International Financial Management
ninth edition

Jeff Madura
Florida Atlantic University


International Financial Management, Ninth Edition
Jeff Madura
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Dedicated to my parents


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Brief Contents

Part 1: The International Financial Environment
1.
2.
3.
4.
5.

1

Multinational Financial Management: An Overview 2
International Flow of Funds 22
International Financial Markets 50
Exchange Rate Determination 85
Currency Derivatives 103

Part 2: Exchange Rate Behavior

153

6. Government Influence on Exchange Rates 154
7. International Arbitrage and Interest Rate Parity 188
8. Relationships among Inflation, Interest Rates, and Exchange Rates 214

Part 3: Exchange Rate Risk Management

249


9. Forecasting Exchange Rates 250
10. Measuring Exposure to Exchange Rate Fluctuations 280
11. Managing Transaction Exposure 307
12. Managing Economic Exposure and Translation Exposure 346

Part 4: Long-Term Asset and Liability Management
13.
14.
15.
16.
17.
18.

369

Direct Foreign Investment 370
Multinational Capital Budgeting 387
International Acquisitions 422
Country Risk Analysis 446
Multinational Cost of Capital and Capital Structure 472
Long-Term Financing 500

Part 5: Short-Term Asset and Liability Management

529

19. Financing International Trade 530
20. Short-Term Financing 549
21. International Cash Management 569

Appendix A: Answers to Self Test Questions 606
Appendix B: Supplemental Cases 618
Appendix C: Using Excel to Conduct Analysis 640
Appendix D: International Investing Project 647
Appendix E: Discussion in the Boardroom 650
Glossary 658
Index 665

v


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Contents

Blades, Inc. Case: Decision to Expand Internationally, 19
Small Business Dilemma: Developing a Multinational
Sporting Goods Corporation, 20
Internet/Excel Exercises, 21

Preface, xvii

Part 1: The International
Financial Environment

1

Chapter 1: Multinational Financial
Management: An Overview


2

Managing the MNC, 2

Facing Agency Problems, 3
Governance: How SOX Improved Corporate Governance
of MNCs, 3

Management Structure of an MNC, 4
Why Firms Pursue International Business, 5

Theory of Comparative Advantage, 6
Imperfect Markets Theory, 6
Product Cycle Theory, 6
How Firms Engage in International Business, 7

International Trade, 8
Licensing, 8
Franchising, 9
Joint Ventures, 9
Acquisitions of Existing Operations, 9
Establishing New Foreign Subsidiaries, 9
Summary of Methods, 10
Valuation Model for an MNC, 11

Domestic Model, 11
Valuing International Cash Flows, 12
Uncertainty Surrounding an MNC’s Cash Flows, 14
Organization of the Text, 15

Summary, 16
Point Counter-Point: Should an MNC Reduce Its Ethical
Standards to Compete Internationally?, 16
Self Test, 16
Questions and Applications, 17
Advanced Questions, 17
Discussion in the Boardroom, 19
Running Your Own MNC, 19

Chapter 2: International
Flow of Funds

22

Balance of Payments, 22

Current Account, 22
Capital and Financial Accounts, 23
International Trade Flows, 25

Distribution of U.S. Exports and Imports, 26
U.S. Balance-of-Trade Trend, 26
International Trade Issues, 28

Events That Increased International Trade, 28
Trade Friction, 31
Governance: Should Managers Outsource to Satisfy
Shareholders?, 32

Factors Affecting International Trade Flows, 34


Impact of Inflation, 34
Impact of National Income, 34
Impact of Government Policies, 35
Impact of Exchange Rates, 35
Interaction of Factors, 36
Correcting a Balance-of-Trade Deficit, 36

Why a Weak Home Currency Is Not
a Perfect Solution, 37
International Capital Flows, 38

Distribution of DFI by U.S. Firms, 38
Distribution of DFI in the United States, 39
Factors Affecting DFI, 40
Factors Affecting International Portfolio
Investment, 41
Impact of International Capital Flows, 41
Agencies That Facilitate International Flows, 42

International Monetary Fund, 42
World Bank, 43
World Trade Organization, 44
International Financial Corporation, 44
vii


viii

Contents


International Development Association, 45
Bank for International Settlements, 45
Organization for Economic Cooperation and
Development, 45
Regional Development Agencies, 45
How International Trade Affects an MNC’s Value, 45
Summary, 46
Point Counter-Point: Should Trade Restrictions Be Used to
Influence Human Rights Issues?, 46
Self Test, 46
Questions and Applications, 47
Advanced Questions, 47
Discussion in the Boardroom, 47
Running Your Own MNC, 47
Blades, Inc. Case: Exposure to International
Flow of Funds, 48
Small Business Dilemma: Identifying Factors That Will Affect
the Foreign Demand at the Sports Exports Company, 48
Internet/Excel Exercises, 49

Chapter 3: International
Financial Markets

50

Foreign Exchange Market, 50

History of Foreign Exchange, 50
Foreign Exchange Transactions, 51

Foreign Exchange Quotations, 54
Interpreting Foreign Exchange Quotations, 56
Forward, Futures, and Options Markets, 58
International Money Market, 59

Origins and Development, 60
Money Market Interest Rates among Currencies, 61
Standardizing Global Bank Regulations, 61
International Credit Market, 63

Syndicated Loans, 63
International Bond Market, 64

Eurobond Market, 64
Development of Other Bond Markets, 65
International Stock Markets, 66

Issuance of Stock in Foreign Markets, 66
Issuance of Foreign Stock in the United States, 66
Listing of Stock by Non-U.S. Firms on U.S. Stock
Exchanges, 67
Governance: Effect of Sarbanes-Oxley Act on Foreign
Stock Offerings, 67

Investing in Foreign Stock Markets, 67
How Stock Market Characteristics Vary among
Countries, 70
How Financial Markets Facilitate MNC Functions, 70
Summary, 71
Point Counter-Point: Should Firms That Go Public Engage

in International Offerings?, 72

Self Test, 72
Questions and Applications, 72
Advanced Questions, 73
Discussion in the Boardroom, 74
Running Your Own MNC, 74
Blades, Inc. Case: Decisions to Use International Financial
Markets, 74
Small Business Dilemma: Use of the Foreign
Exchange Markets by the Sports Exports
Company, 75
Internet/Excel Exercises, 75
Appendix 3: Investing in International
Financial Markets, 76

