This document discusses international financing through direct foreign investment and foreign portfolio investment. It provides details on: 1) Motives for direct foreign investment by multinational corporations, including revenue-related motives like accessing new markets and cost-related motives like using cheaper foreign labor. 2) Host government views on direct foreign investment, including incentives to attract beneficial DFI, barriers to protect local industries, and conditions sometimes imposed on DFI deals. 3) Differences between foreign portfolio investment and direct foreign investment, noting that FPI involves passive investment in securities while DFI provides ownership and management control. 4) Various international financial instruments for equity investment, bonds, and money markets, including American depositary receipts

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International Financing
Chapter 08: Long-term Asset and Liability Management
1: Direct Foreign Investment
Multinational corporations frequently capitalize on foreign business opportunities by
engaging in direct foreign investment (DFI), which is investment in real assets (such as land,
building, or even existing plants) in foreign countries. They engage in joint ventures with
foreign firms, acquire foreign firms, and form new foreign subsidiaries. Financial managers
must understand the potential return and risk associated with DFI so that they can make
investment decisions that maximize MNC’s value.
1-1 Motives for Direct Foreign Investment
Multinational corporations often consider direct foreign investment because it can improve
the profitability and enhance shareholder wealth. They are normally focused on investing in
real asset such as machinery or buildings that can support operations, rather than financial
assets. The direct foreign investment decisions of MNCs usually involve foreign real assets
and not foreign financial assets. When MNCs review various foreign investment
opportunities, they must consider whether the opportunity is compatible with their operations.
In most cases, MNCs engage in DFI because they are interested in boosting revenues,
reducing costs or both. Motives of MNCs related to revenue and cost are:
1-1a Revenue-Related Motives
The following are typical motives of MNCs that are attempting to boost revenues.
 Attract new sources of demand: Multinational corporations commonly pursue DFI
in countries experiencing economic growth so that they can benefit from the increased
demand for products and services there. The increased demand is typically driven by
local residents’ higher income levels. Higher income allows for higher consumption,
and higher consumption within the country results in higher income. Many developed
countries, such as Argentina, Chile, Mexico, Hungary, and China, have been
perceived as attractive sources of new demand. Many countries have penetrated these
countries since barriers have been removed.
 Enter profitable markets: When an MNC notices that other corporations in its
particular industry are generating high earnings in a particular country, it may decide
to sell its own products in those markets. If it believes that its competitors are
charging exclusively high prices in a particular country, it may penetrate that market
and undercut those prices. A typical problem with this strategy is that previously
established sellers in a new market may prevent a new competitor from taking away
their business by lowering their prices just when the new competitor attempts to break
into that market.

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 Exploit monopolistic advantages: Firms may become internationalized if they
possess resources or skills not available to competing firms. If a firm possesses
advanced technology and has exploited this advantage successfully in local markets,
then the firm may attempt to exploit it internationally as well. In fact, the firm may
have a more distinct advantage in markets that have less advanced technology.
 React to trade barriers: In some cases, MNCs use DFI as a defensive rather than an
aggressive strategy. Specifically, MNCs may pursue DFI to circumvent trade barriers.
 Diversify internationally: Since economies of countries do not move perfectly in
tandem over time, net cash flow from sales of products across countries should be
more stable than comparable sales of the products in a single country. By diversifying
sales (and possibly even production) internationally, a firm can make its net cash
flows less volatile. Thus, the possibility of a liquidity deficiency is less likely. In
addition, the firm may enjoy a lower cost of capital as shareholders and creditors
perceive the MNCs risk to be lower because of the more stable cash flows.
1-1b Cost-Related Motives
MNCs also engage in DFI in an effort to reduce costs. The following are typical motives
of MNCs that are trying to cut costs.
 Fully benefit from economies of scale: A corporation that attempts to sell its
primary product in new markets may increase its earnings and shareholder
wealth due to economies of scale (lower average cost per unit resulting from
increased production). Firms that utilize much machinery are most likely to
benefit from economies of scale.
 Use foreign factors of production: Labor and land costs can vary dramatically
among countries. Multinational corporations often attempt to set up production
in locations where land and labor are cheap. Because of market imperfections
such as imperfect information, relocation transaction costs, and barriers to
industry entry, specific labor costs are seldom equal among markets. Thus, it is
worthwhile for MNCs to survey markets to determine whether they can benefit
from cheaper costs by producing in those markets.
 Use foreign raw materials: Because of transportation costs, a corporation may
attempt to avoid importing materials from a given country, especially when it
plans to sell the finished product back to consumers in that country. Under such
circumstances, a more feasible solution may be to develop the product in that
country where raw materials are located.
 Use foreign technology: Corporations are increasingly establishing overseas
plants or acquiring existing overseas plants to learn about technologies in foreign
countries. This technology is then used to improve their own production
processes and increase production efficiency at all subsidiary plants around the
world.

