International Financial Management

Course Overview and Introduction to International Financial Management

1

Course Overview
 Prerequisites  BusFin 810 and/or BusFin 811  Requirements and Grading  Class participation and Cases (20%+20%)  Midterm Exam (30%)  Final Paper or Final Exam (30%)  Class Materials  Eun and Resnick, 2007, International Financial Management,

Irwin McGraw-Hill, Boston, 4th Edition (3rd Edition OK).  Packet of Cases and Readings available in Uniprint Tuttle and online at http://uniprint.osu.edu/coursepackets/  Web-page:

http://fisher.osu.edu/fin/faculty/werner/

2

Course Overview
 Course Objective To provide a framework for making corporate financial

decisions in an international context.
 Related Courses F821 Seminar in Corporate Financial Analysis F822 Security Markets F823 Special Topics in Investment Management F826 Management of Financial Institutions F829 Risk Management and Derivatives

3

Course Overview
Foreign Exchange Markets Sourcing Capital in Global Markets

International Financial Management

Synthesis

Managing FOREX Exposure

Foreign Investment Decisions

4

Course Overview 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 5 .

Course Overview International investment analysis Cost of capital International bond markets International equity markets Capital structure Corporate strategy and foreign investment analysis Offshoring/Outsourcing Project Finance Cross-border Joint Ventures Cross-border Mergers 6 .

Course Overview Global Financial Crisis Bailouts and Bans Can a country go bankrupt? 7 .

.. trade barriers and tax incentives may Expanded opportunity sets E. an unexpected devaluation adversely affects your export market… E.g.g...g. an unexpected overturn of the government that jeopardizes existing negotiated contracts… affect location of production… from economies of scale… Market imperfections E. raise funds in global markets. gains 8 .g.What is special about international finance? Foreign exchange risk Political risk E.

What is money? Barter economy Search frictions Indivisibilities Transferability Commodity money Beaver pelts Dried corn Metals Fiat money Faith in government… 9 .

10 .

11 .

Germany in 1875.  The gold standard provided a 40 year period of unprecedented stability of exchange rates which served to promote international trade.  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 US in 1879. 12 . diving more scarce metals out of circulation  Classic gold standard: 1875-1914  Great Britain introduced full-fledged gold standard in 1821. Russia and Japan in 1897.The Monetary System  Bimetallism: Before 1875  Free coinage was maintained for both gold and silver  Gresham’s Law: Only the abundant metal was used as money. France (effectively) in the 1850s.

S. most countries abandoned the gold standard.The Monetary System  Interwar period: 1915-1944  World War I ended the classical gold standard in 1914  Trade in gold broke down  After the war. and ensuing banking crises.  Bretton Woods system: 1945-1972  U.00/oz.  After the great depression. Deviations of ±1% were allowed. many countries suffered hyper inflation  Countries started to “cheat” (sterilization of gold)  Predatory devaluations (recovery through exports!)  The US. Great Britain. dollar was pegged to gold at $35. and devaluations could be negotiated. France and the Scandinavian countries restored the gold standard in the 1920s. 13 .  Other major currencies established par values against the dollar. Switzerland.

14 .

15 .

Guess what happened to inflation? 16 .

The Monetary System Broad Real US dollar Index Source: www.gov 130 120 110 100 0 1 = 3 7 h c r a M 90 80 70 17 .federalreserve.

 Gold was officially abandoned as an international reserve asset.S.The Monetary System  Jamaica Agreement (1976)  Central banks were allowed to intervene in the foreign exchange markets to iron out unwarranted volatilities. dollar to depreciate. 18 .  G-7 countries agreed to more closely consult and coordinate their macroeconomic policies. and the U.K.) agreed that it would be desirable for the U..  Non-oil exporting countries and less-developed countries were given greater access to IMF funds.  Plaza Accord (1985)  G-5 countries (France.S. Germany. the U. with proceeds used to help poor nations. Half of the IMF’s gold holdings were returned to the members and the other half were sold.  Louvre Accord (1987)  G-7 countries (Canada and Italy were added) would cooperate to achieve greater exchange rate stability. Japan.

