slide 1 of 48 slides developed by jeff madura, with additions and enhancements by tim richardson

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Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson

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Overview

Foreign exchange marketForeign exchange market Eurocurrency marketEurocurrency market Eurocredit marketEurocredit market Eurobond marketEurobond market International stock marketsInternational stock markets

Corporate use of:Corporate use of:

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Motives for Investing in a Foreign Market

Which would therefore require financial considerations to

assist in the investment

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Why FDI Exits

Land, Resources and some types of Land, Resources and some types of business cannot be relocatedbusiness cannot be relocated

If a company wants access, they have to If a company wants access, they have to go therego there

eg. Mining operations, forest harvestingeg. Mining operations, forest harvesting If your customer moves overseas, you If your customer moves overseas, you

may follow to continue to be able to may follow to continue to be able to supplysupply

eg. Autoparts companieseg. Autoparts companies

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Why FDI Exits

Some companies set up operations Some companies set up operations overseas because manufacturing locally overseas because manufacturing locally is cheaper than exporting and paying is cheaper than exporting and paying the shipping coststhe shipping costs

Companies also setup mfg. Overseas in Companies also setup mfg. Overseas in low-wage areas to make products that low-wage areas to make products that are then sent back to customers in the are then sent back to customers in the Home Country, or to a 3rd marketHome Country, or to a 3rd market

eg. Japanese companies mfg. Electronic eg. Japanese companies mfg. Electronic goods in Malaysia, and export to the USAgoods in Malaysia, and export to the USA

Page 63~64Page 63~64

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Why would you want to provide Credit in Foreign Markets

Some countries have higher interest Some countries have higher interest ratesrates so the businesses in those so the businesses in those countries find it expensive to borrowcountries find it expensive to borrow

eg. Japanese interest rate is low, eg. Japanese interest rate is low, mathematically it is cheaper for North mathematically it is cheaper for North American businesses to sometimes American businesses to sometimes borrow money from Japanese banks, borrow money from Japanese banks, than North American banksthan North American banks

4Page 64

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Exchange rate expectationsExchange rate expectations Japanese banks would lend money to Japanese banks would lend money to

U.S. companies if the U.S. dollar goes U.S. companies if the U.S. dollar goes up up

- it means when they get paid back, - it means when they get paid back, they make more money because the they make more money because the U.S. dollar rose in the meantimeU.S. dollar rose in the meantime

Page 64Page 64

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International diversificationInternational diversification Some lenders might want to lend Some lenders might want to lend

money to business in several different money to business in several different countries to reduce the risk countries to reduce the risk

If a lender in one country goes bankrupt If a lender in one country goes bankrupt because of the situation in that country because of the situation in that country - they still have income from businesses - they still have income from businesses in other countriesin other countries

Page 64Page 64

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Why would you want to borrowborrow money from Foreign Markets

Low Interest RatesLow Interest Rates Some banks in some countries have a lot Some banks in some countries have a lot

of money to lend at low interest rates - of money to lend at low interest rates - and nobody to lend to because the and nobody to lend to because the businesses in that country cannot, or do businesses in that country cannot, or do not borrow this moneynot borrow this money

These banks make effort to attract foreign These banks make effort to attract foreign lenders - especially those with currency lenders - especially those with currency exchange rates that are going upexchange rates that are going up

Page 65Page 65

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Exchange rate expectationsExchange rate expectations If you expect a foreign currency to go If you expect a foreign currency to go

down, it would be advantageous to down, it would be advantageous to borrow that money, then you have less borrow that money, then you have less to pay back to pay back

Page 65Page 65

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Exchange rate expectationsExchange rate expectations If an American company borrowed $ If an American company borrowed $

1,000,000 from a Canadian bank, it 1,000,000 from a Canadian bank, it might cost them $800,000 US to do thismight cost them $800,000 US to do this

If the Cdn currency goes down, they If the Cdn currency goes down, they might only have to pay back $750,000 might only have to pay back $750,000 because at the time of paying back, because at the time of paying back, their US dollars are worth moretheir US dollars are worth more

Page 65Page 65

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Foreign Exchange Market

Facilitates trade with exchange of currencies

Developed over long period of time– gold standard, 1876-1913– pegged rates in 1930s– fixed exchange rates 1944-1973– market determined exchange rates

1973-present

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Foreign Exchange Market:

No specific trading marketNo specific trading market Market is just a word for the global Market is just a word for the global

collection of various buyers and collection of various buyers and sellerssellers– US banks’ opening exchange rates use US banks’ opening exchange rates use

prevailing rates of London banks prevailing rates of London banks

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“The most common type

of 4X transaction is for

immediate exchange at

the Spot Rate”

Page 66Page 66

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Spot ContractSpot Contract a 4X transaction with funds delivered for

immediate value the rate “on the spot” in practice, this means settlement within

2 days see

http://www.mellon.com/inst/fx/tools/services.html

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– immediate exchanges made at banksimmediate exchanges made at banks– volume of exchange linked to volume of exchange linked to

international trade and financeinternational trade and finance– 20 large banks handle 50% of the 20 large banks handle 50% of the

volumevolume six currencies comprise 90% of US exchange six currencies comprise 90% of US exchange

volumevolume– Japanese yen, German mark, British poundJapanese yen, German mark, British pound– Canadian dollar, French franc, Swiss francCanadian dollar, French franc, Swiss franc

Foreign Exchange Market: Role of Banks

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?Why would it be that the chart on page 67 shows German Marks, Japanese Yen and British Pounds being used much more than Canadian dollars - cause isn’t Canada the largest trading partner with the U.S.?

