international financial management ppt mba

8/2/2019 International Financial Management PPT MBA

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INTERNATIONAL FINANCIALMANAGEMENT

BABASAB PATIL

1


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Course Overview2

International

Financial

Management

Foreign

Exchange

Markets

Sourcing

Capital in

Global Markets

Managing

FOREX

Exposure

Foreign

Investment

Decisions

Synthesis


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Course Overview3

Introduction to international finance Introduction and course overview

The foreign exchange market

Corporate governance

Parity conditions in international finance

Foreign exchange derivative contracts

International corporate finance issues Transactions exposure to exchange rates Translation exposure to exchange rates

Operating exposure to exchange rates


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Course Overview4

International investment analysis Cost of capital

International bond markets

International equity markets

Capital structure

Corporate strategy and foreign investmentanalysis Offshoring/Outsourcing Project Finance

Cross-border Joint Ventures

Cross-border Mergers


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Course Overview5

Global Financial Crisis

Bailouts and Bans

Can a country go bankrupt?


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What is special about international finance?

6

Foreign exchange risk E.g., an unexpected devaluation adversely affects

your export market

Political risk E.g., an unexpected overturn of the government

that jeopardizes existing negotiated contracts

Market imperfections E.g., trade barriers and tax incentives may affect

location of production Expanded opportunity sets E.g., raise funds in global markets, gains from

economies of scale


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What is money?7

Barter economy Search frictions

Indivisibilities

Transferability Commodity money

Beaver pelts

Dried corn

Metals

Fiat money Faith in government


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8


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9


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The Monetary System10

Bimetallism: Before 1875 Free coinage was maintained for both gold and silver Greshams Law: Only the abundant metal was used as money,

diving more scarce metals out of circulation Classic gold standard: 1875-1914

Great Britain introduced full-fledged gold standard in 1821,France (effectively) in the 1850s, Germany in 1875, the US in1879, Russia and Japan in 1897.

Gold alone is assured of unrestricted coinage There is a two-way convertibility between gold and national

currencies at a stable ratio Gold may be freely exported and imported Cross-border flow of gold will help correct misalignment of

exchange rates and will also regulate balance of payments. The gold standard provided a 40 year period of unprecedented

stability of exchange rates which served to promote internationaltrade.


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Interwar period: 1915-1944

World War I ended the classical gold standard in 1914

Trade in gold broke down

After the war, many countries suffered hyper inflation

Countries started to cheat (sterilization of gold)

Predatory devaluations (recovery through exports!) The US, Great Britain, Switzerland, France and the Scandinavian

countries restored the gold standard in the 1920s.

After the great depression, and ensuing banking crises, mostcountries abandoned the gold standard.

Bretton Woods system: 1945-1972

U.S. dollar was pegged to gold at $35.00/oz.

Other major currencies established par values against the dollar.Deviations of 1% were allowed, and devaluations could benegotiated.


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12


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13


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Guess what happened toinflation?

14


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70

80

90

100

110

120

130

March73=100

Broad Real US dollar IndexSource: www.federalreserve.gov


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Jamaica Agreement (1976) Central banks were allowed to intervene in the foreign exchange

markets to iron out unwarranted volatilities. Gold was officially abandoned as an international reserve asset.

Half of the IMFs gold holdings were returned to the membersand the other half were sold, with proceeds used to help poor

nations. Non-oil exporting countries and less-developed countries were

given greater access to IMF funds. Plaza Accord (1985)

G-5 countries (France, Japan, Germany, the U.K., and the U.S.)agreed that it would be desirable for the U.S. dollar to depreciate.

Louvre Accord (1987) G-7 countries (Canada and Italy were added) would cooperate to

achieve greater exchange rate stability. G-7 countries agreed to more closely consult and coordinate

their macroeconomic policies.


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70

80

90

100

110

120

130

March73=100

Broad Real US dollar IndexSource: www.federalreserve.gov

Jamaica 1978

Plaza 1985

Louvre 1987

????