gov 130 120 Plaza 1985 110 100 ???? Jamaica 1978 Louvre 1987 0 1 = 3 h c r a M 7 90 80 70 19 .The Monetary System Broad Real US dollar Index Source: www.federalreserve.

but they maintain a peg to another currency such as the U. . such as the U. and the British pound are determined largely by market forces.  41 countries do not have their own national currencies!  40 countries. dollar. the Euro. and Singapore. adopt some forms of “Managed Floating” system. dollar. many African nations. India.Current Exchange Rate Arrangements  36 major currencies.S. including the China. UAE and Venezuela. Russia.S. 2005. the Japanese yen.  The remaining countries have some mixture of fixed and floating exchange-rate regimes. including many islands in the Caribbean. do have their own currencies.  50 countries. 20 Note: As of July 31.

Ireland. Belgium. and the U. France. Sweden. Luxembourg. and Spain. Euro notes and coins were introduced in 2002 Greece adopted the Euro in 2001 Slovenia adopted the Euro in 2007 21 .The Euro Product of the desire to create a more integrated European economy. The following countries opted out initially:  Denmark. Italy. Portugal.K. Netherlands. Finland. Greece. 1999:  Austria. Eleven European countries adopted the Euro on January 1. Germany.

Eastern European countries. e.Will the UK (Sweden) join the Euro? The Mini-Case can be found in E&R.. Economic and political constraints facing the country. Please read E&R pp.S. p. The potential impact of British adoption of the euro on the international financial system. including the role of the U. 22 . 35-46 in preparation for the discussion next time. The implications for the value of the euro of expanding the EU to include. 57. Think about: Potential benefits and costs of adopting the euro. dollar.g.

The Foreign Exchange Market The FX market encompasses: Conversion of purchasing power from one currency to another. and currency swaps dealers (IBanks. trading in foreign currency options & futures. credit denominated in foreign currency. and FX brokers—like an international OTC market No central market place World-wide linkage of bank currency traders. non-bank Largest financial market in the world Daily trading is estimated to be US$3.). foreign trade financing. bank deposits of foreign currency. etc.21 trillion Trading occurs 24 hours a day London is the largest FX trading center 23 . insurance companies.

.Global Foreign Exchange Market Turnover 24 Source: BIS Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in April 2007.

BIS Triennial Survey… 25 .

non-bank dealers. their customers. and central banks 26 Note: Data is from 2007. .The Foreign Exchange Market  The FX market is a two-tiered market: Interbank Market (Wholesale)  Accounts for about 83% of FX trading volume—mostly speculative or arbitrage transactions  About 100-200 international banks worldwide stand ready to make a market in foreign exchange  FX brokers match buy and sell orders but do not carry inventory and FX specialists Client Market (Retail)  Accounts for about 17% of FX trading volume  Market participants include international banks. FX brokers.

S. Canada.S. buying a total of 1. exchange rate policy. FX intervention has become less frequent in recent years. NOVEMBER 8. 2000 U. the Federal Reserve Bank of New York said today in its quarterly report to the U.  According to the report.S.Central Banking  The U.  . http://www.S. on behalf of the Treasury and the Federal Reserve System. Congress. executive vice president of the New York Fed and the Federal Open Market Committee’s (FOMC) manager for the system open market account.  The report was presented by Peter R.ny.S. The amount was split evenly between the Federal Reserve System and the U. Treasury Department’s Exchange Stabilization Fund (ESF).org/ 27 WEDNESDAY. in consultation with the Federal Reserve System. has responsibility for setting U. 2000. operating in coordination with the European Central Bank (ECB) and the monetary authorities of Japan.2 percent against the euro and appreciated 2 percent against the Japanese yen during the three month period that ended September 30.S.5 BILLION EUROS NEW YORK FED REPORTS NEW YORK – The U. INTERVENES IN THIRD QUARTER TO BUY 1.S.5 billion euros. Fisher.  The intervention was carried out by the foreign exchange trading desk at the New York Fed. while the Federal Reserve Bank New York is responsible for executing FX intervention.frb. monetary authorities intervened in the foreign exchange markets on one occasion during the third q .  U. monetary   authorities occasionally intervene in the foreign exchange (FX) market to counter disorderly market conditions. the dollar appreciated 8.  The Treasury. and the United Kingdom.