Because Cdn dollar business done by Canadian banks

and because Cdn business with the U.S. is more frequently quoted in U.S. dollars anyway - negating the need for conversion

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“… “… the exchange rate between 2 the exchange rate between 2 currencies should be similar across currencies should be similar across the various banks that provide 4X - the various banks that provide 4X - causecause

if there was a large difference, if there was a large difference, customers, or other banks would customers, or other banks would immediately start trading currencyimmediately start trading currency

page 66page 66

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“… “… if a bank begins to experience a if a bank begins to experience a shortage of a particular foreign shortage of a particular foreign currency it can purchase this from currency it can purchase this from other banks. This trading is called other banks. This trading is called the Interbank Market…”the Interbank Market…”

page 67page 67

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US banks’ opening exchange rates US banks’ opening exchange rates use prevailing rates of London banks use prevailing rates of London banks

sometimes change happen the world sometimes change happen the world over night which negate the over night which negate the exchange rate used the previous dayexchange rate used the previous day

due to time zones, people trade 24hrs due to time zones, people trade 24hrs a day around the planeta day around the planet

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Attributes of Banks- things you look for in deciding to

use a particular bank for 4x Competitiveness Special Relationship Speed of Execution Advice about current market

conditions Forecasting advice

page 68

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Foreign Exchange Market: Bid/Ask Spread

Represents fee for bank’s service in currency exchange– difference between a bank’s bid (buy)

quote and ask (sell) quote remember: banks buy low, sell high

bid/ask spread = (ask-bid)/ask

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Foreign Exchange Market: Bid/Ask Spread

In currencies that are bought and sold frequently, the bid / ask spread is usually not too big

In currencies that are NOT bought and sold frequently, the bid / ask spread is larger so the bank can have a better chance of making some money

This also helps them if they cannot sell some currencies page 71

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Foreign Exchange Market: Forward Contracts

Agreement made today to buy or sell currency at a specific time in the future

“… allow for the purchasing or selling of currencies in future periods…”

“… establishes a firm rate today, for settlement at a future day” Mellon Bank

Bank acts as middle agentPage 70Page 70

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MNCs use forward contracts for:– hedging against currency fluctuations– bypassing cashflow constraints– they might not have the money right now– MNCs cannot always plan exactly when

the product will be finished, and need to be shipped and paid for, so forward contracts are sometimes bought and sold if the planning time changes

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“MNCs also use forward contracts to lock in the rate at which they can sell currencies - this is used to hedge against the possibility of the currencies depreciating over time”

page 71

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Forward contracts have premiums, discounts– premium: forward > spot rate– discount: forward < spot rate

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Forward contracts have premiums, discounts– premium: forward > spot rate– discount: forward < spot rate

example If McCains foods bought

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Arbitrage

“… “… capitalizing on a discrepancy in capitalizing on a discrepancy in quoted prices…” quoted prices…” page 203

TR - “taking advantage of the fact that TR - “taking advantage of the fact that one thing has two different prices - you one thing has two different prices - you can then buy it at the low price, and sell can then buy it at the low price, and sell it for a profit to the person who is paying it for a profit to the person who is paying the higher price”the higher price”

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Interpreting Foreign Exchange Quotes

Direct quote– dollar value of foreign currency per one

unit of the foreign currency e.g., British pound = $1.5205

Indirect quote – number of currency units per one US

dollar e.g., British pound = 0.6557

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Direct quote YEN– one unit of that currency equal to the number of

dollars– one Yen = 0.01179 CDN $

Indirect quote – the number of units of that currency per one dollar– 80.45 Yen = 1 $ CDN

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For consistency, Direct Quotes are used in

Madura’s Text

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Refer to your green handout on the IMF

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Foreign Exchange Market:Exchange Rates

Cross exchange ratesCross exchange rates– exchange rate between non-US currenciesexchange rate between non-US currencies– value of Canadian dollar in German marksvalue of Canadian dollar in German marks

value of one CD in $US = $0.7236value of one CD in $US = $0.7236 value of one DM in $US = $0.6077value of one DM in $US = $0.6077

Value of $CD in DM = $0.7236/$0.6077Value of $CD in DM = $0.7236/$0.6077 = 1.1907 = 1.1907

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Foreign Exchange Market:Exchange Rates