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Current Exchange RateArrangements

18

36 major currencies, such as the U.S. dollar, theJapanese yen, the Euro, and the British pound aredetermined largely by market forces.

50 countries, including the China, India, Russia, and

Singapore, adopt some forms of Managed Floatingsystem.

41 countries do not have their own national currencies!

40 countries, including many islands in the Caribbean,

many African nations, UAE and Venezuela, do havetheir own currencies, but they maintain a peg to anothercurrency such as the U.S. dollar.

The remaining countries have some mixture of fixed andfloating exchange-rate regimes.

Note: As of July 31, 2005.


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The Euro19

Product of the desire to create a moreintegrated European economy.

Eleven European countries adopted the Euroon January 1, 1999: Austria, Belgium, Finland, France, Germany, Ireland, Italy,

Luxembourg, Netherlands, Portugal, and Spain.

The following countries opted out initially: Denmark, Greece, Sweden, and the U.K.

Euro notes and coins were introduced in 2002 Greece adopted the Euro in 2001 Slovenia adopted the Euro in 2007


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Will the UK (Sweden) join theEuro?

20

The Mini-Case can be found in E&R, p. 57. Please read E&R pp. 35-46 in preparation for the

discussion next time.

Think about: Potential benefits and costs of adopting the euro.

Economic and political constraints facing the country.

The potential impact of British adoption of the euro onthe international financial system, including the role of

the U.S. dollar. The implications for the value of the euro of

expanding the EU to include, e.g., Eastern Europeancountries.


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The Foreign Exchange Market21

The FX market encompasses: Conversion of purchasing power from one currency to

another; bank deposits of foreign currency; creditdenominated in foreign currency; foreign tradefinancing; trading in foreign currency options & futures,

and currency swaps No central market place World-wide linkage of bank currency traders, non-bank

dealers (IBanks, insurance companies, etc.), and FXbrokerslike an international OTC market

Largest financial market in the world Daily trading is estimated to be US$3.21 trillion Trading occurs 24 hours a day London is the largest FX trading center


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Global Foreign Exchange Market Turnover

22

Source: BIS Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in April 2007.


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BIS Triennial Survey23


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The FX market is a two-tiered market:

Interbank Market (Wholesale) Accounts for about 83% of FX trading volumemostly

speculative or arbitrage transactions

About 100-200 international banks worldwide standready to make a market in foreign exchange

FX brokers match buy and sell orders but do not carryinventory and FX specialists

Client Market (Retail) Accounts for about 17% of FX trading volume

Market participants include international banks, theircustomers, non-bank dealers, FX brokers, and centralbanksNote: Data is from 2007.


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Central Banking

The U.S. monetary authoritiesoccasionally intervene in theforeign exchange (FX) marketto counter disorderly marketconditions.

The Treasury, in consultation

with the Federal ReserveSystem, has responsibility forsetting U.S. exchange ratepolicy, while the FederalReserve Bank New York isresponsible for executing FX

intervention. U.S. FX intervention has

become less frequent inrecent years.

WEDNESDAY, NOVEMBER 8, 2000

U.S. INTERVENES IN THIRD QUARTER TOBUY 1.5 BILLION EUROS NEW YORK FEDREPORTS

NEW YORK The U.S. monetary authoritiesintervened in the foreign exchange markets onone occasion during the third quarter, onSeptember 22nd, buying a total of 1.5 billion

euros, the Federal Reserve Bank of New Yorksaid today in its quarterly report to the U.S.Congress.

According to the report, the dollar appreciated 8.2percent against the euro and appreciated 2percent against the Japanese yen during thethree month period that ended September 30,2000.

The intervention was carried out by the foreignexchange trading desk at the New York Fed,

operating in coordination with the EuropeanCentral Bank (ECB) and the monetary authoritiesof Japan, Canada, and the United Kingdom. Theamount was split evenly between the FederalReserve System and the U.S. TreasuryDepartments Exchange Stabilization Fund (ESF).