Chapter 4: Exchange
Rate Determination

85

Measuring Exchange Rate Movements, 85
Exchange Rate Equilibrium, 86

Demand for a Currency, 87
Supply of a Currency for Sale, 87
Equilibrium, 88
Factors That Influence Exchange Rates, 89

Relative Inflation Rates, 89

Relative Interest Rates, 90
Relative Income Levels, 92
Government Controls, 92
Expectations, 93
Interaction of Factors, 93
Speculating on Anticipated Exchange Rates, 95
Summary, 97
Point Counter-Point: How Can Persistently Weak
Currencies Be Stabilized?, 97
Self Test, 98
Questions and Applications, 98
Advanced Questions, 99
Discussion in the Boardroom, 100
Running Your Own MNC, 100
Blades, Inc. Case: Assessment of Future Exchange Rate
Movements, 101
Small Business Dilemma: Assessment by the Sports
Exports Company of Factors That Affect the British
Pound’s Value, 101
Internet/Excel Exercises, 102

Chapter 5: Currency
Derivatives
Forward Market, 103

How MNCs Use Forward Contracts, 104
Non-Deliverable Forward Contracts, 107
Currency Futures Market, 108

Contract Specifications, 108

Trading Futures, 108

103


Contents

Comparison of Currency Futures and Forward
Contracts, 110
Pricing Currency Futures, 110
Credit Risk of Currency Futures Contracts, 111
Speculation with Currency Futures, 111
How Firms Use Currency Futures, 112
Closing Out a Futures Position, 113
Trading Platforms for Currency Futures, 114
Currency Options Market, 114

Option Exchanges, 114
Over-the-Counter Market, 114
Currency Call Options, 115

Factors Affecting Currency Call Option
Premiums, 115
How Firms Use Currency Call Options, 116
Speculating with Currency Call Options, 117
Currency Put Options, 119

Factors Affecting Currency Put Option
Premiums, 119
Hedging with Currency Put Options, 120

Speculating with Currency Put Options, 120
Contingency Graphs for Currency Options, 122

Contingency Graph for a Purchaser of a Call
Option, 122
Contingency Graph for a Seller of a Call Option, 123
Contingency Graph for a Buyer of a Put Option, 124
Contingency Graph for a Seller of a Put
Option, 124
Governance: Should an MNC’s Managers Use Currency
Derivatives to Speculate?, 124

Conditional Currency Options, 124
European Currency Options, 126
Summary, 126
Point Counter-Point: Should Speculators Use Currency
Futures or Options?, 126
Self Test, 127
Questions and Applications, 127
Advanced Questions, 130
Discussion in the Boardroom, 132
Running Your Own MNC, 132
Blades, Inc. Case: Use of Currency Derivative
Instruments, 133
Small Business Dilemma: Use of Currency Futures
and Options by the Sports Exports Company, 134
Internet/Excel Exercises, 134
Appendix 5A: Currency Option
Pricing, 135


Part 2: Exchange
Rate Behavior
Chapter 6: Government
Influence on Exchange Rates

ix

153
154

Exchange Rate Systems, 154

Fixed Exchange Rate System, 154
Freely Floating Exchange Rate System, 156
Managed Float Exchange Rate System, 158
Pegged Exchange Rate System, 158
Currency Boards Used to Peg Currency Values, 161
Dollarization, 163
Classification of Exchange Rate Arrangements, 163
A Single European Currency, 164

Membership, 165
Impact on European Monetary Policy, 165
Impact on Business within Europe, 165
Impact on the Valuation of Businesses in Europe, 166
Impact on Financial Flows, 166
Impact on Exchange Rate Risk, 167
Status Report on the Euro, 167
Government Intervention, 167


Reasons for Government Intervention, 167
Direct Intervention, 168
Indirect Intervention, 171
Intervention as a Policy Tool, 172

Influence of a Weak Home Currency on the
Economy, 172
Influence of a Strong Home Currency on the
Economy, 172
Summary, 174
Point Counter-Point: Should China Be Forced to Alter the
Value of Its Currency?, 174
Self Test, 175
Questions and Applications, 175
Advanced Questions, 176
Discussion in the Boardroom, 176
Running Your Own MNC, 176
Blades, Inc. Case: Assessment of Government Influence on
Exchange Rates, 177
Small Business Dilemma: Assessment of Central Bank
Intervention by the Sports Exports Company, 178
Internet/Excel Exercises, 178
Appendix 6: Government Intervention
during the Asian Crisis, 179

Appendix 5B: Currency Option
Combinations, 139

Chapter 7: International
Arbitrage and Interest

Rate Parity

Part 1 Integrative Problem:
The International Financial
Environment, 152

International Arbitrage, 188

Locational Arbitrage, 188

188


x

Contents

Triangular Arbitrage, 191
Covered Interest Arbitrage, 194
Comparison of Arbitrage Effects, 197

Why the International Fisher Effect Does
Not Occur, 231
Comparison of the IRP, PPP, and IFE Theories, 231

Interest Rate Parity (IRP), 198

Derivation of Interest Rate Parity, 198
Determining the Forward Premium, 199
Graphic Analysis of Interest Rate Parity, 200

How to Test Whether Interest Rate
Parity Exists, 202
Interpretation of Interest Rate Parity, 202
Does Interest Rate Parity Hold?, 203
Considerations When Assessing Interest Rate
Parity, 204
Forward Premiums across Maturity Markets, 205
Changes in Forward Premiums, 206
Governance: How Arbitrage Reduces the Need to Monitor
Transaction Costs, 207
Summary, 207
Point Counter-Point: Does Arbitrage Destabilize Foreign
Exchange Markets?, 208
Self Test, 208
Questions and Applications, 209
Advanced Questions, 210
Discussion in the Boardroom, 211
Running Your Own MNC, 211
Blades, Inc. Case: Assessment of Potential Arbitrage
Opportunities, 211
Small Business Dilemma: Assessment of Prevailing
Spot and Forward Rates by the Sports Exports
Company, 213
Internet/Excel Exercises, 213

Chapter 8: Relationships
among Inflation, Interest Rates,
and Exchange Rates

214


Purchasing Power Parity (PPP), 214

Interpretations of Purchasing Power Parity, 214
Rationale behind Purchasing Power Parity
Theory, 215
Derivation of Purchasing Power Parity, 216
Using PPP to Estimate Exchange Rate Effects, 217
Graphic Analysis of Purchasing Power Parity, 218
Testing the Purchasing Power Parity Theory, 219
Why Purchasing Power Parity Does Not Occur, 222
Purchasing Power Parity in the Long Run, 223
International Fisher Effect (IFE), 223

