Interna'onal

Business Finance

FINS3616
 Expecta'ons and Important Items
•  A<ending Lectures or Viewing the Lecture Slides is Necessary to Do Well
•  A<ending Tutorials is mandatory. Review the Course Outline for more Details
•  Have access to the textbook: I am working with the most current edi'on. If you
have an old edi'on, you may use it but it is up to you to make sure the content is
the same
•  The midsession exam is held in your assigned lecture in Week 7 (just aSer the
mid-semester break)
•  Read the textbook: I think it is a good idea to do a “skim” of the chapters before
the class, then do a full read of the content aSer the class.
•  You will need to devote at least 8-10 hours out of class to this course. If you can’t
do this, I encourage you to drop the course
•  Par'cipate in class, I will ask ques'ons and I expect answers. It doesn’t need to be
correct.
•  Review and understand the Course Outline on Moodle
•  Administra've ques'ons may be directed to me via email
•  However, content related ques'ons should be sent through the forum on Moodle
or brought up to me during consulta'on 'mes
•  Understanding and following UNSW’s code of conduct. What this means:
–  Do your own work, any form of chea'ng (including sharing individual work with others,
plagiarism in any form, or having your friend sit in the toilet during the exam so you can go in
and ask them ques'ons while you’re toile'ng together) will not be tolerated
 Globaliza'on and the
Mul'na'onal Corpora'on
FINS3616
Week 1
Chapter 1
 Introduc'on

•  Globaliza'on – increasing connec'vity and integra'on of countries
and corpora'ons and the people within them
•  How have countries become closer:
–  socially?
–  poli'cally?
–  economically?
•  What are some of the benefits of globaliza'on?

•  Are there downsides to globaliza'on?
 The US Dollar over the Past Two Years
(end-February 2016 – end of February 2018)
 Interna'onal Trade Growth

•  Trade liberaliza'on
–  Enables “free” trade between countries
–  How could this be beneficial?
•  Specializa'on
•  Compara've advantages
•  Outsourcing (goods and labor)

•  A (very short) history of trade liberaliza'on

–  In the 1960s only 20% of countries were “open”
–  By 2000, over 70% of countries were “open”
–  Post-GFC, pushing the brakes a bit
–  2010s, the rise of populism
 How did Trade Liberaliza'on Happen: Trade Agreements

•  Free Trade Agreements
–  1947: General Agreement on Tariffs and Trade (GATT)
•  Signed by 23 na'ons, in effect un'l World Trade Organiza'on (WTO)
–  1986-1994: World Trade Organiza'on
•  Signed by 123 na'ons is 1994

•  Regional Trade Agreements

–  European Union (Officially 1993, but had roots in ECSC, 1952)
–  North American Free Trade Agreement (NAFTA), 1994
–  Associa'on of Southeast Asian Na'ons, (ASEAN), 1967
–  Chinese Australian Free Trade Agreement (ChAFTA), 2015
 Development and Globaliza'on of Financial Markets

•  Securi'za'on
–  Repackaging of “pools” of loans or other receivables to create a new
financial instrument
–  Long history (examples as far back as the mid-19th century)
–  Much more widespread in 1980’s and 1990’s –Pros and cons of
development

•  Globaliza'on and Securi'za'on happened around the same 'me

–  Posi'ves:
•  Banks (and companies) could hedge against risk
•  Why is this a big deal?
–  Nega'ves:
•  Complex instruments led to opaqueness in financial system
•  How risky were these things? How do we measure risk?
–  Global Financial Crisis (2008 – 2010)
•  Started in the United States
•  Longest and deepest recession/financial crisis in the postwar era
•  Scale and depth of crisis raised issues with how well the global financial system
worked
 Globaliza'on of Financial Markets:
What Happened?
•  Incredible growth in the number of MNCs aSer WWII
–  37,000 MNCs in 1990
–  Over 80,000 today
•  Globaliza'on of financial markets
–  Trends in financial openness
•  1980s countries began to allow foreigners to invest in their markets
•  Crea'on of new asset class – emerging markets
–  New financial landscape – deriva'ves
•  Deriva've security
–  an investment whose payoff over 'me is derived from the performance of
underlying assets
–  Examples include futures, forwards, op'ons and swaps
 How I learned to stop worrying and love the GFC

•  Securi'za'on and U.S. government’s quest to allow everyone to own a
home fueled growth in subprime mortgages between 2000 and 2006
–  People bought houses they could not afford
–  Banks securi'zed those loans and sold them to investors
–  Once house prices started to fall, many defaulted on mortgages
–  Banks holding assets backed by those mortgages suffered losses
–  A bank in the UK faced a bank run in 2007
–  In March, 2008, JP Morgan Chase bought Bear Stearns due to its inability to
fund itself in the money markets
–  Fannie Mae and Freddie Mac were taken over by the government
–  In September, 2008 Lehman Brothers declared bankruptcy
–  Money markets froze and a flight to quality ensued
 How I learned to stop worrying and love the GFC

•  Ramifica'ons of the crisis
–  Many debates of who was responsible
–  Correc'on of global imbalances?
•  U.S. trade deficit
•  China trade surplus
–  Regulatory issues
•  Central banks pumped money into banks
•  Expansionary monetary and fiscal policies
•  Policy implica'ons of “too big to fail”
 Mul'na'onal Corpora'ons

•  A parent company in the firm’s origina'ng country and opera'ng

subsidiaries, branches and affiliates abroad
–  UN calls these “transna'onal corpora'ons”
•  How they enter foreign markets
–  Expor'ng/Impor'ng
–  Licensing – gives local firms right to manufacture their products in
exchange for a fee
–  Franchising – the firm provides sales or service strategies in exchange
for fees
–  Joint venture – two or more firms form a new legal en'ty, jointly
owned by all of the firms
–  Greenfield – star'ng company from scratch
 Goals of a Mul'na'onal Corpora'on

•  Maximize shareholder wealth?