The report was presented by Peter R. Fisher,executive vice president of the New York Fed andthe Federal Open Market Committees (FOMC)manager for the system open market account, on

behalf of the Treasury and the Federal ReserveSystem.

25

http://www.ny.frb.org/
http://www.newyorkfed.org/newsevents/news/markets/2000/fxq300.pdfhttp://www.newyorkfed.org/newsevents/news/markets/2000/fxq300.pdfhttp://www.newyorkfed.org/newsevents/news/markets/2000/fxq300.pdfhttp://www.newyorkfed.org/newsevents/news/markets/2000/fxq300.pdfhttp://www.newyorkfed.org/newsevents/news/markets/2000/fxq300.pdfhttp://www.newyorkfed.org/newsevents/news/markets/2000/fxq300.pdfhttp://www.newyorkfed.org/newsevents/news/markets/2000/fxq300.pdfhttp://www.newyorkfed.org/newsevents/news/markets/2000/fxq300.pdf


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The Spot Market27

The spot market involves the immediate purchaseor sale of foreign exchange Cash settlement occurs 1-2 days after the transaction

Currencies are quoted against the US dollar

Interbank FX traders buy currency for theirinventory at the bid price

Interbank FX traders sell currency for their

inventory at the ask price Bid price is less than the ask price

Bid-ask spread is a transaction cost

Th S M k Di


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The Spot MarketDirectQuotes

28

US dollar price of 1 unit of foreign currency$ are in the numerator(foreign currency is priced in terms of dollars)

$/ = 1.5000 (1 costs $1.5000)

$/ = 2.0000 (1 costs $2.0000)

Currency changes Suppose that today, $/ = 1.5000 and in 1 month, $/ = 1.5050

The $ has depreciatedin value

Alternatively, the has appreciatedin value

Suppose that today, $/ = 2.0000 and in 1 month, $/ = 1.9950 The $ has appreciatedin value

Alternatively, the has depreciatedin value

Th S t M k t I di t


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The Spot MarketIndirectQuotes

29

Foreign currency price of $1$ are in the denominator (US dollar ispriced in terms of foreign currency)

/$ = 0.6667 ($1costs0.6667)

/$ = 0.5000 ($1 costs 0.5000)

Currency changes Suppose that today,/$ = 0.6667 and in 1 month,/$ = 0.6600

The $ has depreciatedin value

Alternatively, the has appreciatedin value

Suppose that today, /$ = 0.5000 and in 1 week, /$ = 0.5050. The $ has appreciatedin value

Alternatively, the has depreciatedin value


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The Spot Market - Conventions30

Denote the spot rate as S

For most currencies, use 4 decimal places in calculations

With exceptions: i.e. S(/$)=109.0750, but S($/)=0.009168

If we are talking about the US, always quote spot rates as the dollar

price of the foreign currency

i.e. as direct quotes, S($/), S($/C$), S($/), etc

Increase in the exchange rate the US dollar is depreciating

Costs more to buy 1 unit of foreign currency

Decrease in the exchange rate the US dollar is appreciating Costs less to buy 1 unit of foreign currency


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The New Y ork foreign exchange sel ling rates below apply totrading among banks in amounts of $1 mil lion and more, as quotedat 4 p.m. Eastern time by Dow Jones T elerate Inc. and other sources.Retail transactions provide fewer units of foreign currency perdollar.

Special Drawing Rights (SDR) are based on exchange rates forthe U.S., German, British, French, and Japanese currencies. Source:International Monetary Fund.

European Currency Unit (ECU) is based on a basket of communitycurrencies.

a-fixing, Moscow Interbank Currency Exchange.

