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.

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

In the choice of FDI location . supply chain effectiveness and technology competencies. local resources . 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 . .

Disadvantage of this system is the intervention of these Bumiputras that may impede the aggressive growth of the MNCs. 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.2) Define political risks. An example will be Malaysia where any foreign invested companies must have a ³Bumiputra´ shareholder. . The Bumiputras enjoy only the benefits but the business risk. These sleeping partner may act as ³spies´ and any trade secrets maybe leak out via these channels. 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) 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 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. if the risk of blocking funds transfer arises in the foreign .In some countries where there is a requirement from the government that any foreign invested company must have local representatives in the shareholder. Explain the classification of political risks a) Political risk are factors that impede the performance of the subsidiary in a foreign country.

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

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

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

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. insurance etc. b) Factor income payments which represent income from interest and dividend receive by investors on foreign investment. If that country has a positive BOP . it also includes value of non produced non financial assets such as patents and trademarks. 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 . 3) Financial accounts includes DFI and portfolio investment. c) Transfer payments which represent aid . grants and gifts from one country to another.4) Define balance of payments. 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 .legal . BOP is important measurement as it can be used as an indicator of a country µs economic and political stability.individual and government for a specific country and the rest of the countries over a specified period of time. .

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. 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.capital and financial account should have a sum of zero .

3333 or expressed in percentage : 33.5714% b) Indirect quotation : P = [(140/120)-1]X360/180 = 0. 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 . P = [(120/140) ± 1] X360/180 express as % equals to -28.5) The Japanese Yen ±US dollar spot rate is 140¥/$ and the 6 months forward rate is 120¥/$.3333% . Calculate the annual forward premium/discount for Jap.

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

Taxes such as GST .7) Outline the 2 basic approaches of the tax system. therefore no risk are involve. . 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. Direct tax can be calculated and provision can made in advance to be paid when the due date. a) Direct tax ± Taxes paid directly by individual or corporation to the government. b) Indirect tax .

. Therefore over time . In the 1971 the US economy is almost devastated resulting in a depreciation of US dollars. 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. the Bretton Woods system was abolished. The US dollars is pegged at 35US dollars per ounce of gold. Under the Bretton Woods system .8) Briefly discuss the main reasons for the demises of the Bretton Woods system. 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. due to over-value of the US dollars and the economic situation in the US .

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

ii) Tragner measurement = (Ri ± Rf) unique risk. R is return of asset. . 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 . 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. iii) Since i is / i where i is unsystematic risk or a subset of i .

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