Key Terms: - Financial Disintermediation - Securitization - Financial Deregulation - Capital Markets

Key terms
• Financial disintermediation
• Securitization
• Financial deregulation
• Capital markets
• segmented
• Integrated
• emergence continuum
IBUS 3530:
International Trade Finance
Foreign Investment Analysis

Learning objectives
• The contractual modes of foreign market entry.
• The pros and cons of international licensing.
• The difference between licensing and franchising.
• The theories motivating foreign direct investment.
• What country risk is and how to mitigate it.
• How a costs and benefits analysis of foreign direct investment informs
country risk forecasting.
Contractual modes of foreign market entry
• Random exporting
• The firm is simply reacting to an opportunity knocking at the door
• Systematic exporting
• a foothold in that export market with in-house expertise
• exporter has to assess its potential client’s credit risk, currency risk, and country risk.
• Indirect exporting
• subcontracting to Export Management Company (EMC) carrying the goods to foreign client.
• no control in selecting distributor, or shaping marketing policy.
• special attention on termination/cancellation clause of the contract with the EMC.
• Semi-indirect exporting
• Interfacing directly with its foreign distributor, eliminating the EMC as an intermediary
• Responsible for the transfer activities from loading dock to distributor’s warehouse.
• Foreign marketing activities outsourced to the foreign distributor
• Direct exporting
• a foreign sales branch with adequate warehousing facilities.
• controls the foreign marketing activities
• International licensing
• Contractual arrangements: licensor offers intangible assets such as patents, technological
know-how, trade secrets, or trademarks to licensee in return for royalties.
• International licensing: pros and cons
• Low-cost entry mode without import barriers: tariffs, quotas, transportation, ban on imports
and foreign direct investment
• No managerial control over the manufacturing and marketing
• Licensee fails to perform according to expectations
• Licensor may have created a competitor in third markets
• International licensing: the contract should include:

• definition of the technology package;
• conditions for using the technology, including territorial and sublicensing rights;
• compensation; and
• termination of contract.
• International Franchising:
• franchisor licenses a business system and other property rights such as brand names—rather
than technology—to a franchisee.
• most used in service industries such as fast-food restaurants, car rentals, hotels and motels,
and real estate brokerage.
• using franchisor’s trade name and logo, operating guidelines as set by franchisor.
• franchisor is compensated by the periodic payment of royalties as a sales percentage.
• Kentucky Fried Chicken, McDonald’s, Avis, and Century 21

Foreign direct investment
• Contractual modes: low-cost but low-return and risky.
• FDI transfers of an entire enterprise to the foreign target market

• more cost competitive
• savings on transportation costs and customs duties
• value to transportation costs is low.
• investment entry often creates marketing advantage.
Country risk
• Uncertainty about the host country’s foreign investment climate impacts the
value of the multinational firm’s.
• Macropolitical risk: instability of the host country’s political system
• Ownership/control risk: adverse policies implemented by the host country government in the
form of expropriation or nationalization of a foreign investor’s plant and equipment—as well
as interference in the managing of its operations.
• Venezuela nationalized foreign oil interests twice in the past 50 years
• Government limits to foreign managerial control may force the multinational investor to divest the
majority stake in its subsidiary.
Country risk
• Operations risk: uncertainty about government policies regarding the rules of the game
governing day-to-day operations.
• Changes in local procurement requirements
• Labor laws may force the multinational subsidiary to restrict its employees’ workweek to 35 hours as the French
socialist government did in the early 2000s;
• Transfer risk: host country policy change that impacts the flow of money, goods, and
technology between the subsidiary and the rest of the multinational enterprise system.
Managing country risk
• Negotiating the environment
• Taxation
• Tax rates, taxable income, tax holidays, and ancillary taxes.
• Imports.
• Restrictions on imports of key inputs such as subassemblies versus local procurement requirements.
• Remittances
• Rules pertaining to the access to foreign exchange for payment of management fees, dividends, royalties, and so on to the
parent company.
• Local financing
• Access to the domestic banking system or local capital market, including concessionary/subsidized financing from the host
government.
• Labor laws.
• Allowing the use of expatriate managers or technicians for operating the local subsidiary by expediting their work permit
documents as necessary.
• Corporate governance.
• Host country restrictions on ownership and/or control of the local subsidiary, and guidelines for planned divestiture from
investment and exit modalities.
• Protection of intellectual property rights & Conflict resolution
Managing country risk
• Structuring the investment
• Raising the maximum amount of capital from local sources
• Loading up on local debt, financing from multilateral lending agencies such as the
International Finance Corporation or regional development bank.
• Political risk insurance

• against expropriation due to war, insurrection, terrorism, or revolution, business
interruptions arising from political violence.
• against restrictions on repatriation of dividends, royalties, or other contractual payments due
to currency inconvertibility.
Host countries: FDI
• National income effect
• FDI in the form of a manufacturing subsidiary should positively impact GDP.
• Benefits =
• Output − Inputs = Value added =
• Benefits = Payments to factors of production − Opportunity costs + Externalities (indirect benefits or

costs)
• Costs = Payments to foreign factors of production

Host countries: FDI
• Balance of payments effect
• Many emerging-market economies are often burdened by heavy foreign debt service and
maintain only partially convertible currencies.
• Benefits = Capital inflow + Exports sales + Imports substitution

• Costs = Payment to foreign factors of production + Imports + Divestment
• Discounting Future Benefits and Costs

• FDIs have a multiyear economic life
Key terms/issues
• Contractual modes of foreign market entry
• Foreign Direct Investment (FDI)
• Country risk and managing country risks
• FDI – Benefit and cost analysis

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Key terms

Foreign Investment Analysis

• International licensing: the contract should include:

• Kentucky Fried Chicken, McDonald’s, Avis, and Century 21

• FDI transfers of an entire enterprise to the foreign target market

• Macropolitical risk: instability of the host country’s political system

• Political risk insurance

• Benefits = Payments to factors of production − Opportunity costs + Externalities (indirect benefits or

• Costs = Payments to foreign factors of production

• Benefits = Capital inflow + Exports sales + Imports substitution

• Discounting Future Benefits and Costs

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