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 React to exchange rate movements: When a firm perceives that a foreign
currency is undervalued, the firm may consider DFI in that country because the
initial outlay should be relatively low.
1-1c Steps Taken by MNCs to Determine Whether to Pursue Direct Foreign Investment
 Identify Motives: Review the revenue and cost-related motives for DFI, and
determine which motives may apply.
 Capital Budgeting: Identify a particular international project that may be feasible,
and estimate the cash flows and the initial investment associated with that project.
Apply a capital budgeting analysis of corporate control candidates and to any existing
subsidiaries that could be sold.
 Country Risk Analysis: Analyze the country risk of countries where the MNC
presently does business as well as in countries where the MNC plans to expand.
Incorporate any conclusions from the country risk analysis into the capital budgeting
analysis for those proposed projects in which the country risk may affect cash flows
or the cost of financing projects.
 Capital Structure: Assess the existing capital structure, and determine whether it is
suitable based on the MNCs existing operations and its ability to repay debt. Estimate
the cost of capital that could be obtained to finance new international projects, and
incorporate that estimate within the capital budgeting analysis.
 Long-Term Financing: Consider sources of long-term funds in foreign countries.
Determine whether to revise the financing in order to hedge exchange rate risk or to
reduce the cost of capital.
1-2 Host Government Views of DFI
Each government must weigh the advantages and disadvantages of direct foreign investment
in its country. The most frequently cited advantage is that direct foreign investment will
create local jobs and thereby reduce the unemployment rate. However, if the products
produced as a result of direct foreign investment are sold in the same country, it may take
market share away from other local competitor firms and therefore cause layoffs. Some types
of DFI could eliminate as many local jobs as it creates. Therefore, governments may provide
incentives to encourage some forms of DFI, barriers to prevent other forms of DFI, and
impose conditions on some other forms of DFI.
1-2a Incentives to Encourage DFI
The ideal DFI solves problems such as unemployment and lack of technology without taking
business away from local firms. In some cases, government will offer incentives to MNCs
that consider DFI in its country. Governments are particularly willing to offer incentives for
DFI that will result in the employment of local citizens or an increase in technology.
Common incentives offered by the host government include tax breaks on the income earned
there, rent-free land and buildings, low interest loans, subsidized energy, and reduced

