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.

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. 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. iii) Use of foreign raw material . establish subsidiary in countries where the currency is weak but will strengthen over time. 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. MNCs will make decision on where to establish the subsidiary in order to maximize shareholder¶s wealth. 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. With these motives . Besides these motives .establish subsidiary where the foreign labor . International projects allow MNCs to achieve lower risk than 100% domestic projects without reducing their expected returns. v) React to exchange rate movements. iv) Use of foreign technology . Another form of FDI is international diversification where MNC can reduce it¶s risk exposure in their home countries due to economic conditions.ii) Use foreign factors of production . .

local resources . . supply chain effectiveness and technology competencies.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 .

Some advantage of this setup are local knowledge and government network which is key importance to new MNCs that setup in these countries. 2) Ownership . Explain the classification of political risks a) Political risk are factors that impede the performance of the subsidiary in a foreign country.2) Define political risks. 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. if the risk of blocking funds transfer arises in the foreign . Elimination of ³red tapes´ can be a motivation factor for MNCs to have these Bumiputras. These sleeping partner may act as ³spies´ and any trade secrets maybe leak out via these channels.In some countries where there is a requirement from the government that any foreign invested company must have local representatives in the shareholder. The Bumiputras enjoy only the benefits but the business risk. 3) Blockage of funds transfer ± foreign entities initiate FDI to increase the wealth of shareholders. An example will be Malaysia where any foreign invested companies must have a ³Bumiputra´ 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. . Disadvantage of this system is the intervention of these Bumiputras that may impede the aggressive growth of the MNCs.

At the same time .Corruption may also affects a company image and reputation. 4) Corruption and Neopotism ± corruption may result in inefficient bureaucracy and breach company¶s policy . . any funds that cannot be transfer may result in business obstacles as funds are needed for operational matters to purchase materials etc.country where the subsidiary is . 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. 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. it loses its initial objective of setting up the subsidiary.

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

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

c) Transfer payments which represent aid . 2) Capital account includes financial assets transfer across borders . grants and gifts from one country to another. Why balance of payment is important? Balance of payment is a summary of transactions between domestic and foreign businesses . 3) Financial accounts includes DFI and portfolio investment. 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 . insurance etc.individual and government for a specific country and the rest of the countries over a specified period of time. b) Factor income payments which represent income from interest and dividend receive by investors on foreign investment.4) Define balance of payments. 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 . it means that there is a substantial investment in that country and it does not export much of it¶s currency.legal . BOP is important measurement as it can be used as an indicator of a country µs economic and political stability. it also includes value of non produced non financial assets such as patents and trademarks.

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. .4) Errors and Omissions and Reserve. Therefore the BOP has a category of errors and omissions. In theory the current account .capital and financial account should have a sum of zero . which means it should be perfectly balance.

P = [(120/140) ± 1] X360/180 express as % equals to -28. Yen using direct and indirect quotations. 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 .5) The Japanese Yen ±US dollar spot rate is 140¥/$ and the 6 months forward rate is 120¥/$.5714% b) Indirect quotation : P = [(140/120)-1]X360/180 = 0.3333% . Calculate the annual forward premium/discount for Jap.3333 or expressed in percentage : 33.

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.the balance of trade dips further. b) A devaluation of its currency means that the import became more expensive or its export becomes cheaper but due to the devalued currency . However due to cheaper 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.

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

due to over-value of the US dollars and the economic situation in the US . The US dollars is pegged at 35US dollars per ounce of gold.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. Therefore over time . 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. the Bretton Woods system was abolished. Under the Bretton Woods system . In the 1971 the US economy is almost devastated resulting in a depreciation of US dollars.

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

b) Conceptually 2 methods are used: i) Sharpe measurement = (Ri ± Rf) / i where i is the total risk comprising of systematic and unsystematic risk. . iii) Since i is / i where i is unsystematic risk or a subset of i . R is return of asset. the Tragner method will be a preferred method. ii) Tragner measurement = (Ri ± Rf) unique risk. 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 .