The Foreign Exchange Market 28 .

The Spot Market The spot market involves the immediate purchase or 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 their inventory 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 29 .

$/£ = 1.5000 (1€ costs $1.0000 and in 1 month.0000)  Currency changes  Suppose that today. $/£ = 2.5000)  $/£ = 2.0000 (1£ costs $2.9950  The $ has appreciated in value  Alternatively. the € has appreciated in value  Suppose that today. $/€ = 1.The Spot Market – Direct Quotes  US dollar price of 1 unit of foreign currency—$ are in the numerator (foreign currency is priced in terms of dollars)  $/€ = 1.5050  The $ has depreciated in value  Alternatively. $/€ = 1. the £ has depreciated in value 30 .5000 and in 1 month.

The Spot Market – Indirect Quotes  Foreign currency price of $1—$ are in the denominator (US dollar is priced in terms of foreign currency)  €/$ = 0.5000 ($1 costs £0.5000)  Currency changes  Suppose that today. £/$ = 0. £/$ = 0. the £ has depreciated in value 31 .6600  The $ has depreciated in value  Alternatively.  The $ has appreciated in value  Alternatively.5050.6667)  £/$ = 0. the € has appreciated in value  Suppose that today. €/$ = 0.5000 and in 1 week.6667 and in 1 month. €/$ = 0.6667 ($1costs €0.

e. etc  Increase in the exchange rate depreciating ⇒ the US dollar is  Costs more to buy 1 unit of foreign currency  Decrease in the exchange rate appreciating ⇒ the US dollar is  Costs less to buy 1 unit of foreign currency 32 .e. S($/£).009168  If we are talking about the US. use 4 decimal places in calculations  With exceptions: i. but S($/¥)=0.The Spot Market Conventions  Denote the spot rate as S  For most currencies. always quote spot rates as the dollar price of the foreign currency  i.0750. S(¥/$)=109. S($/€). as direct quotes. S($/C$).

