国际财务管理(第五版)习题解答

CHAPTER 1 GLOBALIZATION AND THE MULTINATIONAL FIRM SUGGESTED ANSWERS TO END-OF-CHAPTER QUESTIONS

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, i.e., consumption, production, and investment, 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 some twenty years 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 three major trends that have prevailed in international business during the last two decades.

Answer: The 1980s 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

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economic integration and globalization that began in the eighties is picking up speed in the 1990s via privatization. Privatization is the process by which a country divests itself of the ownership and operation of a business venture by turning it over to the free market system. Lastly, trade liberalization and economic integration continued to proceed at both the regional and global levels.

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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 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 at 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?s citizens produce what they have a comparative advantage in producing relative to the citizens of other countries, and then trade products. Underlying the theory are the assumptions of free trade between nations and that the factors of production (land, buildings, labor, technology, and capital) are relatively immobile. To the extent that these assumptions do not hold, the theory of comparative advantage will not realistically describe international trade.

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 several other countries. Indeed, some MNCs have operations in dozens of different countries. MNCs obtain financing from major money centers around the world in many different currencies to finance their operations.

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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.

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7. Mr. Ross Perot, a former Presidential candidate of the Reform Party, which is 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, for the fear of losing American jobs to Mexico where it is much cheaper to hire workers. What are the merits and demerits of Mr. Perot?s position on NAFTA? Considering the recent economic developments in North America, how would you assess Mr. 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. Currently, the unemployment rate in the U.S. is quite low by historical standard. 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. Mr. 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 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. In France, about 15% of households own shares.

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9. Emphasizing the importance of voluntary compliance, as opposed to enforcement, in the aftermath of corporate scandals, e.g., Enron and WorldCom, U.S. President George W. Bush stated that while toug her 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 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.

10. Suppose you are interested in investing in shares of Nokia Corporation of Finland, which is a world leader in wireless communication. But before you make investment decision, you would like to learn about the company. Visit the website of CNN Financial network (c0611925cc7931b765ce1549) and collect information about Nokia, including the recent stock price history and analysts? views of the compa ny. 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.

Answer: As students might have learned from visiting the website, information is readily available even for foreign companies like Nokia. 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 transmitted to other markets.

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MINI CASE: NIKE?S DE CISION

Nike, a U.S.-based company with a globally recognized brand name, manufactures athletic shoes in such Asian developing countries as China, Indonesia, and Vietnam using subcontractors, and sells the products in the U.S. and foreign markets. The company has no production facilities in the United States. In each of those Asian countries where Nike has production facilities, the rates of unemployment and underemployment are quite high. The wage rate is very low in those countries by the U.S. standard; hourly wage rate in the manufacturing sector is less than one dollar in each of those countries, which is compared with about $18 in the U.S. In addition, workers in those countries often are operating in poor and unhealthy environments and their rights are not well protected. Understandably, Asian 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 a world-wide criticism for its practice of hiring workers for such a low pay, “next to nothing” in the words of critics, and condoning poor working conditions in host countries.

Evaluate and discuss various …ethical? as well as economic ramifications of Nike?s decision to invest in those Asian countries.

Suggested Solution to Nike?s Decision

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 t he 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 ignore the fact that the company is making contributions to the economic welfare of those Asian countries by creating job opportunities.

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CHAPTER 1A THEORY OF COMPARATIVE ADV ANTAGE

SUGGESTED SOLUTIONS TO APPENDIX PROBLEMS

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.

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INPUT/OUTPUT WITHOUT TRADE

_______________________________________________________________________

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

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Textiles 200 60 260

________________________________________________________________________

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Solution:

Examination of the no-trade input/output table indicates that Country X has an absolute advantage in the production of f ood 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 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.

