TOPIC 1: INTRODUCTION TO INTERNATIONAL FINANCE
Learning objectives After reading this topic you should be able to: • • • • • • Understand the background of international finance Define international finance Explain the reason for studying international finance Explain the roles of international financial manager Understand the background of multinational corporations Distinguish between international finance and domestic finance
1.1 BACKGROUND TO INTERNATIONAL FINANCE International finance as a subject is not new in the area of financial management, it has been widely covered earlier in international economics and it is only the fast growth of international business in the post-world war II and the associated complexities in the international transactions that made the subject as an independent area of study. For several centuries, international economists have used the classical economic theory of comparative advantage to explain the trade movements between nations. Looking at the writings of Adam Smith and David Ricardo in the eighteenth and nineteenth century, the theory in simple terms, states that everyone gains if each nation specializes in the production of those goods that it produces relatively most efficiently and imports those goods that other countries produces most relatively efficiently. The theory supported free trade arguments, such as the North American Free Trade Agreement (NAFTA) The doctrine of comparative advantage made an initial assumption that although the products of economic activities could move internationally; the factors of production were relatively fixed in a geographical sense. Land, labor and capital were assumed internationally immobile. The fast growing of the cross-border business transactions in the second half of the last twentieth century triggered the birth of multinational corporations, which is considered the most important phenomena in the economic development in that century. This development, which holds such potential for the economic betterment of the world’s population runs counter to the postulates of Smith and Ricardo in that, it is based on international mobility of the most important factors of production in the twentieth century. • Capital raised in Tanzania by a South African- based corporation may finance acquisition of machinery by a subsidiary located in Botswana. © firstname.lastname@example.org, 0754 327487
CPA REVIEWS NOTES- INTERNATIONAL FINANCE
• A management team from Tanzania Breweries may take over a Zimbabwe brewery complex in Malawi. • If money is the language of business, foreign exchange is the language of international business. With growing operation of multinational corporations, a number of complexities arose in the area of their financial decisions. Apart from the considerations of where, when and how to invest, the decision concerning the management of working capital among their different subsidiaries and the parent units became more complex, especially because the basic policies varied from one MNC to another. Those MNCs that were more interested in maximizing the value of global wealth adopted a centralized approach while those not interfering much with their subsidiaries believed in a decentralized approach. Normally there is a mix of the two approaches in varying proportions, for which the study of international finance has come to be more relevant. The second half of the twentieth century has also experienced a vast magnitude of lending by international and regional development banks (e.g. Citi bank, Barclays, African development Bank, Standard Chartered bank etc) and different governmental and non-governmental agencies. The movement of funds in form of interest and amortization payments needed proper management. Besides, there were big changes in the character of the international financial market with the emergence of euro banks and offshore banking centers and of various instruments, such...