Relationship with Purchasing Power Parity, 223
Implications of the IFE for Foreign Investors, 224
Derivation of the International Fisher Effect, 225
Graphic Analysis of the International
Fisher Effect, 227
Tests of the International Fisher Effect, 229

Summary, 232
Point Counter-Point: Does PPP Eliminate Concerns about
Long-Term Exchange Rate Risk?, 233
Self Test, 233
Questions and Applications, 234
Advanced Questions, 235
Discussion in the Boardroom, 237
Running Your Own MNC, 237
Blades, Inc. Case: Assessment of Purchasing

Power Parity, 238
Small Business Dilemma: Assessment of the IFE by the
Sports Exports Company, 239
Internet/Excel Exercises, 239
Part 2 Integrative Problem:
Exchange Rate Behavior, 240
Midterm Self Exam, 241

Part 3: Exchange Rate
Risk Management
Chapter 9: Forecasting
Exchange Rates

249
250

Why Firms Forecast Exchange Rates, 250
Forecasting Techniques, 252

Technical Forecasting, 253
Fundamental Forecasting, 254
Market-Based Forecasting, 258
Mixed Forecasting, 261
Forecasting Services, 262

Reliance on Forecasting Services, 262
Forecast Error, 263

Potential Impact of Forecast Errors, 263
Measurement of Forecast Error, 263

Forecast Accuracy over Time, 264
Forecast Accuracy among Currencies, 264
Forecast Bias, 265
Graphic Evaluation of Forecast
Performance, 266
Comparison of Forecasting Methods, 269
Forecasting under Market Efficiency, 269
Governance: Governance of Managerial Forecasting, 270

Using Interval Forecasts, 270

Methods of Forecasting Exchange Rate
Volatility, 271
Summary, 272
Point Counter-Point: Which Exchange Rate Forecast
Technique Should MNCs Use?, 272


Contents
Self Test, 273
Questions and Applications, 273
Advanced Questions, 275
Discussion in the Boardroom, 277
Running Your Own MNC, 277
Blades, Inc. Case: Forecasting Exchange Rates, 277
Small Business Dilemma: Exchange Rate Forecasting by
the Sports Exports Company, 278
Internet/Excel Exercises, 278

Chapter 10: Measuring

Exposure to Exchange Rate
Fluctuations
Is Exchange Rate Risk Relevant?, 280

Purchasing Power Parity Argument, 280
The Investor Hedge Argument, 280
Currency Diversification Argument, 281
Stakeholder Diversification Argument, 281
Response from MNCs, 281
Types of Exposure, 281
Transaction Exposure, 282

Estimating “Net” Cash Flows in Each
Currency, 282
Measuring the Potential Impact of the
Currency Exposure, 284
Assessing Transaction Exposure Based on
Value at Risk, 286
Economic Exposure, 289

Economic Exposure to Local Currency
Appreciation, 291
Economic Exposure to Local Currency
Depreciation, 291
Economic Exposure of Domestic Firms, 292
Measuring Economic Exposure, 292
Translation Exposure, 295

Does Translation Exposure Matter?, 295
Determinants of Translation Exposure, 296

Examples of Translation Exposure, 297
Summary, 297
Point Counter-Point: Should Investors Care about an
MNC’s Translation Exposure?, 298
Self Test, 298
Questions and Applications, 299
Advanced Questions, 300
Discussion in the Boardroom, 304
Running Your Own MNC, 304
Blades, Inc. Case: Assessment of Exchange Rate
Exposure, 304
Small Business Dilemma: Assessment of Exchange
Rate Exposure by the Sports Exports
Company, 305
Internet/Excel Exercises, 306

280

Chapter 11: Managing
Transaction Exposure
Transaction Exposure, 307

Identifying Net Transaction Exposure, 307
Adjusting the Invoice Policy to Manage
Exposure, 308
Governance: Aligning Manager Compensation with
Hedging Goals, 308

Hedging Exposure to Payables, 308


Forward or Futures Hedge on Payables, 309
Money Market Hedge on Payables, 309
Call Option Hedge, 310
Summary of Techniques Used to Hedge
Payables, 313
Selecting the Optimal Technique for Hedging
Payables, 313
Optimal Hedge versus No Hedge, 316
Evaluating the Hedge Decision, 316
Hedging Exposure To Receivables, 317

Forward or Futures Hedge on
Receivables, 317
Money Market Hedge on Receivables, 317
Put Option Hedge, 318
Selecting the Optimal Technique for Hedging
Receivables, 320
Optimal Hedge versus No Hedge, 323
Evaluating the Hedge Decision, 323
Comparison of Hedging Techniques, 324
Hedging Policies of MNCs, 325
Limitations of Hedging, 326

Limitation of Hedging an Uncertain
Amount, 326
Limitation of Repeated Short-Term
Hedging, 326
Hedging Long-Term Transaction
Exposure, 328


Long-Term Forward Contract, 328
Parallel Loan, 328
Alternative Hedging Techniques, 329

Leading and Lagging, 329
Cross-Hedging, 329
Currency Diversification, 329
Summary, 330
Point Counter-Point: Should an MNC Risk
Overhedging?, 330
Self Test, 331
Questions and Applications, 331
Advanced Questions, 334
Discussion in the Boardroom, 338
Running Your Own MNC, 338
Blades, Inc. Case: Management of Transaction
Exposure, 338

xi

307


xii

Contents

Small Business Dilemma: Hedging Decisions by the Sports
Exports Company, 340
Internet/Excel Exercises, 340

Appendix 11: Nontraditional
Hedging Techniques, 341

Chapter 12: Managing
Economic Exposure and
Translation Exposure

369

Chapter 13: Direct
Foreign Investment

370

Motives for Direct Foreign Investment, 370

346

Economic Exposure, 346

Use of Projected Cash Flows to Assess Economic
Exposure, 347
How Restructuring Can Reduce Economic
Exposure, 348
Issues Involved in the Restructuring
Decision, 351
A Case Study in Hedging Economic Exposure, 352