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environment regulations. The extent to which a government will offer such incentives
depends on how much it benefits from the MNCs DFI.
1-2b Barriers to DFI
Barriers to DFI are:
 Protective Barriers. When MNCs consider engaging in DFI by acquiring a foreign
company, they may face various barriers imposed by the host government agencies.
All countries have one or more government agencies that monitor mergers and
acquisitions. These agencies may prevent an MNC from acquiring companies in their
country if they believe it will attempt to lay off employees. They may even restrict
foreign ownership of any local firms.
 “Red Tape” Barriers. An implicit barrier to DFI in some countries is the “Red Tape”
involved, such as procedural and documentation requirements. An MNC pursuing
DFI is subject to a different set of requirements in each country. Therefore, it is
difficult for an MNC to become proficient at the process unless it concentrates on DFI
within a single foreign country.
 Industry Barriers. The local firms of some industries in certain countries have
substantial influence on the government and will likely use their influence to prevent
competition from MNCs that attempt DFI. Multinational corporations that consider
DFI need to recognize the influence that these local firms on the local government.
 Environmental Barriers. Each country enforces its own environmental constraints.
Some countries may enforce more of these restrictions on a subsidiary whose parent is
based in a different country. Building codes, disposal of production waste materials,
and pollution controls are examples of restrictions that force subsidiaries to incur
additional costs.
 Regulatory Barriers. Each country also enforces its own environmental constraints
pertaining to taxes, currency convertibility, earnings remittance, employee rights, and
other policies that can affect cash flows of a subsidiary established there. Because
these regulations can influence cash flows, financial manager must consider them
when assessing policies.
 Ethical Differences. There is no consensus standard of business conduct that applies
to all countries. A business practice that is perceived to be unethical in one country
may be considered totally ethical in another. An MNC that does not engage in such
practices may be at a competitive disadvantage when attempting DFI in some
countries. Hence the firm may wish to forgo competing for some types of
international business when it knows that illegal payments will be expected.

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 Political Instability. The governments of some countries may prevent DFI. If a
country is susceptible to abrupt changes in government and political conflicts, the
feasibility of DFI may depend on the outcome of those conflicts. Multinational
corporations prefer to avoid direct investment in a foreign country whose government
is likely to be removed after the DFI is made.
1-2c Government-Imposed Conditions on Engaging in DFI
Some governments allow international acquisitions but impose special requirements on
MNCs that desire to acquire local firm. For example, the MNC may be required ensure
pollution control for its manufacturing or to structure the business to export the products
it produces so that it does not threaten the market share of other local firms. The MNC
may even be required to retain all the employees of the target firm so that unemployment
and general economic conditions in the country are not adversely affected.
Government imposed conditions do not necessarily prevent an MNC from pursuing DFI
in a specific foreign country, but they can be costly. Therefore, MNCs should not
consider DFI that requires costly conditions unless the potential benefits outweigh the
costs.
2: Foreign Portfolio Investment
Foreign Portfolio Investment consists of securities and other financial assets held by
investors in another country. It does not provide the investor with direct ownership of a
company’s assets and is relatively liquid depending on the volatility of market. This type
of investment is a way for investors to diversify their portfolio with an international
advantage. Foreign Portfolio Investments can be made by individuals, companies or
governments in international countries.
2-1 Merits and Demerits of Foreign Portfolio Investment
Merits
Some benefits that come to investors utilizing foreign portfolio investments include:
 Portfolio diversification: Foreign Portfolio Investment gives investors a fairly
simple way to diversify their portfolio internationally.
 International credit: Foreign Portfolio Investment gives investors larger credit
base because they are able to access credit in the foreign countries that they have
large amounts of investment in.
 Benefits from the exchange rates: International currency exchange rates
constantly fluctuate. Investors can reap benefits if they have Foreign Portfolio
Investments in a foreign country with a stronger currency than their own country.
 Access to a larger market: Often foreign markets offer slightly less competitive
but larger market than one’s home country. Investors can take advantage of the
less competitive markets internationally by using Foreign Portfolio Investments.