70 477.1889 . Commercial r ate .5952 ....7357 .03080 .6352 . s adua ay r 8 .71 90-Da y Forward .002098 .03800 .9865 6.26 114.3539 90-Da y Forward . . European Currency Unit (ECU) is based on a bask et of comm unity currencies ...03259 30.2723 3.7124 1.03105 32.1292 . as quoted at 4 p .7624 2.1548 6.0001787 .3386 1..6705 4.3389 .3516 1.7685 1.006164 162.7450 1.3272 8...2741 90-Da y Forward .02787 .0009985 . Tues.. Financial .7387 1.7386 1..3488 1.1201 . and other sources .75 844.470 32.5714 1.7105 .0012 1. Countr y Wed..2655 Austria (Schilling) .625 25.008639 .5552 1. ..6843 1.S.3079 .15 2362.1431 .3460 ..3770 .7523 1...52 131.2617 5.9988 Australia (Dollar) ...3085 3.002356 425.3770 Belgium (Franc) .0004233 2362.3367 3..4140 1. Retail tr ansactions pro vide f ewer units of f oreign currency per dollar . Ger man. 1 9 9 7 Jn EXCHANGE RA TES The Ne w York foreign e xchange selling r ates belo w apply to trading among banks in amounts of $1 million and more .3126 5.1879 ..6001 ..489 27...5547 180-Da y Forward .7334 .9633 Ecuador (Sucre) .2243 German y (Mar k) .3370 1.4990 Malta (Lir a) 2.7106 1.9615 1.02529 ..1896 5.23 India (Rupee) .09043 .S. Tues.6986 .9607 .058 10.7072 . Br itish.40 China (Renminbi) . .1882 .28 113.688 South Africa (Rand) .3422 Chile (Peso) .7479 .9988 .493 Thailand (Baht) .03902 .7401 .4075 1.4315 1.5928 .6880 £1 costs $1. Easter n time b y Do w Jones Teler ate Inc.6364 .3437 1.03677 27.5655 .6525 2.6802 1. Wed..7390 Hungar y (Forint) .02786 35.76 180-Da y Forward .00 Currenc y U.6720 Urugua y (New Peso) .1893 5.6867 ...2667 3.7150 4.. Wed.09101 11..6430 .65 Spain (Peseta) .03802 26.4926 6.7503 3.6880 1.6880 UK pound price: S(£/$)=0...001184 .80 Hong K ong (Dollar) .6472 1.0009985 1001..6218 2.0006445 1551.7300 Venezuela (Boliv ar) .307 27.7502 Singapore (Dollar) .0006510 1542.2838 30-Da y Forward . And note that 1 S ($ / £) = S (£/$) 33 ..0006483 .50 1536.00 109235.00 3587. Currenc y per U .S. .7470 .008681 115..001184 844...3593 1.03637 27.1277 7.98 245.80 112. per U .5924 Special Dr awing Rights (SDR) are based on e xchange r ates f or the U .3635 1..6980 ECU 1. $ Countr y Wed.004068 246.6714 .3537 30-Da y Forward .008676 . ..875 35.6946 .5937 .0001788 5595.605 Turke y (Lira) .2404 .6525 .0409 1.7902 1.3494 90-Da y Forward .1901 .1663 .006139 .12 --SDR 1..50 Mala ysia (Ringgit) ... Floating r ate .6389 .1677 6. and J apanese currencies .9697 Switz erland (Franc) .7701 .5450 Greece (Drachma) .988 Bahrain (Dinar) 2. .2997 . Argentina (Peso) 1.008907 112. Source: Inter national Monetar y Fund.4599 Pakistan (Rupee) ..55 157.8220 7..2142 4.6394 1.03638 .5924 $1 costs £0.3840 2.3511 1.6869 1. .7454 1.00 Saudi Arabia (Riyal) .7116 .3620 .7805 .5639 30-Da y Forward .002096 476.1903 5.3220 5. Rep (Krouna) .50 Czech.The Spot Market We d n ey.3475 2.5652 1..205 Brazil (Real) ..1145 . . ..3416 180-Da y Forward .75 115.. US dollar price: S($/£)=1.2935 5.0012 .8900 2.6720 3.7414 .2412 Italy (Lira) ..1292 7.4018 .S.6690 South K orea (Won) .3276 Colombia (Peso) ..5924 .4326 .03906 25.6664 1..25 424.0401 Britain (Pound) 1.6935 .4037 Slovak Rep .7411 1.7413 1.4075 ...63 Ireland (Punt) 1.002352 ..2812 1.m.1201 8.00 5594. Mosco w Interbank Currency Exchange .02 Russia (Rub le) (a) .0006445 ..7547 New Zealand (Dollar) .318 26.5983 Israel (Shek el) .2558 180-Da y Forward .03259 .540 39.8330 Netherland (Guilder) ..00 United Arab (Dirham) ..7390 7.2666 .008791 114.3814 ..0002787 3615.006369 158.7442 .0002766 .53 Sweden (Krona) .7399 .6039 Philippines (Peso) . $ equiv .0118 5.6432 1..5699 1. Tues..4002 2.6841 France (Franc) .2141 ...5914 180-Da y Forward 1.5607 90-Da y Forward ..3610 Mexico (Peso) .300 Poland (Zloty) .2723 .1145 8. . Tues.008865 .7370 1. F rench.007546 .5901 30-Da y Forward 1.006307 .1278 . .4073 Norwa y (Krone) .008750 .00000911 . $ equiv .03662 .. (Koruna) . Floating r ate .688 30..2995 Lebanon (Pound) .7105 Kuwait (Dinar) 3.20 30-Da y Forward . Japan (Yen) . .89 162.50 Finland (Mar kka) .004049 .S.1914 5.3489 180-Da y Forward .3568 30-Da y Forward .2308 1.6407 1.890 Indonesia (Rupiah) .7300 8. a-fixing. .007603 132.00000915 109755.008718 115.02529 39.5905 90-Da y Forward 1.50 1551.1540 .2135 4.4053 1.4885 2.50 1001..6910 .540 Peru (new Sol) ..5744 1.5929 Canada (Dollar) ..3293 Taiwan (Dollar) .2474 3.0004233 .194 Denmark (Krone) ..8780 Portugal (Escudo) .28 Jordan (Dinar) 1.1435 6. $ U..2121 .

