Solution Manual for International Financial

Management, 9th Edition, Cheol Eun, Bruce Resnick

Tuugi Chuluun
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CHAPTER 1 GLOBALIZATION AND THE MULTINATIONAL FIRM

ANSWERS & SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS

QUESTIONS

1. Why is it important to study international financial management?

Answer: We are now living in a world where all the major economic functions, such as
consumption, production, investment, and financing, are highly globalized. It is thus essential for
financial managers to fully understand vital international dimensions of financial management.
This global shift is in marked contrast to a situation that existed when the authors of this book
were learning finance a few decades ago. At that time, most professors customarily (and safely,
to some extent) ignored international aspects of finance. This mode of operation has become
untenable since then.

2. How is international financial management different from domestic financial management?

Answer: There are three major dimensions that set apart international finance from domestic
finance. They are:
1. foreign exchange and political risks,
2. market imperfections, and
3. expanded opportunity set.

3. Discuss the major trends that have prevailed in international business during the last two

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decades.

Answer: The 2000s brought a rapid integration of international capital and financial markets.
Impetus for globalized financial markets initially came from the governments of major countries
that had begun to deregulate their foreign exchange and capital markets. The economic
integration and globalization that began in the eighties and nineties are picking up speed in the
2000s. Trade liberalization and economic integration continued to proceed at both the regional
and global levels. Despite sovereign debt crisis in Europe, more EU member countries have
adopted the common currency, the euro, that effectively became the second global currency after
the U.S. dollar. In the last few years, however, economic nationalism has been gaining some
popularity, as exemplified by the Brexit decision of the United Kingdom and the so-called “America
First” policies of the Trump Administration. To the extent that economic nationalism is a populist
response to the global financial crisis and Great Recession, it may subside as the world economy
continues to recover.

4. How is a country’s economic well-being enhanced through free international trade in goods
and services?

Answer: According to David Ricardo, with free international trade, it is mutually beneficial for two
countries to each specialize in the production of the goods that it can produce relatively most
efficiently and then trade those goods. By doing so, the two countries can increase their combined
production, which allows both countries to consume more of both goods. This argument remains
valid even if a country can produce both goods more efficiently in absolute terms than the other
country. International trade is not a ‘zero-sum’ game in which one country benefits at the expense
of another country. Rather, international trade could be an ‘increasing-sum’ game from which all
players become winners.

5. What considerations might limit the extent to which the theory of comparative advantage is
realistic?

Answer: The theory of comparative advantage was originally advanced by the nineteenth century
economist David Ricardo as an explanation for why nations trade with one another. The theory
claims that economic well-being is enhanced if each country produces what it has a comparative
advantage in producing relative to other countries, and then trade products. Underlying the theory

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are the assumptions of free trade between nations and that the factors of production (labor,
technological know-how, and capital) are relatively immobile. To the extent that these
assumptions do not hold, the theory of comparative advantage may not realistically describe
international trade. In addition, free trade produces winners and losers and if the losers are not
compensated, free trade may faces political opposition from them.

6. What are multinational corporations (MNCs) and what economic roles do they play?

Answer: A multinational corporation (MNC) can be defined as a business firm incorporated in

one country that has production and sales operations in many other countries. Indeed, some
MNCs have operations in a few dozens of different countries. MNCs obtain financing from major
money centers around the world in many different currencies to finance their operations. Global
operations force the treasurer’s office to establish international banking relationships, to place
short-term funds in several currency denominations, and to effectively manage foreign exchange
risk. By circumventing and also taking advantage of various market imperfections, such as
barriers to trade and barriers to flow of people and capital across countries, MNCs contribute to
greater integration of the world economy and ing more perfect functioning of global markets.

7. Ross Perot, a former Presidential candidate of the Reform Party, which was a third political
party in the United States, had strongly objected to the creation of the North American Trade
Agreement (NAFTA), which nonetheless was inaugurated in 1994. Perot feared the loss of
American jobs to Mexico where it is much cheaper to hire workers. What are the merits and
demerits of Perot’s position on NAFTA? Considering the recent economic developments in North
America, how would you assess Perot’s position on NAFTA?

Answer: Since the inception of NAFTA, many American companies indeed have invested heavily
in Mexico, sometimes relocating production from the United States to Mexico. Although this might
have temporarily caused unemployment of some American workers, they were eventually rehired
by other industries often for higher wages. At the same time, Mexico has been experiencing a
major economic boom. It seems clear that both Mexico and the U.S. have benefited from NAFTA.
Perot’s concern appears to have been ill founded.