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Demerits
 Political factors: Risk of changes in the political environment of a country always
exists. Political risks can result in changes in investment norms as well as repatriation
regulations.
 Low retail participation: Emerging markets which are mostly beneficiaries of
Foreign Portfolio Investments may suffer from low retail participation. This can
results to inadequate liquidity which then turns to price volatility.
 Unpredictable nature of assets: With this, there is a tendency for investors to shift
from one market to another at short intervals. The resulting volatility from the Foreign
Portfolio Investments’ inflows and outflows can have adverse effects to the host
country’s economy.
2-2 Foreign Portfolio Investment vs. Foreign Direct Investment
Foreign Portfolio Investment and Foreign Direct Investment are similar in the context that
both involve investing in foreign country but there are lots of differences. Differences
between these two modes of international investment are:
Foreign Direct Investment Foreign Portfolio Investment
1. FDI investors play an active role in
the management of a investee
company
1. FPI investors play a passive role in
the foreign company
2. As the FDI investors gain both
ownership and management right
through investment, the level of
control is relatively high
2. In FPI, degree of control is less as
the investors obtain only ownership
right
3. It’s a long term investment 3. It’s a short term investment
4. FDI Projects are managed with great
efficiency
4. FPI projects are less efficiently
managed
5. Investors of FDI invest in financial
and non financial assets like
resources and technical know-how
along with securities.
5. Investors of FPI invest in financial
assets only
6. It is not easy for FDI investors to
sell out the stake acquired.
6. As in FPI investment is made in
financial assets which are liquid,
they can be easily sold.
3: International Financial Instruments
International financial instruments include Equity, Bond and Money Market Instruments.
About these instruments are discussed below:

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3-1 International Equity Instruments
a) Cross-listing: Cross-listing refers to having shares listed on one or more foreign
exchanges. In particular, MNC do this generally, but non-MNCs also cross list. A
firm cross-list its shares for the following reasons:
 It provides a way to expand the investor’s base
 It offers recognition of a company in a new capital market and
also more investors
 It may be seen as a signal to investors that improved corporate
governance is imminent
 It diminishes the probability of a hostile takeover of the firm
via the broader investor base formed for the firm’s shares.
b) American Depository Receipts (ADR): An ADR is a receipt that has a number
of foreign shares remaining on deposit with the U.S. depository’s custodian in the
issuer’s home market. The bank is the transfer agent for the ADRs that are traded
in the United States Exchanges or in the OTC market. There are two types of
ADRs which are:
I. Sponsored ADRs: Sponsored ADRs are created by a bank after the
request of the foreign company. These are listed on the US stock
markets. New ADR issues must be sponsored.
II. Unsponsored ADRs: Unsponsored ADRs are generally created on
request of US investment banking firms without any direct
participation of the foreign issuing firm.
c) Global Registered Shares (GRS): GRS are shares that traded globally. GRS are
fully transferrable that is GRS purchased on one exchange can be sold on another.
They usually trade in both US dollars and Euros.
The main advantage of GRS over ADRs is that all shareholders have equal status
and the direct voting rights. The main disadvantage is the cost of establishing the
global registrar and the clearing facility.
3-2 International Bond Instruments
3-2a General categories
There are three general categories for international bonds which are described below:
a) Domestic Bonds: Domestic bonds are bonds that issued, underwritten and then traded
locally by a domestic borrower. These bonds are denominated in the local currency.
Example: A US dollar bond issued in the USA by a US company.
b) Euro Bonds: Euro bonds are not sold in any specific international bond market. A
group of multinational banks issue Euro bonds. A Euro bond of any currency is sold
outside the nation that has the currency. Such as a Euro bond in the US dollar would
not be sold in the United States.
c) Foreign Bonds: Foreign bonds are issued in a domestic country by a foreign
company using regulations and currency of domestic country. Under supervision of