it is S(€/$)=0. – Now we see that the exchange rate has decreased ⇒ US dollar has appreciated. S($/€)=1.6689 to: 1/S(€/$)=S($/€)=1.5000. – The % change per month is: 1.5000 34 .6689 – Has the US dollar appreciated or depreciated? – By what % has the exchange rate changed? • Convert S(€/$)=0.5000 = −0.1.33 % 1. In 1 month.4950 .4950.The Spot Market • The current exchange.

0000.3333 35 . the € price of £? ∈ ∈ $ 1 ∈1.e. i.Cross Exchange Rates • The exchange rate between 2 currencies where neither currency is the US dollar • We know the dollar rates. i.5000 and S($/£)=2. What if we want to know other rates. S(€/£) ? – Calculate cross-rates from dollar rates – S($/€)=1.0000 = £ $ £ 1.5000 £1 ⇒ S (∈ / £) = 1.e.3333 = × = × 2. What is S(€/£).

otherwise arbitrage profit opportunities exist. • Suppose that: ∈ ∈ $  × £ $ £ • A profit opportunity exists. 36 . Either S(€/£) is too high or S(€/$) or S($/£) is too low.Cross-Exchange Rates • Cross-rates must be internally consistent. • How does this work? • Sell high and buy low.

25%. Bank3: S(€/¥)=0.0081 Sell ¥ high!  Go to Bank 2.  Go to Bank 1.125 to $10.0080. You have ¥1. Bank2: S($/€)=1.0084) The initial ¥1. Buy ¥ low! Convert $10. The implied cross rate between Bank 1 and 2 is: S(€/¥)=0.125.25 to ¥1. What should you do?  Go to Bank 3.25 @ 1.625.000 to €10.250. Convert ¥1. You earn a risk-free profit of ¥15.00 @ (1/0.265.250.631.000 becomes ¥1.Cross-Exchange Rates Example Bank1: S($/¥)=0.0500.0084.631. Convert €10.00 @ 0.0081.000.625.625. 37 .265.250.0500. or 1.

e. F180 ($/€). F30 ($/£). F90 (€/ ¥).The Forward Market Forward market involves contracting today for the future purchase or sale of foreign exchange Forward prices are quoted the same way as spot prices Denote the forward price maturing in N days as FN i. 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) 38 .

Wrap-Up  The foreign exchange market is by far the largest financial market in the world.  Currency traders trade currencies for spot and forward delivery.  Triangular arbitrage forces the cross-rates to be internally consistent. but cross-rates can easily be calculated from bilateral rates.S. 39 . and the currency has the potential of becoming a major world currency.  The euro has enhanced trade within Europe. dollar.  Exchange rates are by convention quoted against the U.

at 5am you receive a phone call from the Royal Swedish Academy informing you that you have been awarded the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for your work on international trade and economic geography.  What should you do? 40 .000.Assignment  Suppose you are Professor Paul Krugman (Princeton University Economics Professor and NYT columnist (Op-Ed Page)).000 or US$ 1. at which time you will receive the a medal.1729US$). 2008.  The prize will be awarded at a ceremony on December 10th in Stockholm.394.the news sink in and you realize you have a small problem.  On October 13. a diploma.  After first thinking this is a practical joke – “that is surely a fake Swedish accent” .136 at the current spot rate (SEK 7. and a prize check for SEK 10.

Nobel Prize Problem… 41 .

Sign up to vote on this title
UsefulNot useful