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Individual assignments Section A ± short answer questions: 1) Summarize the five main motives that drive the decision

to initiate FDI.

In general the are 2 main objectives for MNCs to initiate FDI , 1)Revenue related objectives and 2)Cost related objectives . Revenue related motives can be summarized as follows i) Attract new sources of demand. A MNC will reach a market saturation in their home country and when this happens , MNCs will look out for markets where can they find a new demand for their product or expansion of their products. ii) iii) Enter new markets where superior profit is possible. Exploit monopolistic advantages , enter the market where there is demand and yet the local competitor do not have the means or technology to produce and sell the product. iv) React to trade restriction , establish a subsidiary in a market where tougher trade restriction will adversely affect the existing export volume. v) Diversify internationally ,establish subsidiary in markets whose business cycle differ from those where existing subsidiaries are based. Cost related motives i) Fully benefit from economies of scale , establish subsidiary in a new market that can sell products produced elsewhere , this allows for increase production and possibly better production efficiency.

participate in joint venture in order to learn about new technology or processes. land is cheaper and sell the products to countries where it is more expensive. it is important for decision makers to compare benefits of FDI in different countries . Implement these technologies to countries where it is not available for product efficiency and technically more competent. iii) Use of foreign raw material . v) React to exchange rate movements. International projects tends to be able to reduce risk when the FDI is targeted to countries whose economies are somewhat unrelated to the home country economy. iv) Use of foreign technology . With these motives . establish subsidiary where raw materials is easily available and cheaper and manufacture the product in these countries and sell the products to countries where it is more expensive to produced. Another form of FDI is international diversification where MNC can reduce it¶s risk exposure in their home countries due to economic conditions. International projects allow MNCs to achieve lower risk than 100% domestic projects without reducing their expected returns. Besides these motives . establish subsidiary in countries where the currency is weak but will strengthen over time.establish subsidiary where the foreign labor . MNCs will make decision on where to establish the subsidiary in order to maximize shareholder¶s wealth.ii) Use foreign factors of production . .

supply chain effectiveness and technology competencies. . local resources .In the choice of FDI location . few factors need to be consider: 1) Protectionism barriers 2) Red tape barrier 3) Industry barrier 4) Environmental barrier 5) Regulatory barrier 6) Ethical barrier 7) Political stability Other factors that affect choice of FDI locations are cost of capital .

Explain the classification of political risks a) Political risk are factors that impede the performance of the subsidiary in a foreign country. These sleeping partner may act as ³spies´ and any trade secrets maybe leak out via these channels. Disadvantage of this system is the intervention of these Bumiputras that may impede the aggressive growth of the MNCs.In some countries where there is a requirement from the government that any foreign invested company must have local representatives in the shareholder. The extreme example is the possibility of the host country that will take over the subsidiary either by confiscating the assets and no compensation is provided. 2) Ownership . Some advantage of this setup are local knowledge and government network which is key importance to new MNCs that setup in these countries. The Bumiputras enjoy only the benefits but the business risk. An example will be Malaysia where any foreign invested companies must have a ³Bumiputra´ shareholder. if the risk of blocking funds transfer arises in the foreign . 3) Blockage of funds transfer ± foreign entities initiate FDI to increase the wealth of shareholders. Elimination of ³red tapes´ can be a motivation factor for MNCs to have these Bumiputras. . b) Classification of political risks: 1) Protectionism ± actions where the local government heavily subsidize the local manufacturer or ban foreign enterprises from trading in the local context.2) Define political risks.

Countries which are rated high on the ³most corruption´ list will be avoided as much as possible by reputable MNCs as unfair treatment whether for legal matters or award of business contracts are treated unfairly. This may also result in mass resignation of the workers and result in operations inefficiency and loss of revenue. 5) Religion/heritage ± Religion may also be a source of political risk in the event of a religious uprising and consumers may ban buying the products from the company.country where the subsidiary is . any funds that cannot be transfer may result in business obstacles as funds are needed for operational matters to purchase materials etc. 4) Corruption and Neopotism ± corruption may result in inefficient bureaucracy and breach company¶s policy . At the same time . .Corruption may also affects a company image and reputation. it loses its initial objective of setting up the subsidiary.

The foreign government may increase taxes or impose barriers on the MNCs subsidiary or the consumers in that country may boycott the MNC . The foreign denominated cash flow can be affected by political situation of that foreign country.t represent the cash flow denominated in a particular currency and Sj. the MNCs will receive lesser amount of dollars as dictate by Sj. b) Hedging will reduce the uncertainties for the exchange rates and the risk exposure of currencies . . This can be explain by the formulae: N m jt jt VMNC= ™ {™[E(CF ) X E(S )]} t=1 j=1 t . Political risk like these will affect the cash flow of the MNCs. Assuming K remains constant if CFj.t are not properly hedge the value of the MNCs are subject to high volatility of the cash flows and currency exchange rates. (1 + K) Where CFj. a) Hedging is a financial instrument used by MNC for payments to be made or receive in the future. If the foreign currencies to be received by the MNCs weaken against the home currency .t in the formulae . the MNCs cash flow and wealth to share holders are certain. The MNCs will locked in the exchange rate and the amount to be paid or receive in the future . and K =weighted cost of capital and WACC = cost of debt +cost of equity.3) what is hedging? Briefly discuss the reasons for and against hedging. This will reduce the uncertainty of the risk of fluctuations and volatility of the cash flows.t and Sj.t represents the exchange rate at which the MNC can convert the foreign currency at the end of period t.By averting these risk .