Savor Co.’s Dilemma, 352
Assessment of Economic Exposure, 352

Assessment of Each Unit’s Exposure, 353
Identifying the Source of the Unit’s
Exposure, 353
Possible Strategies to Hedge Economic
Exposure, 354
Savor’s Hedging Solution, 356
Limitations of Savor’s Optimal Hedging
Strategy, 356
Hedging Exposure to Fixed Assets, 356
Managing Translation Exposure, 357

Use of Forward Contracts to Hedge Translation
Exposure, 357
Limitations of Hedging Translation
Exposure, 358
Governance: Governing the Hedge of Translation
Exposure, 359
Summary, 359
Point Counter-Point: Can an MNC Reduce the Impact
of Translation Exposure by Communicating, 360
Self Test, 360
Questions and Applications, 361
Advanced Questions, 361
Discussion in the Boardroom, 362
Running Your Own MNC, 362
Blades, Inc. Case: Assessment of Economic
Exposure, 363
Small Business Dilemma: Hedging the Sports Exports
Company’s Economic Exposure to Exchange
Rate Risk, 364

Internet/Excel Exercises, 364
Part 3 Integrative Problem:
Exchange Rate Risk
Management, 366

Part 4: Long-Term
Asset and Liability
Management

Revenue-Related Motives, 370
Cost-Related Motives, 371
Governance: Selfish Managerial Motives for DFI, 373

Comparing Benefits of DFI among Countries, 373
Comparing Benefits of DFI over Time, 374
Benefits of International Diversification, 375

Diversification Analysis of International
Projects, 377
Diversification among Countries, 379
Decisions Subsequent to DFI, 380
Host Government Views of DFI, 380

Incentives to Encourage DFI, 380
Barriers to DFI, 381
Government-Imposed Conditions to Engage
in DFI, 382
Summary, 382
Point Counter-Point: Should MNCs Avoid DFI in Countries
with Liberal Child Labor Laws?, 382

Self Test, 383
Questions and Applications, 383
Advanced Questions, 384
Discussion in the Boardroom, 384
Running Your Own MNC, 384
Blades, Inc. Case: Consideration of Direct Foreign
Investment, 385
Small Business Dilemma: Direct Foreign Investment
Decision by the Sports Exports Company, 386
Internet/Excel Exercises, 386

Chapter 14: Multinational
Capital Budgeting
Subsidiary versus Parent Perspective, 387

Tax Differentials, 387
Restricted Remittances, 388
Excessive Remittances, 388
Exchange Rate Movements, 388
Summary of Factors, 388
Input for Multinational Capital Budgeting, 389
Multinational Capital Budgeting Example, 391

Background, 391
Analysis, 392
Factors to Consider in Multinational Capital
Budgeting, 395

Exchange Rate Fluctuations, 395


387


Contents

Inflation, 396
Financing Arrangement, 397
Blocked Funds, 400
Uncertain Salvage Value, 401
Impact of Project on Prevailing Cash Flows, 402
Host Government Incentives, 403
Real Options, 403
Adjusting Project Assessment for Risk, 404

Exchange Rate Effects on the Funds Remitted, 434
Required Return of Acquirer, 434
Other Types of Multinational Restructuring, 434

International Partial Acquisitions, 434
International Acquisitions of Privatized
Businesses, 435
International Alliances, 435
International Divestitures, 436
Restructuring Decisions as Real Options, 437

Risk-Adjusted Discount Rate, 404
Sensitivity Analysis, 404
Simulation, 405

Call Option on Real Assets, 437

Put Option on Real Assets, 438

Governance: Controls over International Project
Proposals, 406
Summary, 406
Point Counter-Point: Should MNCs Use Forward Rates to
Estimate Dollar Cash Flows of Foreign Projects?, 406
Self Test, 407
Questions and Applications, 407
Advanced Questions, 410
Discussion in the Boardroom, 412
Running Your Own MNC, 412
Blades, Inc. Case: Decision by Blades, Inc., to Invest in
Thailand, 412
Small Business Dilemma: Multinational Capital Budgeting
by the Sports Exports Company, 414
Internet/Excel Exercises, 414
Appendix 14: Incorporating
International Tax Laws in
Multinational Capital Budgeting, 415

Chapter 15: International
Acquisitions

xiii

Summary, 438
Point Counter-Point: Can a Foreign Target Be Assessed
Like Any Other Asset?, 439
Self Test, 439

Questions and Applications, 439
Advanced Questions, 440
Discussion in the Boardroom, 443
Running Your Own MNC, 443
Blades, Inc. Case: Assessment of an Acquisition in
Thailand, 443
Small Business Dilemma: Multinational Restructuring by the
Sports Exports Company, 445
Internet/Excel Exercises, 445

Chapter 16: Country
Risk Analysis

446

Why Country Risk Analysis Is Important, 446
Political Risk Factors, 447

422

Background on International Acquisitions, 422

Trends in International Acquisitions, 423
Model for Valuing a Foreign Target, 423
Market Assessment of International
Acquisitions, 424
Assessing Potential Acquisitions after the Asian
Crisis, 424
Assessing Potential Acquisitions in Europe, 425
Governance: Impact of the Sarbanes-Oxley Act on the

Pursuit of Targets, 425

Factors That Affect the Expected Cash Flows of the
Foreign Target, 425

Target-Specific Factors, 425
Country-Specific Factors, 426
Example of the Valuation Process, 427

International Screening Process, 427
Estimating the Target’s Value, 428
Changes in Valuation over Time, 431
Why Valuations of a Target May Vary among MNCs, 433

Estimated Cash Flows of the Foreign Target, 433

Attitude of Consumers in the Host Country, 447
Actions of Host Government, 447
Blockage of Fund Transfers, 448
Currency Inconvertibility, 448
War, 449
Bureaucracy, 449
Corruption, 449
Financial Risk Factors, 450

Indicators of Economic Growth, 450
Types of Country Risk Assessment, 451

Macroassessment of Country Risk, 451
Microassessment of Country Risk, 452

Techniques to Assess Country Risk, 453

Checklist Approach, 453
Delphi Technique, 453
Quantitative Analysis, 454
Inspection Visits, 454
Combination of Techniques, 454
Measuring Country Risk, 454

Variation in Methods of Measuring Country
Risk, 457
Using the Country Risk Rating for Decision
Making, 457


xiv

Contents

Comparing Risk Ratings among Countries, 457
Actual Country Risk Ratings across Countries, 457
Incorporating Country Risk in Capital Budgeting, 459