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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

__________________________________________________________________________ IV. Consumption

(lbs or yards)

(000,000)

_____________________ ________________________________

Food 1,200 330 1,530

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Textiles 210 70 280

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CHAPTER 2 INTERNATIONAL MONETARY SYSTEM

SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER

QUESTIONS AND PROBLEMS

QUESTIONS

1. Explain Gresham?s Law.

Answer: Gresham?s law refers to the phenomenon that bad (abundant) money drives good (scarce) money out of circulation. This kind of phenomenon was often observed under the bimetallic standard under which both gold and silver were used as means of payments, with the exchange rate between the two metals fixed.

2. Explain the mechanism which restores the balance of payments equilibrium when it is disturbed under the gold standard.

Answer: The adjustment mechanism under the gold standard is referred to as the price-specie-flow mechanism expounded by David Hume. Under the gold standard, a balance of payment disequilibrium will be corrected by a counter-flow of gold. Suppose that the U.S. imports more from the U.K. than it exports to the latter. Under the classical gold standard, gold, which is the only means of international payments, will flow from the U.S. to the U.K. As a result, the U.S. (U.K.) will experience a decrease (increase) in money supply. This means that the price level will tend to fall in the U.S. and rise in the U.K. Consequently, the U.S. products become more competitive in the export market, while U.K. products become less competitive. This change will improve U.S. balance of payments and at the same time hurt the U.K. balance of payments, eventually eliminating the initial BOP disequilibrium.

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3. Suppose that the pound is pegged to gold at 6 pounds per ounce, whereas the franc is pegged to gold at 12 francs per ounce. This, of course, implies that the equilibrium exchange rate should be two francs per pound. If the current market exchange rate is 2.2 francs per pound, how would you take advantage of this situation? What would be the effect of shipping costs?

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Answer: Suppose that you need to buy 6 pounds using French francs. If you buy 6 pounds directly in the foreign exchange market, it will cost you 13.2 francs. Alternatively, you can first buy an ounce of gold for 12 francs in France and then ship it to England and sell it for 6 pounds. In this case, it only costs you 12 francs to buy 6 pounds. It is thus beneficial to ship gold due to the overpricing of the pound. Of course, you can make an arbitrage profit by selling 6 pounds for 13.2 francs in the foreign exchange market. The arbitrage profit will be 1.2 francs. So far, we assumed that shipping costs do not exist. If it costs more than 1.2 francs to ship an ounce of gold, there will be no arbitrage profit.

4. Discuss the advantages and disadvantages of the gold standard.

Answer: The advantages of the gold standard include: (I) since the supply of gold is restricted, countries cannot have high inflation; (2) any BOP disequilibrium can be corrected automatically through cross-border flows of gold. On the other hand, the main disadvantages of the gold standard are: (I) the world economy can be subject to deflationary pressure due to restricted supply of gold; (ii) the gold standard itself has no mechanism to enforce the rules of the game, and, as a result, countries may pursue economic policies (like de-monetization of gold) that are incompatible with the gold standard.

5. What were the main objectives of the Bretton Woods system?

Answer: The main objectives of the Bretton Woods system are to achieve exchange rate stability and promote international trade and development.

6. One can say that the Bretton Woods system was programmed to an eventual demise. Comment on this proposition.

Answer: The answer to this question is related to the Triffin paradox. Under the gold-exchange system, the reserve-currency country should run BOP deficits to supply reserves to the world economy, but if the deficits are large and persistent, they can lead to a

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crisis of confidence in the reserve currency itself, eventually causing the downfall of the system.

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7. Explain how the special drawing rights (SDR) is constructed. Also, discuss the circumstances under which the SDR was created.

Answer: SDR was created by the IMF in 1970 as a new reserve asset, partially to alleviate the pressure on the U.S. dollar as the key reserve currency. The SDR is a basket currency comprised of five major currencies, i.e., U.S. dollar, German mark, Japanese yen, French franc, and British pound. Currently, the dollar receives a 40% weight, mark 21%, yen 17%, franc 11%, and pound 11%. The weights for different currencies tend to change over time, reflecting the relative importance of each currency in international trade and finance.