An MNC¶s cost of capital is influenced by the return required by the investors . example funds/earnings from a foreign subsidiary need not be transfer back to parent company and it is use to pay operational expenses. therefore increasing the cost of finance . The higher level of uncertainties will increase the MNC¶s cost of obtaining capital and the valuation of the MNC decreases. investor may invest in the MNC if there is higher rate of return. Instead of hedging .Therefore by hedging the exchange rates . hedging of exchange rates will reduce the uncertainties of risk for MNC. salary . Since WACC is equal to cost of debt and cost of equity . MNCs can do diversification of business investment in order to reduce their risk exposure. It is also time consuming to prepare a good hedging plan which again reflects in costs. c) There are often expensive premiums to be paid for any hedging instrument . if there are uncertainties surrounding the future cash flows . example . .materials and others. Back to back investment is also another way to reduce the risk exposure . the uncertainties of the MNC risk are averted to a certain extent.

individual and government for a specific country and the rest of the countries over a specified period of time. The main components of BOP can be broken down into: 1) current account ± which represent the account for payment of a) merchandise and services ± tangible goods such as computers and clothing and services such as tourism . Why balance of payment is important? Balance of payment is a summary of transactions between domestic and foreign businesses .4) Define balance of payments. . b) Factor income payments which represent income from interest and dividend receive by investors on foreign investment. it means that there is a substantial investment in that country and it does not export much of it¶s currency. 2) Capital account includes financial assets transfer across borders .legal . it also includes value of non produced non financial assets such as patents and trademarks. insurance etc. The BOP is a measure of international money flow and indicate the volume of transaction between specific countries and may signal the potential shift in specific exchange rates. If that country has a positive BOP . c) Transfer payments which represent aid . grants and gifts from one country to another. BOP is important measurement as it can be used as an indicator of a country µs economic and political stability. 3) Financial accounts includes DFI and portfolio investment.

. In theory the current account . which means it should be perfectly balance.4) Errors and Omissions and Reserve. Therefore the BOP has a category of errors and omissions.capital and financial account should have a sum of zero . However in real life this is not the case as it is difficult to have a perfect offset because measurement errors can occur while measuring funds transfer into and out of the country.

3333% . P = [(120/140) ± 1] X360/180 express as % equals to -28. Calculate the annual forward premium/discount for Jap.5714% b) Indirect quotation : P = [(140/120)-1]X360/180 = 0. a) Formulae : direct quotation P (forward premium/discount) = F(forward rate)/S(spot rate) ± 1 Therefore in this case for a 6 month premium or discount . Yen using direct and indirect quotations.3333 or expressed in percentage : 33.5) The Japanese Yen ±US dollar spot rate is 140¥/$ and the 6 months forward rate is 120¥/$.

. However due to cheaper currency . b) A devaluation of its currency means that the import became more expensive or its export becomes cheaper but due to the devalued currency .6) What is J curve effect? How to explain the J-curve effect? a) J curve effect refers to a country trade balance after a devaluation or depreciation of its currency.the balance of trade dips further. its export competitiveness will improve and grow in volume overtime and thus results in improved trade balances as seen in the upward trend of the curve ±hence the J curve effect.

a) Direct tax ± Taxes paid directly by individual or corporation to the government. VAT or excise duties which can be pass on by the suppliers to the end consumer. These provision are known and it is taken into the bottom line of the business . Direct tax can be calculated and provision can made in advance to be paid when the due date. . therefore no risk are involve.Taxes such as GST . b) Indirect tax .7) Outline the 2 basic approaches of the tax system.

. due to over-value of the US dollars and the economic situation in the US . Under the Bretton Woods system . In the 1971 the US economy is almost devastated resulting in a depreciation of US dollars. The US dollars is pegged at 35US dollars per ounce of gold. a) The Bretton Woods system is a fixed exchange rate system between currencies where the US dollars is use as a reference instead of gold. Therefore over time . the Bretton Woods system was abolished.8) Briefly discuss the main reasons for the demises of the Bretton Woods system. countries that has international trade and need foreign currencies will have a unfair value to their own currencies since they are pegged to the US dollars which is over-value at that time.

ii) IFE ± ef = Ih ± If where Ih is home country interest rates and If is foreign country interest rates.9) On its issue of 20 December 2010. If the home country interest rates is higher than the foreign interest rates . European countries sovereign debt crisis has worsen in the meantime. Home country inflation and interest rates are high and that foreign investor are pulling out of the country to invest their money somewhere . a) The situation in the US can be explained as follows: i)PPP ± Since ef = ih . the US currency has gone weaker even though the government is putting a lot of aids in the economy is due to 2 main reasons. the home country currency will be weaker as explain by the formulae.if where if =foreign inflation and ih =home inflation ef will be higher when ih is larger than if. Therefore if the home inflation is higher than foreign country the home currency will be weaker as explain by the formulae. Therefore in the Straits Times as reported . That fall makes the US dollar the worst performer for the period among frequently traded currencies in the world. Please explain why the US dollar depreciated sharply by using the knowledge learnt from international finance class and other reading materials. the straits times newspaper reported that the US dollar has dropped steadily against major currencies since the start of May. This could be related to the current economic conditions in USA. . In addition .

how do the two performance measures define risk differently? a) Optimal international portfolio are defined by less risk and higher return to investor or MNCs which are taking the right decision. .10) Briefly discuss how to determine the optimal international portfolio? Conceptually . ii) Tragner measurement = (Ri ± Rf) unique risk. iii) Since i is / i where i is unsystematic risk or a subset of i . b) Conceptually 2 methods are used: i) Sharpe measurement = (Ri ± Rf) / i where i is the total risk comprising of systematic and unsystematic risk. the Tragner method will be a preferred method. R is return of asset.