Adjustment of the Discount Rate, 459
Adjustment of the Estimated Cash Flows, 459
How Country Risk Affects Financial
Decisions, 462
Governance: Governance over the Assessment
of Country Risk, 462


Reducing Exposure to Host Government Takeovers, 463

Use a Short-Term Horizon, 463
Rely on Unique Supplies or Technology, 463
Hire Local Labor, 463
Borrow Local Funds, 463
Purchase Insurance, 464
Use Project Finance, 464

Revising the Capital Structure in Response to
Changing Conditions, 488
Interaction between Subsidiary and Parent Financing
Decisions, 489

Impact of Increased Debt Financing by the
Subsidiary, 490
Impact of Reduced Debt Financing by the
Subsidiary, 491
Summary of Interaction between Subsidiary and
Parent Financing Decisions, 491
Local versus Global Target Capital Structure, 492

Offsetting a Subsidiary’s High Degree of Financial
Leverage, 492
Offsetting a Subsidiary’s Low Degree of Financial
Leverage, 492
Limitations in Offsetting a Subsidiary’s Abnormal
Degree of Financial Leverage, 492

Summary, 465

Point Counter-Point: Does Country Risk Matter for U.S.
Projects?, 465
Self Test, 465
Questions and Applications, 466
Advanced Questions, 467
Discussion in the Boardroom, 469
Running Your Own MNC, 469
Blades, Inc. Case: Country Risk Assessment, 469
Small Business Dilemma: Country Risk Analysis at the
Sports Exports Company, 471
Internet/Excel Exercises, 471

Summary, 493
Point Counter-Point: Should the Reduced Tax Rate on
Dividends Affect an MNC’s Capital Structure?, 493
Self Test, 494
Questions and Applications, 494
Advanced Questions, 495
Discussion in the Boardroom, 497
Running Your Own MNC, 497
Blades, Inc. Case: Assessment of Cost of Capital, 497
Small Business Dilemma: Multinational Capital Structure
Decision at the Sports Exports Company, 499
Internet/Excel Exercises, 499

Chapter 17: Multinational Cost
of Capital and Capital Structure 472

Chapter 18: Long-Term
Financing


Background on Cost of Capital, 472

Long-Term Financing Decision, 500

Comparing the Costs of Equity and Debt, 472
Cost of Capital for MNCs, 473

Cost-of-Equity Comparison Using the CAPM, 475
Implications of the CAPM for an MNC’s Risk, 476
Costs of Capital across Countries, 477

Country Differences in the Cost of Debt, 477
Country Differences in the Cost of Equity, 478
Combining the Costs of Debt and Equity, 480
Estimating the Cost of Debt and Equity, 480
Using the Cost of Capital for Assessing Foreign
Projects, 481

Derive Net Present Values Based on the Weighted
Average Cost of Capital, 481
Adjust the Weighted Average Cost of Capital for the
Risk Differential, 482
Derive the Net Present Value of the Equity
Investment, 482
The MNC’s Capital Structure Decision, 486

Influence of Corporate Characteristics, 486
Influence of Country Characteristics, 487


500

Sources of Equity, 500
Sources of Debt, 501
Governance: Stockholder versus Creditor
Conflict, 501

Cost of Debt Financing, 501

Measuring the Cost of Financing, 502
Actual Effects of Exchange Rate Movements on
Financing Costs, 504
Assessing the Exchange Rate Risk of Debt
Financing, 506

Use of Exchange Rate Probabilities, 506
Use of Simulation, 506
Reducing Exchange Rate Risk, 507

Offsetting Cash Inflows, 507
Forward Contracts, 508
Currency Swaps, 508
Parallel Loans, 510
Diversifying among Currencies, 514
Interest Rate Risk from Debt Financing, 515

The Debt Maturity Decision, 515


Contents


The Fixed versus Floating Rate Decision, 517
Hedging with Interest Rate Swaps, 517
Plain Vanilla Swap, 517
Summary, 521
Point Counter-Point: Will Currency Swaps Result in Low
Financing Costs?, 521
Self Test, 521
Questions and Applications, 522
Advanced Questions, 523
Discussion in the Boardroom, 524
Running Your Own MNC, 524
Blades, Inc. Case: Use of Long-Term Financing, 524
Small Business Dilemma: Long-Term Financing Decision by
the Sports Exports Company, 525
Internet/Excel Exercises, 526

Prepayment, 531
Letters of Credit (L/Cs), 531
Drafts, 532
Consignment, 532
Open Account, 532
Trade Finance Methods, 533

Accounts Receivable Financing, 533
Factoring, 533
Letters of Credit (L/Cs), 534
Banker’s Acceptance, 538
Working Capital Financing, 540
Medium-Term Capital Goods Financing

(Forfaiting), 541
Countertrade, 541
Agencies That Motivate International Trade, 542

Export-Import Bank of the United States, 542
Private Export Funding Corporation
(PEFCO), 544
Overseas Private Investment Corporation
(OPIC), 544
Summary, 545
Point Counter-Point: Do Agencies That Facilitate
International Trade Prevent Free Trade?, 545
Self Test, 545
Questions and Applications, 545
Advanced Questions, 546

Chapter 20: Short-Term
Financing

549

Sources of Short-Term Financing, 549

Short-Term Notes, 549
Commercial Paper, 549
Bank Loans, 549
Internal Financing by MNCs, 550

Why MNCs Consider Foreign Financing, 550


Part 5: Short-Term Asset and
Liability Management
529

Payment Methods for International Trade, 530

Discussion in the Boardroom, 546
Running Your Own MNC, 546
Blades, Inc. Case: Assessment of International Trade
Financing in Thailand, 546
Small Business Dilemma: Ensuring Payment for Products
Exported by the Sports Exports Company, 548
Internet/Excel Exercise, 548

Governance: Governance over Subsidiary Short-Term
Financing, 550

Part 4 Integrative Problem:
Long-Term Asset and Liability
Management, 527

Chapter 19: Financing
International Trade

xv

530

Foreign Financing to Offset Foreign Currency
Inflows, 550

Foreign Financing to Reduce Costs, 551
Determining the Effective Financing Rate, 552
Criteria Considered for Foreign Financing, 553

Interest Rate Parity, 553
The Forward Rate as a Forecast, 554
Exchange Rate Forecasts, 555
Actual Results from Foreign Financing, 558
Financing with a Portfolio of Currencies, 558