EXCHANGE R ATES

CountryArgentina (Peso)Australia (Dollar)Austria (Schilling)Bahrain (Dinar)Belgium (Franc)Brazil (Real)

Britain (Pound)30-Day Forward90-Day Forward180-Day Forward

Canada (Dollar)30-Day Forward90-Day Forward180-Day Forward

Chile (Peso)China (Renminbi)Colombia (Peso)Czech. Rep (Krouna)

Commercial rateDenmark (Krone)Ecuador (Sucre)

Floating rateFinland (Markka)France (Franc)

30-Day Forward90-Day Forward180-Day Forward

Germany (Mark)30-Day Forward90-Day Forward180-Day Forward

Greece (Drachma)Hong Kong (Dollar)Hungary (Forint)India (Rupee)Indonesia (Rupiah)Ireland (Punt)Israel (Shekel)Italy (Lira)

Wed.1.0012.7805

.090432.6525.03080.9607

1.68801.68691.68431.6802.7399.7414.7442.7479

.002352.1201

.0009985....

.03662.1663

.....0002766

.2121

.1879

.1882

.1889

.1901

.6352

.6364

.6389

.6430.004049

.1292.006139.02787

.00042331.6664.3079

.0006483

Tues.1.0012.7902

.091012.6525.03105.9615

1.69461.69351.69101.6867.7370.7386.7413.7450

.002356.1201

.0009985....

.03677.1677

.....0002787

.2135

.1893

.1896

.1903

.1914

.6394

.6407

.6432

.6472.004068

.1292.006164.02786

.00042331.6714.3085

.0006510

Wed..9988

1.281211.058.3770

32.4701.0409

.5924.5928

.5937.5952

1.35161.34881.34371.3370425.258.3272

1001.50....

27.3076.0118

....3615.004.71505.32205.31265.29355.26171.57441.57141.56521.5552246.987.7390162.8935.875

2362.15.6001

3.24741542.50

Tues..9988

1.265510.988.3770

32.2051.0401

.5901.5905

.5914

.59291.35681.35391.34891.3422424.408.3276

1001.50....

27.1945.9633

....3587.504.68415.28385.27415.25585.22431.56391.56071.55471.5450245.807.7390162.2335.890

2362.63.5983

3.24121536.00

U.S. $ equiv. per U.S. $Currency

CountryJapan (Yen)


Jordan (Dinar)Kuwait (Dinar)Lebanon (Pound)Malaysia (Ringgit)Malta (Lira)Mexico (Peso)

Floating rateNetherland (Guilder)New Zealand (Dollar)Norway (Krone)Pakistan (Rupee)Peru (new Sol)Philippines (Peso)Poland (Zloty)Portugal (Escudo)Russia (Ruble) (a)Saudi Arabia (Riyal)Singapore (Dollar)Slovak Rep. (Koruna)South Africa (Rand)South Korea (Won)Spain (Peseta)Sweden (Krona)Switzerland (Franc)


Taiwan (Dollar)Thailand (Baht)Turkey (Lira)United Arab (Dirham)

Uruguay (New Peso)Financial

Venezuela (Bolivar)

SDRECU

Wed..008639.008676.008750.0088651.40753.3367

.0006445.4018

2.7624....

.1278

.5655

.7072

.1540.02529.3814

.03800.3460

.006307.0001787

.2666

.7116.03259.2141

.001184

.007546.1431.7334.7357.7401.7470

.03638

.03902.00000911

.2723

.....1145

.002098- - -

1.43151.2308

Tues..008681.008718.008791.0089071.40753.3389

.0006445.4002

2.7701....

.1277

.5699

.7106

.1548.02529.3840

.03802.3475

.006369.0001788

.2667

.7124.03259.2142

.001184

.007603.1435.7387.7411.7454.7523

.03637

.03906.00000915

.2723

.....1145

.002096

1.43261.2404

Wed.115.75115.26114.28112.80.7105.2997

1551.502.4885.3620

....7.82201.76851.41406.492639.5402.621826.3182.8900158.55

5595.003.75031.405330.6884.6705844.75132.526.98651.36351.35931.35111.338627.48925.625

109755.003.6720

....8.7300476.70

.6986..........

Tues.115.20114.71113.76112.28.7105.2995

1551.502.4990.3610

....7.83301.75471.40736.459939.5402.603926.3002.8780157.02

5594.003.75021.403730.6884.6690844.65131.536.96971.35371.34941.34161.329327.49325.605

109235.003.6720

....8.7300477.12

.6980...........