8. Explain the arrangements and workings of the European Monetary System (EMS).

Answer: EMS was launched in 1979 in order to (I) establish a zone of monetary stability in Europe, (ii) coordinate exchange rate policies against the non-EMS currencies, and (iii) pave the way for the eventual European monetary union. The main instruments of EMS are the European Currency Unit (ECU) and the Exchange Rate Mechanism (ERM). Like SDR, the ECU is a basket currency constructed as a weighted average of currencies of EU member countries. The ECU works as the accounting unit of EMS and plays an important role in the workings of the ERM. The ERM is the procedure by which EMS member countries manage their exchange rates. The ERM is based on a parity grid system, with parity grids first computed by defining the par values of EMS currencies in terms of the ECU. If a country?s ECU market exchange rate diverges from the central rate by as much as the maximum allowable deviation, the country has to adjust its policies to maintain its par values relative to other currencies. EMS achieved a complete monetary union in 1999 when the common European currency, the euro, was adopted.

9. There are arguments for and against the alternative exchange rate regimes.

a. List the advantages of the flexible exchange rate regime.

b. Criticize the flexible exchange rate regime from the viewpoint of the proponents of the

fixed exchange rate regime.

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c. Rebut the above criticism from the viewpoint of the proponents of the flexible exchange rate regime.

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Answer: a. The advantages of the flexible exchange rate system include: (I) automatic achievement of balance of payments equilibrium and (ii) maintenance of national policy autonomy.

b. If exchange rates are fluctuating randomly, that may discourage international trade and encourage market segmentation. This, in turn, may lead to suboptimal allocation of resources.

c. Economic agents can hedge exchange risk by means of forward contracts and other techniques. They don?t have to bear it if they choose not to. In addition, under a fixed exchange rate regime, governments often restrict international trade in order to maintain the exchange rate. This is a self-defeat ing measure. What?s good about the fixed exchange rate if international trade need to be restricted?

10. In an integrated world financial market, a financial crisis in a country can be quickly transmitted to other countries, causing a global crisis. What kind of measures would you propose to prevent the recurrence of a Asia-type crisis.

Answer: First, there should be a multinational safety net to safeguard the world financial system from the Asia-type crisis. Second, international institutions like IMF and the World Bank should monitor problematic countries more closely and provide timely advice to those countries. Countries should be required to fully disclose economic and financial information so that devaluation surprises can be prevented. Third, countries should depend more on domestic savings and long-term foreign investments, rather than short-term portfolio capital. There can be other suggestions.

11. Discuss the criteria for a …good? international monetary system.

Answer: A good international monetary system should provide (i) sufficient liquidity to the world economy, (ii) smooth adjustments to BOP disequilibrium as it arises, and (iii) safeguard against the crisis of confidence in the system.

12. Once capital markets are integrated, it is difficult for a country to maintain a fixed

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exchange rate. Explain why this may be so.

Answer: Once capital markets are integrated internationally, vast amounts of money may flow in and out of a country in a short time period. This will make it very difficult for the country to maintain a fixed exchange rate.

13. Assess the possibility for the euro to become another global currency rivaling the U.S. dollar. If the euro really becomes a global currency, what impact will it have on the U.S. dollar and the world economy?

Answer: In light of the large transactions domain of the euro, which is comparable to that of the U.S. dollar, and the mandate for the European Central Bank (ECB) to guarantee the monetary stability in Europe, the euro is likely to become another global currency over time.

A major uncertainty about this prospect is the lack of political integration of Europe. If Europe becomes politically more integrated, the euro is more likely to become a global currency. If the euro becomes a global currency, it will come at the expense of the dollar. Currently, the U.S. derives substantial benefits from the dollar?s status as the dominant global currency – for instance, the U.S. can run trade deficits without having to maintain substantial foreign exchange reserves, can carry out international commercial and financial transactions in dollars without bearing exchange risk, etc. If the euro is to be used as a major denomination, reserve, and invoice currency in the world economy, dollar-based agents will start to bear more exchange risk, among other things.

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