Portfolio Diversification Effects, 561
Repeated Financing with a Currency
Portfolio, 562
Summary, 564
Point Counter-Point: Do MNCs Increase Their Risk When
Borrowing Foreign Currencies?, 564
Self Test, 564
Questions and Applications, 565
Advanced Questions, 566
Discussion in the Boardroom, 567
Running Your Own MNC, 567
Blades, Inc. Case: Use of Foreign Short-Term
Financing, 567
Small Business Dilemma: Short-Term Financing by the
Sports Exports Company, 568
Internet/Excel Exercises, 568

Chapter 21: International
Cash Management


569

Multinational Management of Working Capital, 569

Subsidiary Expenses, 569
Subsidiary Revenue, 570
Subsidiary Dividend Payments, 570
Subsidiary Liquidity Management, 570


xvi

Contents

Centralized Cash Management, 571
Governance: Monitoring of MNC Cash Positions, 571

Techniques to Optimize Cash Flows, 572

Accelerating Cash Inflows, 572
Minimizing Currency Conversion Costs, 573
Managing Blocked Funds, 575
Managing Intersubsidiary Cash Transfers, 575
Complications in Optimizing Cash Flow, 576

Company-Related Characteristics, 576
Government Restrictions, 576
Characteristics of Banking Systems, 576
Investing Excess Cash, 576


How to Invest Excess Cash, 577
Centralized Cash Management, 577
Determining the Effective Yield, 579
Implications of Interest Rate Parity, 581
Use of the Forward Rate as a Forecast, 581
Use of Exchange Rate Forecasts, 582
Diversifying Cash across Currencies, 585
Dynamic Hedging, 586
Summary, 586
Point Counter-Point: Should Interest Rate Parity Prevent
MNCs from Investing in Foreign Currencies?, 587

Self Test, 587
Questions and Applications, 587
Advanced Questions, 588
Discussion in the Boardroom, 589
Running Your Own MNC, 589
Blades, Inc. Case: International Cash Management, 589
Small Business Dilemma: Cash Management at the Sports
Exports Company, 590
Internet/Excel Exercises, 590
Appendix 21: Investing in a Portfolio of
Currencies, 592
Part 5 Integrative Problem:
Short-Term Asset and Liability
Management, 596
Final Self Exam, 598

Appendix A: Answers to Self Test Questions, 606
Appendix B: Supplemental Cases, 618

Appendix C: Using Excel to Conduct Analysis, 640
Appendix D: International Investing Project, 647
Appendix E: Discussion in the Boardroom, 650
Glossary, 658
Index, 665


Preface

Businesses evolve into multinational corporations (MNCs) so that they can capitalize
on opportunities. Their fi nancial managers must be able to detect opportunities, assess
exposure to risk, and manage the risk. The MNCs that are most capable of responding
to changes in the international fi nancial environment will be rewarded. The same can
be said for the students today who may become the future managers of MNCs.

Intended Market
International Financial Management, Ninth Edition, presumes an understanding of
basic corporate fi nance. It is suitable for both undergraduate and master’s level courses
in international fi nancial management. For master’s courses, the more challenging
questions, problems, and cases in each chapter are recommended, along with special
projects.

Organization of the Text
International Financial Management, Ninth Edition, is organized fi rst to provide a
background on the international environment and then to focus on the managerial
aspects from a corporate perspective. Managers of MNCs will fi rst need to understand the environment before they can manage within it.
The fi rst two parts of the text provide the macroeconomic framework for the text.
Part 1 (Chapters 1 through 5) introduces the major markets that facilitate international
business. Part 2 (Chapters 6 through 8) describes relationships between exchange rates
and economic variables and explains the forces that influence these relationships.

The remainder of the text provides a microeconomic framework, with a focus
on the managerial aspects of international fi nancial management. Part 3 (Chapters 9
through 12) explains the measurement and management of exchange rate risk. Part 4
(Chapters 13 through 18) describes the management of long-term assets and liabilities, including motives for direct foreign investment, multinational capital budgeting,
country risk analysis, and capital structure decisions. Part 5 (Chapters 19 through 21)
concentrates on the MNC’s management of short-term assets and liabilities, including
trade fi nancing, other short-term fi nancing, and international cash management.
Each chapter is self-contained, so that professors can use classroom time to focus
on the more comprehensive topics and rely on the text to cover the other concepts.
The management of long-term assets (chapters on direct foreign investment, multinational capital budgeting, multinational restructuring, and country risk analysis)
is covered before the management of the long-term liabilities (chapters on capital
structure and long-term fi nancing), since the fi nancing decisions are dependent on

xvii


xviii

Preface

the investments. Yet, concepts are explained with an emphasis of how management of
long-term assets and long-term liabilities is integrated. For example, the multinational
capital budgeting analysis demonstrates how the feasibility of a foreign project may be
dependent on the fi nancing mix. Some professors may prefer to teach the chapters on
managing long-term liabilities before the chapters on managing long-term assets.
The strategic aspects such as motives for direct foreign investment are covered
before the operational aspects such as short-term fi nancing or investment. For professors who prefer to cover the MNC’s management of short-term assets and liabilities
before the MNC’s management of long-term assets and liabilities, the parts can be rearranged because they are self-contained.
Professors may limit their coverage of chapters in some sections where they believe
the text concepts are covered by other courses or do not need additional attention beyond what is in the text. For example, they may limit their attention given to the chapters in Part 2 (Chapters 6 through 8) if students take a course in international economics. If professors focus on the main principles, they may limit their coverage of Chapters

5, 15, 16, and 18. In addition, they may limit their attention given to Chapters 19
through 21 if they believe that the text description does not require elaboration.

Approach of the Text
International Financial Management, Ninth Edition, focuses on management decisions that maximize the value of the fi rm. It is designed in recognition of the unique
styles of instructors for reinforcing key concepts within a course. Numerous methods of reinforcing these concepts are provided in the text so instructors can select the
methods and features that fit their teaching styles.
• Part-Opening Diagram. A diagram is provided at the beginning of each part to
illustrate how the key concepts covered in that part are related. This offers some
information about the organization of chapters in that part.
• Objectives. A bulleted list at the beginning of each chapter identifies the key concepts in that chapter.
• Examples. The key concepts are thoroughly described in the chapter and supported by examples and illustrations.
• Governance. This feature is infused throughout the text in recognition of its
increasing popularity and use in explaining concepts in international fi nancial
management.
• Web Links. Websites that provide useful related information regarding key concepts are identified.
• Summary. A bulleted list at the end of each chapter summarizes the key concepts.
This list corresponds to the list of objectives at the beginning of the chapter.
• Point/Counter-Point. A controversial issue is introduced, along with opposing arguments, and students are asked to determine which argument is correct and explain why.