8. In 1995, a working group of French chief executive officers was set up by the Confederation of
French Industry (CNPF) and the French Association of Private Companies (AFEP) to study the

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French corporate governance structure. The group reported the following, among other things:
“The board of directors should not simply aim at maximizing share values as in the U.K. and the
U.S. Rather, its goal should be to serve the company, whose interests should be clearly
distinguished from those of its shareholders, employees, creditors, suppliers and clients but still
equated with their general common interest, which is to safeguard the prosperity and continuity
of the company”. Evaluate the above recommendation of the working group.

Answer: The recommendations of the French working group clearly show that shareholder wealth
maximization is not a universally accepted goal of corporate management, especially outside the
United States and possibly a few other Anglo-Saxon countries including the United Kingdom and
Canada. To some extent, this may reflect the fact that share ownership is not wide spread in most
other countries.

9. Emphasizing the importance of voluntary compliance, as opposed to enforcement, in the

aftermath of such corporate scandals as those involving Enron and WorldCom, U.S. President
George W. Bush stated that while tougher laws might help, “ultimately, the ethics of American
business depends on the conscience of America’s business leaders.” Describe your view on this
statement.

Answer: There can be different answers to this question. If business leaders always behave with
a high ethical standard, many of the corporate scandals we have seen lately might not have
happened. Since we cannot fully depend on the ethical behavior on the part of individual business
leaders, the society should protect itself by adopting the rules/regulations and governance
structure that would induce business leaders to behave in the interest of the society at large. But
at the same time, we need to make sure that excessive regulations do not stymy free enterprises,
an important engine of economic growth. It is important to strike the right balance.

10. Suppose you are interested in investing in shares of Samsung Electronics of Korea, which is
a world leader in mobile phones, TVs, and home appliances. But before you make investment
decision, you would like to learn about the company. Visit the website of Yahoo
(http://finance.yahoo.com) and collect information about Samsung Electronics, including the
recent stock price history and analysts’ views of the company. Discuss what you learn about the
company. Also discuss how the instantaneous access to information via internet would affect the
nature and workings of financial markets.

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Answer: As students might have learned from visiting the website, information is readily available
even for foreign companies like Samsung Electronics. Ready access to international information
helps integrate financial markets, dismantling barriers to international investment and financing.
Integration, however, may help a financial shock in one market to be quickly transmitted to other
markets.

MINI CASE: NIKE AND SWEATSHOP LABOR

Nike, a company headquartered in Beaverton, Oregon, is a major force in the sports

footwear and fashion industry, with annual sales exceeding $ 30 billions, more than half of which
now come from outside the United States. The company was co-founded in 1964 by Phil Knight,
a CPA at Price Waterhouse, and Bill Bowerman, college track coach, each investing $ 500 to
start. The company, initially called Blue Ribbon Sports, changed its name to Nike in 1971 and
adopted the “Swoosh” logo—recognizable around the world—originally designed by a college
student for $35. Nike became highly successful in designing and marketing mass-appealing
products such as the Air Jordan, the best selling athletic shoe of all time.
Nike has no production facilities in the United States. Rather, the company manufactures
athletic shoes and garments in such Asian countries as India, Indonesia, and Vietnam using
subcontractors, and sells the products in the U.S. and international markets. In each of those
Asian countries where Nike has production facilities, the rates of unemployment and under-
employment are relatively high. The wage rate is very low in those countries by U.S. standards—
the hourly wage rate in the manufacturing sector is less than $ 2 in each of those countries,
compared with about $ 38 in the United States. In addition, workers in those countries often
operate in poor and unhealthy environments and their rights are not particularly well protected.
Understandably, host countries are eager to attract foreign investments like Nike’s to develop
their economies and raise the living standards of their citizens. Recently, however, Nike came
under worldwide criticism for its practice of hiring workers for such a low rate of pay—“next to
nothing” in the words of critics—and overlooking poor working conditions in host countries.
Initially, Nike denied the sweatshop charges and lashed out at critics. But later, the company
began monitoring the labor practice at its overseas factories and grading the factories in order to
improve labor standards. Nike also agreed to random factory inspections by disinterested parties.
Discussion points
1. Do you think the criticism of Nike is fair, considering that the host countries are in dire

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 needs of creating jobs?
2. What do you think Nike’s executives might have done differently to prevent the sensitive
charges of sweatshop labor in overseas factories?
3. Do firms need to consider the so-called corporate social responsibilities in making
investment decisions?