Cross exchange ratesCross exchange rates– exchange rate between non-US currenciesexchange rate between non-US currencies– value of Canadian dollar in German marksvalue of Canadian dollar in German marks

value of one CD in $US = $0.6757value of one CD in $US = $0.6757 value of one DM in $US = $0.5297value of one DM in $US = $0.5297

Value of $CD in DM = $0.6757/$0.5297Value of $CD in DM = $0.6757/$0.5297 = 1.275 17 May 1999 = 1.275 17 May 1999 Using the handout of 17May99, calculate the cross rate

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Foreign Exchange Market:Futures and Options

Futures– contract for future delivery of a currency– specific volume of a currency to be

delivered on a specified date at a specified rate

– volume is a fancy way of saying “how much” eg, dollars volume = 50,000,000

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The difference between a Futures Contract and a Forward Contract is that the

Future Contract specifies the volume on a specific date

- sold on an Exchange

, the Foward Contract specifies the exchange rate

- sold by commercial banks

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Foreign Exchange Market:Futures and Options

Options– contract for the option to buy/sell a

currency at a specified price in a specified time period

– call option gives right to buy a currency– put option gives right to sell a currency

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Eurocurrency Market Eurodollar market

– MNCs depositing $US in European banks– mostly American companies making

deposits in European banks– the European banks took this money cause

they could easily lend it to European customers who needed dollars to buy American goods and services

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Eurocurrency Market Eurodollar market

– outgrowth of international banking needs and circumvention of US banking regulations

US limits foreign lending by US banks meaning US law doesn’t allow US banks to lend

money easily to non-US customers If they do lend money at all, reserve limits are high Eurobanks have no reserve requirements smaller bid/ask spread exists in the more efficient

European market for US dollars

Page 76Page 76

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Eurocurrency Market

Composition of marketComposition of market– Eurobanks work with deposits and loans in Eurobanks work with deposits and loans in

different currenciesdifferent currencies primarily work with US dollarsprimarily work with US dollars petrodollars are deposits by OPEC countries, in petrodollars are deposits by OPEC countries, in

dollarsdollars

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Syndicated Loans

When you want to borrow a very large When you want to borrow a very large amount of money, several banks form a amount of money, several banks form a temporary alliance to provide the temporary alliance to provide the amountamount

this “syndication” allows for very large this “syndication” allows for very large projects to be financed, and the people projects to be financed, and the people who lend the money, will proportionately who lend the money, will proportionately share in the interest paymentsshare in the interest payments

Page 77Page 77

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Asian dollar marketAsian dollar market– Asian banks (usually in Hong Kong, Singapore)Asian banks (usually in Hong Kong, Singapore)

accommodate financing needs of MNCs with $US accommodate financing needs of MNCs with $US

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Eurocredit Market

Medium-term fundsMedium-term funds– financing for one to five yearsfinancing for one to five years

LIBORLIBOR– - London Interbank Offer Rate- London Interbank Offer Rate– rate commonly charged for loans between rate commonly charged for loans between

EurobanksEurobanks

Page 80Page 80

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Foreign Bonds

Foreign bondsForeign bonds– issued by a MNC in a foreign countryissued by a MNC in a foreign country– “… “… issued by a borrower foreign to the country issued by a borrower foreign to the country

in which the bond is placed” page 80in which the bond is placed” page 80– e.ge.g., US company issues bond in London that ., US company issues bond in London that

are denominated in British pounds are denominated in British pounds

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Euro Bonds Euro bondsEuro bonds

– “… “… sold in countries other than the country sold in countries other than the country represented by the currency denominating represented by the currency denominating them” page 80them” page 80

– e.ge.g., English company issues bond in Germany ., English company issues bond in Germany that are denominated in British pounds that are denominated in British pounds

– issued in bearer formissued in bearer form– coupon payments made yearlycoupon payments made yearly– most are denominated in U.S. dollarsmost are denominated in U.S. dollars

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International Stock Markets

Equity financing in non-domestic countriesEquity financing in non-domestic countries Yankee stock offeringsYankee stock offerings

– issuance in the US by non-US companiesissuance in the US by non-US companies– MNCs attracted by the liquidity of US marketMNCs attracted by the liquidity of US market

American Depository Receipts (ADR)American Depository Receipts (ADR)– certificates traded in UScertificates traded in US

represent bundles of stock in foreign countriesrepresent bundles of stock in foreign countries

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Summary

Foreign exchange marketForeign exchange market– facilitates financial trade/transactions by exchanging facilitates financial trade/transactions by exchanging

currenciescurrencies Eurocurrency marketEurocurrency market

– provide services for deposits, short-term loansprovide services for deposits, short-term loans Eurobond marketEurobond market

– facilitates int’l business with long-term creditfacilitates int’l business with long-term credit International stock marketsInternational stock markets

– provides equity financing in different countriesprovides equity financing in different countries

slide 1 of 48 slides developed by jeff madura, with additions and enhancements by tim richardson

Documents

money u

rates u

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u land

risk u

foreign markets u low

investment slide

jeff madura