates of this country and the way by which they are determined.

Wikipedia gives the following definition for exchange rate: “in finance, the exchange rate between two currencies specifies how much one currency is worth in terms of the other.”

(http://en.wikipedia.org/wiki/Exchange_rates)

There are a number of methods that can be used to determine an exchange rate:

a) A flexible or floating exchange rate is where the market forces of supply and demand determine the exchange rate.

Under a flexible or floating exchange rate the value of a countries currency changes frequently, even by the minute. The market rate will depend on the demand for, and supply of, that currency in the forex (foreign exchange) markets. When there is no intervention in the free market operations by a government or its’ agency a “clean float” is said to exist.

b) A fixed exchange rate is where the government determines the exchange rate for a period of time based on the value of another countries currency such as the US dollar.

c) A managed exchange rate is where the government intervenes in the market to influence the exchange rate or set the rate for short periods such as a day or week.

(http://hsc.csu.edu.au/economics/place/exchange_rates/Tutorial5DeterminationofEx.html)

A MNC may influence a floating exchange rate regime by using its market forces to determine the exchange rate of the respective currency. Cross (1998) found that “as in other countries, U.S. authorities do take steps at times to influence the exchange rate, via policy measures and direct intervention in the foreign exchange market to buy or sell foreign currencies”. (http://www.ny.frb.org/education/addpub/usfxm/chap11.pdf)

The International Monetary System (IMS)

According to Eun & Resnick (2004), “the international monetary system can be defined as the institutional framework within which international payments are made, the movements of capital are accommodated, and exchange rates among currencies are determined”. (p.54)

In this website (http://www.fame.org/#volatility) is stated that: “Companies that produce and distribute goods for international sale require monetary stability. Therefore, the structure of the monetary system needs to be revisited.”

It is clear that volatility of exchange rates creates risk, but it may also create certain profit opportunities for MNC and foreign investors. However, if the MNCs want to use those opportunities successfully, the managers must, before all, examine the way in which the international monetary system functions.

The Balance of Payments (BOP)

Eiteman, Stonhill, & Moffett (2004) believe that “the measurement of all international economic transactions between the residents of a country and foreign residents is called the balance of payments (BOP). (p. 47)

Shapiro (1999) distinguishes three major balance-of-payments categories:

• Current Account, which records flows of goods, services, an transfers

• Capital Account, which shows public and private investment and lending activities

• Official Reserves Account, which measures changes in holdings of gold and foreign currencies - reserve assets – by official monetary institutions

(p. 117)

When a country has a current account deficit that