• Self Test Questions. A “Self Test” at the end of each chapter challenges students on
the key concepts. The answers to these questions are provided in Appendix A.


Preface

xix

• Questions and Applications. Many of the questions and other applications at
the end of each chapter test the student’s knowledge of the key concepts in the

chapter.
• Continuing Case. At the end of each chapter, the continuing case allows students
to use the key concepts to solve problems experienced by a fi rm called Blades, Inc.
(a producer of roller blades). By working on cases related to the same MNC over
a school term, students recognize how an MNC’s decisions are integrated.
• Small Business Dilemma. The Small Business Dilemma at the end of each chapter places students in a position where they must use concepts introduced in the
chapter to make decisions about a small MNC called Sports Exports Company.

• Internet/Excel Exercises. At the end of each chapter, there are exercises that expose the students to applicable website information, enable the application of Excel to related topics, or a combination of these. For example, students learn how
to obtain exchange rate information online and apply Excel to measure the value
at risk.

• Integrative Problem. An integrative problem at the end of each part integrates the
key concepts of chapters within that part.

• Midterm and Final Examinations. A midterm self-exam is provided at the end of
Chapter 8, which focuses on international macro and market conditions (Chapters 1 through 8). A fi nal self-exam is provided at the end of Chapter 21, which
focuses on the managerial chapters (Chapters 9 through 21). Students can compare their answers to those in the answer key provided.
• Supplemental Cases. Supplemental cases allow students to apply chapter concepts
to a specific situation of an MNC. All supplemental cases are located in Appendix
B at the end of the text.
• Running Your Own MNC. This project (provided at www.thomsonedu.com/finance/
madura) allows each student to create a small international business and apply key
concepts from each chapter to run the business throughout the school term.
• Online Analysis of an MNC. This project (provided at www.thomsonedu.com/
finance/madura) allows each student to select an MNC and determine how the key
concepts from each chapter apply to that MNC throughout the school term.


xx


Preface

• International Investing Project. This project (in Appendix D and also provided
at www.thomsonedu.com/finance/madura) allows students to simulate investing in
stocks of MNCs and foreign companies and requires them to assess how the values of these stocks change during the school term in response to international
economic conditions.
• Discussion in the Boardroom. This project (in Appendix E and also provided at
www.thomsonedu.com/finance/madura) allows students to play the role of managers or board members of a small MNC that they created and make decisions about
that fi rm.
The variety of end-of-chapter and end-of-part exercises and cases offer many opportunities for students to engage in teamwork, decision making, and communication.

Online Resources
The text website at www.thomsonedu.com/finance/madura provides numerous resources
for both students and instructors.
• Online Quizzes. Online quizzes reinforce student comprehension of chapter concepts. Answers are provided for immediate feedback, so students know why the
correct answer is correct. The quizzes may be sent to the student’s instructor for
grading or credit.
• References. References to related readings are provided for every chapter.
• Internet Links. Links noted in each chapter are provided for easy access with
a click.

Other Supplements
The following supplements are available to students and instructors:

For the Student
• PowerPoint Lecture Slides. A PowerPoint presentation package of lecture slides is
available on the text website and the Instructor’s Resource CD as a lecture aid
for instructors and a study aid for students. In addition, key figures from the text
are also provided in a separate PowerPoint package, also included on the website

and Instructor’s Resource CD.
• South-Western Finance Resource Center. The South-Western Finance Resource
Center, found at www.thomsonedu.com/finance, provides unique features, customer
service information, and links to book-related websites. It also has resources such
as Finance in the News, FinanceLinks Online, Wall Street Analyst Reports from
the Gale Group, and more. Learn about valuable products and services to help
with your fi nance studies, or contact the fi nance editors at South-Western.

For the Instructor
• Instructor’s Manual. The Instructor’s Manual contains the chapter theme, topics to stimulate class discussion, and answers to end-of-chapter Questions, Case
Problems, Continuing Cases (Blades, Inc.), Small Business Dilemmas, Integrative
Problems, and Supplemental Cases. The Instructor’s Manual is available on the
text website and the Instructor’s Resource CD.
• Test Bank. An expanded Test Bank contains a large set of questions in multiplechoice or true/false format, including content questions as well as problems. The
Test Bank is available on the text website and the Instructor’s Resource CD.


Preface

xxi

• ExamView™ Computerized Testing. The ExamView computerized testing program contains all of the questions in the Test Bank. ExamView is an easy-to-use
test creation software compatible with Microsoft Windows. Instructors can add or
edit questions, instructions, and answers and select questions by previewing them
on the screen. Instructors can also create and administer quizzes online, whether
over the Internet, a local area network (LAN), or a wide area network (WAN).
• PowerPoint Presentation Slides. Revised for this edition, these PowerPoint slides
are intended to enhance lectures and provide a guide for student note-taking.
Versions 1 and 2, the Basic Lecture Slides and the Expanded Lecture Slides, can
be downloaded from the text website. Version 3 and Enhanced PowerPoint Lecture Slides are available on the CD-ROM.

• South-Western Finance Resource Center. The South-Western Finance Resource
Center, found at www.thomsonedu.com/finance, provides unique features, including Finance in the News, FinanceLinks Online, Wall Street Analysts Reports,
the Digital Finance Case Library, and more, as well as customer service information and relevant product information and links. You may learn how to become
an author with South-Western, request review copies, contact the fi nance editors,
register for Thomson Investors Network, and more.
• Thomson Investors Network. This offer is complimentary to adopters! Instructors
using International Financial Management, Ninth Edition, may receive a complimentary password to Thomson Investors Network. This website provides individual investors with a wealth of information and tools, including portfoliotracking software, live stock quotes, and company and industry reports. Contact
your South-Western sales rep for more information about this offer.

