CHAPTER 1: INTRODUCTION
Chapter 1 emphasizes the internationalization of business and economic activity that has occurred since the
end of World War II. Although international business activities have existed for centuries, primarily in the
form of exporting and importing, it is only in the postwar period that multinational firms have become
preeminent. The distinguishing characteristic of the MNC is its emphasis on global, rather than affiliate,
performance. Specifically, MNCs ask, "Where in the world should we build our plants, sell our products,
raise capital, and hire personnel?" Thus the true multinational is characterized more by attitude than the
physical reality of an integrated system of marketing and production activities worldwide. It involves
looking beyond the boundaries of the home country, and treating the world as "our oyster." Good examples
include the globalization of GE's medical systems division and Arco Chemical.
After stimulating student interest with this vision of the MNC, I then introduce the financial decisions that
multinationals must make. I begin by discussing the key concepts and lessons from domestic finance that
apply directly to international corporate finance. The lessons include the emphasis on cash flow rather than
accounting earnings, the time value of money, the importance of taxes, and the unwillingness of investors
to reward companies for activities (like corporate diversification) which investors could replicate for
themselves at no greater cost.
The key concepts, which I point out will arise time and again in the course, are arbitrage, market efficiency,
and the separation of risk into systematic risk, which must be rewarded, and unsystematic risk, which is not
rewarded. The latter concept, of course, is the intuition underlying both the capital asset pricing model
(CAPM) and the arbitrage pricing theory (APT). Although imperfect, the theoretical framework of
domestic corporate finance provides a useful frame of reference, and understanding it is essential before
proceeding with the more complex aspects of international financial management. I devote some time to
explaining that total risk matters, even if the CAPM or APT holds. Otherwise the astute student will see a
conflict between the irrelevance of unsystematic risk and hedging activities.
I then outline the key decision areas in international financial management: foreign exchange risk
management, managing working capital and the internal financial system, financing foreign units, capital
budgeting, and evaluation and control. I emphasize the additional parameters that MNC financial
executives must cope with, including multiple currencies, rates of inflation, tax systems, and capital
markets, as well as foreign exchange and political risks.
SUGGESTED ANSWERS TO “GENERAL ELECTRIC GLOBALIZES”