U.S. $ equiv.Currencyper U.S. $Wednesday, January 8, 1997

US dollar price:

S($/)=1.6880

1 costs $1.6880

UK pound price:S(/$)=0.5924

$1 costs 0.5924

/$)(

1)/($

thatnoteAnd

SS

The Spot Market31


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The current exchange, S($/)=1.5000. In 1 month, it is

S(/$)=0.6689

Has the US dollar appreciated or depreciated?

By what % has the exchange rate changed?

Convert S(/$)=0.6689 to:

1/S(/$)=S($/)=1.4950.

Now we see that the exchange rate has decreased US dollar has

appreciated.

The % change per month is:

%33.01.5000

1.5000-1.4950

The Spot Market32


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The exchange rate between 2 currencies where neither

currency is the US dollar

We know the dollar rates. What if we want to know other

rates, i.e. S(/) ?

Calculate cross-rates from dollar rates

S($/)=1.5000 and S($/)=2.0000. What is S(/), i.e. the priceof ?

1.3333)/(

13333.10000.2

5000.11

$

$

S

Cross Exchange Rates33


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Cross-rates must be internally consistent; otherwisearbitrage profit opportunities exist.

Suppose that:

A profit opportunity exists. Either S(/) is too high or

S(/$) or S($/) is too low.

How does this work?

Sell high and buy low.

$

$

Cross-Exchange Rates34

C E h R t


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Cross-Exchange RatesExample

35

Bank1: S($/)=0.0084; Bank2: S($/)=1.0500;Bank3: S(/)=0.0081.

The implied cross rate between Bank 1 and 2 is:S(/)=0.0080.

You have 1,250,000. What should you do? Go to Bank 3.

Convert 1,250,000 to10,125.00 @ 0.0081 Go to Bank 2.

Convert10,125 to $10,631.25 @ 1.0500. Go to Bank 1.

Convert $10,631.25 to 1,265,625.00 @ (1/0.0084) The initial 1,250,000 becomes 1,265,625. You earn

a risk-free profit of 15,625, or 1.25%.

Buy low!

Sell high!


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The Forward Market36

Forward market involves contracting today forthe future purchase or sale of foreignexchange

Forward prices are quoted the same way asspot prices

Denote the forward price maturing in N daysas FN i.e. F30($/), F180($/), F90(/ ), etc

The forward dollar price of the euro can be: Same as the spot price

Higher than the spot price (euro at a premium)

Lower than the spot price (euro at a discount)


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37

The foreign exchange market is by far the largestfinancial market in the world.

Currency traders trade currencies for spot andforward delivery.

Exchange rates are by convention quoted againstthe U.S. dollar, but cross-rates can easily becalculated from bilateral rates.

Triangular arbitrage forces the cross-rates to beinternally consistent.

The euro has enhanced trade within Europe, andthe currency has the potential of becoming a majorworld currency.

Wrap-Up


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Assignment38

Suppose you are Professor Paul Krugman (Princeton UniversityEconomics Professor and NYT columnist (Op-Ed Page)).

On October 13, 2008, at 5am you receive a phone call from theRoyal Swedish Academy informing you that you have beenawarded the Sveriges Riksbank Prize in Economic Sciences in

Memory of Alfred Nobel for your work on international trade andeconomic geography.

After first thinking this is a practical jokethat is surely a fakeSwedish accent - the news sink in and you realize you have asmall problem.

The prize will be awarded at a ceremony on December 10th inStockholm, at which time you will receive the a medal, adiploma, and a prize check for SEK 10,000,000 or US$1,394,136 at the current spot rate (SEK 7.1729US$).

What should you do?


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Nobel Prize Problem

5

5.5

6

6.5

7

7.5

8

8.5

9

SEK/USD

1000000

1100000

1200000

1300000

1400000

1500000

1600000

1700000

1800000

Nobel Prize in US$

39
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