Acknowledgments
Several people have contributed to this textbook. First, the motivation to write the
textbook was primarily due to encouragement by professors Robert L. Conn (Miami
University of Ohio), E. Joe Nosari and William Schrode (Florida State University),
Anthony E. Scaperlanda (Northern Illinois University), and Richard A. Zuber (University of North Carolina at Charlotte).
Many of the revisions and expanded sections contained in this edition are due to
comments and suggestions from students who used previous editions. In addition,
many professors reviewed various editions of the text and had a major influence on its
content and organization. All are acknowledged in alphabetical order:
Raj Aggarwal, John Carroll University
Alan Alford, Northeastern University
H. David Arnold, Auburn University
Robert Aubey, University of Wisconsin
Bruce D. Bagamery, Central Washington University
James C. Baker, Kent State University
Gurudutt Baliga, University of Delaware
Laurence J. Belcher, Stetson University
Richard Benedetto, Merrimack College
Bharat B. Bhalla, Fairfield University
Rahul Bishnoi, Hofstra University
Rita Biswas, State University of New York–Albany

Steve Borde, University of Central Florida
Sarah Bryant, George Washington University


xxii

Preface

Francisco Carrada-Bravo, American Graduate School of International
Management
Andreas C. Christofi, Azusa Pacific University
Ronnie Clayton, Jacksonville State University
Alan Cook, Baylor University
W. P. Culbertson, Louisiana State University
Maria deBoyrie, New Mexico State University
Andrea L. DeMaskey, Villanova University
Mike Dosal, SunTrust Bank (Orlando)
Robert Driskill, Ohio State University
Anne M. Drougas, Dominican University
Milton Esbitt, Dominican University
Larry Fauver, University of Miami
Paul Fenton, Bishop’s University
Robert G. Fletcher, California State University–Bakersfield
Stuart Fletcher, Appalachian State University
Jennifer Foo, Stetson University
Robert D. Foster, American Graduate School of International Management
Hung-Gay Fung, University of Baltimore
Juli-Ann E. Gasper, Texas A&M University
Farhad F. Ghannadian, Mercer University
Joseph F. Greco, California State University–Fullerton

Deborah W. Gregory, Bentley College
Nicholas Gressis, Wright State University
Indra Guertler, Babson College
Ann M. Hackert, Idaho State University
John M. Harris, Jr., Clemson University
Andrea J. Heuson, University of Miami
Ghassem Homaifar, Middle Tennessee State University
James A. Howard, University of Maryland
Nathaniel Jackendoff, Temple University
Pankaj Jain, University of Memphis
Kurt R. Jesswein, Texas A&M International
Steve A. Johnson, University of Texas–El Paso
Manuel L. Jose, University of Akron
Rauv Kalra, Morehead State University
Ho-Sang Kang, University of Texas–Dallas
Frederick J. Kelly, Seton Hall University
Robert Kemp, University of Virginia
Coleman S. Kendall, University of Illinois–Chicago
Dara Khambata, American University
Doseong Kim, University of Akron
Elinda F. Kiss, University of Maryland
Thomas J. Kopp, Siena College
Suresh Krishman, Pennsylvania State University
Merouane Lakehal-Ayat, St. John Fisher College
Boyden E. Lee, New Mexico State University
Jeong W. Lee, University of North Dakota
Richard Lindgren, Graceland University
Charmen Loh, Rider University
Carl Luft, DePaul University
K. Christopher Ma, KCM Investment Co.

Richard D. Marcus, University of Wisconsin–Milwaukee


Preface

xxiii

Anna D. Martin, Fairfield University
Leslie Mathis, University of Memphis
Ike Mathur, Southern Illinois University
Wendell McCulloch, Jr., California State University–Long Beach
Carl McGowan, University of Michigan–Flint
Fraser McHaffie, Marietta College
Stuart Michelson, Stetson University
Penelope E. Nall, Gardner-Webb University
Vivian Okere, Providence College
Edward Omberg, San Diego State University
Prasad Padmanabhan, San Diego State University
Ali M. Parhizgari, Florida International University
Anne Perry, American University
Larry Prather, East Tennessee State University
Abe Qastin, Lakeland College
Frances A. Quinn, Merrimack College
S. Ghon Rhee, University of Rhode Island
William J. Rieber, Butler University
Ashok Robin, Rochester Institute of Technology
Tom Rosengarth, Westminster College
Kevin Scanlon, Notre Dame University
Jacobus T. Severiens, Kent State University
Peter Sharp, California State University–Sacramento

Dilip K. Shome, Virginia Tech University
Joseph Singer, University of Missouri–Kansas City
Naim Sipra, University of Colorado–Denver
Jacky So, Southern Illinois University–Edwardsville
Luc Soenen, California Polytechnic State University–San Luis Obispo
Ahmad Sohrabian, California State Polytechnic University–Pomona
Caroline Spencer, Dowling College
Angelo Tarallo, Ramapo College
Amir Tavakkol, Kansas State University
Stephen G. Timme, Georgia State University
Eric Tsai, Temple University
C. Joe Ueng, University of St. Thomas
Mahmoud S. Wahab, University of Hartford
Ralph C. Walter III, Northeastern Illinois University
Elizabeth Webbink, Rutgers University
Ann Marie Whyte, University of Central Florida
Marilyn Wiley, Florida Atlantic University
Rohan Williamson, Georgetown University
Larry Wolken, Texas A&M University
Glenda Wong, De Paul University
Mike Yarmuth, Sullivan University
Yeomin Yoon, Seton Hall University
David Zalewski, Providence College
Emilio Zarruk, Florida Atlantic University
Stephen Zera, California State University–San Marcos
Beyond the suggestions provided by reviewers, this edition also benefited from
the input of many people who I met outside the United States and who were willing
to share their views about international fi nancial management. In addition, I thank
my colleagues at Florida Atlantic University, including John Bernardin, Antoine



xxiv

Preface

Giannetti, and Kim Gleason. I also thank Joel Harper (Oklahoma State University),
Victor Kalafa (Cross Country Inc.), Thanh Ngo (Florida Atlantic University), Oliver
Schnusenberg (University of North Florida), and Alan Tucker (Pace University) for
their suggestions.
I acknowledge the help and support from the people at South-Western, including Mike Reynolds (Executive Editor), Jason Krall (Marketing Manager), Mike
Guendelsberger (Developmental Editor), Adele Scholtz (Senior Editorial Assistant),
and Angela Glassmeyer (Senior Marketing Coordinator). A special thanks is due to
Scott Dillon (Associate Content Project Manager) and Pat Lewis (Copy Editor) for
their efforts to ensure a quality fi nal product.
Finally, I wish to thank my wife, Mary, and my parents, Arthur and Irene Madura,
for their moral support.
Jeff Madura
Florida Atlantic University