Suggested Solution to Nike and Sweatshop Labor

Obviously, Nike’s investments in such Asian countries as China, Indonesia, and Vietnam
were motivated to take advantage of low labor costs in those countries. While Nike was criticized
for the poor working conditions for its workers, the company has recognized the problem and has
substantially improved the working environments recently. Although Nike’s workers get paid very
low wages by the Western standard, they probably are making substantially more than their local
compatriots who are either under- or unemployed. While Nike’s detractors may have valid points,
one should not downplay the fact that the company is making contributions to the economic
welfare of those Asian countries by creating job opportunities and also helping earn hard
currencies that can be used to fund economic growth of those countries.

APPENDIX 1A. GAIN FROM TRADE: THE THEORY OF COMPARATIVE ADVANTAGE

PROBLEMS

1. Country C can produce seven pounds of food or four yards of textiles per unit of input.
Compute the opportunity cost of producing food instead of textiles. Similarly, compute the
opportunity cost of producing textiles instead of food.

Solution: The opportunity cost of producing food instead of textiles is one yard of textiles per 7/4
= 1.75 pounds of food. A pound of food has an opportunity cost of 4/7 = .57 yards of textiles.

2. Consider the no-trade input/output situation presented in the following table for Countries X
and Y. Assuming that free trade is allowed, develop a scenario that will benefit the citizens of
both countries.

INPUT/OUTPUT WITHOUT TRADE

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_______________________________________________________________________

Country
X Y Total
________________________________________________________________________
I. Units of Input (000,000)
_______________________ ______________________________
Food 70 60
Textiles 40 30
________________________________________________________________________
II. Output per Unit of Input (lbs or yards)
____________________________________________________
Food 17 5
Textiles 5 2
________________________________________________________________________
III. Total Output (lbs or yards) (000,000)
____________________________________________________
Food 1,190 300 1,490
Textiles 200 60 260
________________________________________________________________________
IV. Consumption (lbs or yards) (000,000)
___________________________________________________
Food 1,190 300 1,490
Textiles 200 60 260
________________________________________________________________________

Solution:
Examination of the no-trade input/output table indicates that Country X has an absolute
advantage in the production of food and textiles. Country X can “trade off” one unit of production
needed to produce 17 pounds of food for five yards of textiles. Thus, a yard of textiles has an
opportunity cost of 17/5 = 3.40 pounds of food, or a pound of food has an opportunity cost of 5/17
= .29 yards of textiles. Analogously, Country Y has an opportunity cost of 5/2 = 2.50 pounds of
food per yard of textiles, or 2/5 = .40 yards of textiles per pound of food. In terms of opportunity
cost, it is clear that Country X is relatively more efficient in producing food and Country Y is

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relatively more efficient in producing textiles. Thus, Country X (Y) has a comparative advantage
in producing food (textile) is comparison to Country Y (X).
When there are no restrictions or impediments to free trade the economic-well being of
the citizens of both countries is enhanced through trade. Suppose that Country X shifts
20,000,000 units from the production of textiles to the production of food where it has a
comparative advantage and that Country Y shifts 60,000,000 units from the production of food to
the production of textiles where it has a comparative advantage. Total output will now be
(90,000,000 x 17 =) 1,530,000,000 pounds of food and [(20,000,000 x 5 =100,000,000) +
(90,000,000 x 2 =180,000,000) =] 280,000,000 yards of textiles. Further suppose that Country X
and Country Y agree on a price of 3.00 pounds of food for one yard of textiles, and that Country
X sells Country Y 330,000,000 pounds of food for 110,000,000 yards of textiles. Under free trade,
the following table shows that the citizens of Country X (Y) have increased their consumption of
food by 10,000,000 (30,000,000) pounds and textiles by 10,000,000 (10,000,000) yards.

INPUT/OUTPUT WITH FREE TRADE

__________________________________________________________________________

Country
X Y Total
__________________________________________________________________________
I. Units of Input (000,000)
_______________________________________________________
Food 90 0
Textiles 20 90
__________________________________________________________________________
II. Output per Unit of Input (lbs or yards)
______________________________________________________
Food 17 5
Textiles 5 2
__________________________________________________________________________
III. Total Output (lbs or yards) (000,000)
_____________________________________________________
Food 1,530 0 1,530
Textiles 100 180 280

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__________________________________________________________________________
IV. Consumption (lbs or yards) (000,000)
_____________________________________________________
Food 1,200 330 1,530
Textiles 210 70 280
__________________________________________________________________________

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of McGraw-Hill Education.