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domestic market authority foreign bonds are traded and issued. Example: US dollar
bond issued in the USA by a Non-US company is a foreign bond.
Other than general categories there are also other bonds which are traded in international
market. These are:
a) Global Bonds: Global bonds are bonds that are issued in several countries at the same
time. Global bond was first issued by the World Bank in 1989. These bonds are
usually issued by large multinational corporations and sovereign entities, both of
which regularly carry out large fund raising exercises. Global bonds are issued in
different currencies and unlike Euro bonds; these are distributed in the currency of the
country where it is issued. For example, a global bond issued in the United States will
be in US Dollars (USD), while a global bond issued in Netherlands will be in Euros.
b) Straight Bonds: Straight bonds are bonds that pay fixed interest rate and at maturity
pay back the principal that was originally invested. These are traditional type of bond.
c) Floating Rate Notes: Floating Rate Notes are bonds that have a variable coupon rate,
equal to money market reference rate, like LIBOR. Interest rate is revised
periodically.
d) Convertible Bonds: Bonds that converted into pre-determined number of equity
shares are called Convertible bonds. In case of Convertible bonds, investors are
usually willing to accept a lower coupon rate of interest than comparable straight
fixed coupon bond rate because they find the call feature attractive.
e) Cocktail Bonds: Cocktail bonds are denominated in a mixture of currencies. Cocktail
bonds represent weighted average of 5 currencies. Cocktail bonds reduce exchange
rate fluctuation risk as these are portfolio of currencies. Depreciation of one currency
is offset by appreciation of another currency.
3-3 International Money Market Instruments
a) Euro Notes: Euro notes are denominated in foreign currency other than the currency
of the country where they are issued. They represent low cost funding route.
Documentation facilities are minimum. Investors prefer these bonds in view of short
term maturity.
b) Medium term Euro Notes: Medium term Euro Notes are just an extension of short
term Euro notes as these notes fill the gap existing in the maturity structure of
international financial market instruments. These are compromise between short term
Euro notes and long term Euro bonds as their maturity ranges between one year to and
five years to seven years. Medium term Euro Notes carry fixed interest rate and are
issued to get medium term funds in any foreign currency without any need for
redemption and fresh issue.
c) Euro Commercial Papers: Euro Commercial Papers are unsecured, short-term, non
underwritten loan issued by a bank or a commercial organization in the international
money markets, denominated in a currency different from the home currency of the
bank of the organization. These are advantageous as these provide flexible

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alternatives to short term finance without the requirement of collateral and interest
rate charged set at a very small margin above the market rate.
4: International Bond Markets and Equity Markets
4-1 International Bond Markets
International bond markets facilitate the flow of funds between borrowers who need long-
term funds and investors who are willing to supply long-term funds. Multinational
corporations can obtain long-term debt by issuing bonds in their local markets, and they can
also access long-term funds in foreign markets. An MNC may choose to issue bonds in the
international bond markets for three reasons:
First, issuers recognize that they may be able to attract a stronger demand by issuing their
bonds in a particular foreign country rather than in their home country. Some issuing
countries have a limited investor base, so MNCs in those countries naturally seek financing
elsewhere.
Second, MNCs may prefer to finance a specific project in a particular currency and thus may
seek funds where that currency is widely used.
Third, an MNC might attempt to finance projects in a foreign currency with a lower interest
rate in order to reduce its cost of financing, although doing so would increase its exposure to
exchange rate risk.
Institutional investors such as commercial banks, mutual funds, insurance companies and
pension funds from many countries are major investors in the international bond market.
Institutional investors may prefer to invest in international bond markets, rather than in their
respective local markets, when they can earn a higher return on bonds denominated in foreign
currencies. International bond market is composed of three separate types of bond markets
which are Domestic bonds market, Foreign bonds market and Euro market.
In Domestic bonds market and Foreign bonds market, Domestic bonds and Foreign bonds are
bought and sold which are already discussed. And Euro market is the trading place of Euro
Bonds, Euro Currency, Euro Notes and Euro Commercial papers.
4-2 International Equity Markets
International Equity Markets refer to all international markets that negotiate stocks from their
domestic companies. These markets are an important platform for global finance. They not
only ensure the participation of a wide variety of participants but also offer global economies
to prosper. Cross listing, American Depository Receipt (ADR) and Global Registered Shares
(GRS) are important elements of stock markets. MNCs attract funds by issuing stock in
international markets and by issuing stock in a foreign country MNCs can enhance their firm’
name recognition and image there.

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References
1. International Financial Management, 12th
edition, Jeff Madura.
2. https://www.investopedia.com
3. https://fsmsmarterviews.blogspot.com/2018/03/introduction-to-foreign-portfolio-
investment.html?m=1
4. https://keydifferences.com/difference-between-FDI-and-FPI.html
5. https://www.tutorialspoint.com/international_finance.html
6. https://www.scribd.com/doc/32999470/International-Financial-Market-Instruments