–  Australia, Canada, U.K. and U.S.
–  Appropriate 'me horizon is long
•  Maximize stakeholder wealth?
–  Europe and Asia
•  How do owners and stakeholders make sure this
happens?
–  Agency Theory – studies problems that arise from the separa'on of ownership
and control
•  Corporate governance
–  legal/financial structure controlling the principal-agent rela'onship
•  Corporate fraud
–  Enron
–  Worldcom
–  Tyco
–  Parmalat
Methods of Overcoming Agency Problems Due to the Separa'on of
Ownership and Control
 Another way of entering foreign markets

•  Foreign Direct Investment (FDI)

–  When a company from one country buys at least 10% of a company in another
country
–  Has grown 30-fold since 1980 to $18 trillion
–  M&A play a huge role in this trend

FDI as a % of GDP
 Other Important Interna'onal Players

•  Interna'onal banks
–  We’ll talk about these a lot over the course of the semester
•  Interna'onal ins'tu'ons
–  Interna'onal Monetary Fund (IMF)
•  Goal: ensure the stability of the interna'onal monetary and financial system
•  Through surveillance and technical assistance
–  The World Bank
•  Goals: Development, poverty allevia'on and advising
–  Mul'lateral development banks
•  Regional development banks (including World Bank and regional banks in Africa,
Asia and Europe)
•  Provide financing and grants
 Other Important Interna'onal Players

•  Interna'onal ins'tu'ons (con'nued)
–  World Trade organiza'on (WTO)
•  Mediates trade disputes
–  Organiza'on for Economic Coopera'on and Development (OECD)
•  Examines, devised and coordinates policies across 34 rela'vely wealthy na'ons
•  Goal: foster sustainable economic growth and employment, rising standards of
living and financial stability
–  Bank for Interna'onal Se<lements (BIS)
•  Fosters interna'onal monetary and financial coopera'on
•  Think of it as the central bank of central banks
 Other Important Interna'onal Players

•  Interna'onal ins'tu'ons (s'll con'nued)
–  European Union (EU)
•  Coopera'on among countries in this region
•  (In most cases) Adopt the same currency to promise interna'onal business and
prevent war
•  Economic and monetary union (EMU)
–  Governments
–  Individual investors
–  Ins'tu'onal investors
–  Sovereign wealth funds – government-run investment pools
–  Hedge funds
–  Private equity funds
 Is Globaliza'on Worth It?

•  Rise of protec'onism, slowing trade liberaliza'on
–  Increasing tariffs and trade li'ga'on/technical barriers
–  Why might it be poli'cally beneficial to reduce openness?

•  Countries who had opened their markets to foreigners subsequently

fell into crisis
 Is Globaliza'on Worth It?

•  Benefits of openness
–  Channels savings to most produc've uses
–  Sharing of risk beyond what is possible domes'cally
–  Domes'c recessions can be buffered through borrowing
–  Cost of capital decreases

•  Costs of openness
–  Some'mes capital is not used wisely
–  Foreign capital can leave quickly causing financial vola'lity
–  Difficulty in taxing profits – MNCs shiS to avoid
–  Capital control effec'veness decreases
 An'-Globalists

•  Iden'fies MNCs as “villains” of globaliza'on

•  Cri'cize global financial ins'tu'ons such as the World Bank,

IMF and WTO

•  They fear that MNC ac'vi'es will harm the environment

•  They argue that globaliza'on is seen as a threat to

employment in their own country
 Final Thoughts on Globaliza'on

•  Can be valuable
•  Some evidence that workers in developed countries have not
benefited
–  Globaliza'on destroys some jobs and creates others
•  “Crea've destruc'on”

•  Some believe that government must intervene to be<er
spread the newly created wealth
–  Helping those that have been displaced by globaliza'on
•  Retraining, subsidies
Foreign Exchange Market

Chapter 2
 The Structure of the Foreign Exchange Market

Most important cities:

London
New York
Tokyo

ForEx (or FX)

operates 24 hrs/day

Interbank market – 50%

Most trades are $1M

or more!

Largest financial market in the

world
-  $5.5 trillion a day
-  Compared to less than $50
billion on NYSE
 Types of Contracts Traded on the Forex Market

•  Spot contracts
–  Today

•  Future transac'ons
–  Swaps and forward contracts
–  Next week (Ch. 3)

•  Deriva'ves
–  Futures and op'ons
–  End of semester (Ch. 20)
 Foreign Exchange Dealers and Brokers

•  Foreign exchange dealers

–  Who are they?
•  Commercial banks
•  Investment banks

–  Dealers are “market makers”

•  they make it easier for buyers and sellers to come together

•  Brokerage firms
–  Intermediaries, not market makers – they don’t put own money at risk
•  Liquidity
–  Ease with which one can sell an asset AT ITS FAIR VALUE
–  Highly liquid assets have low transac'on costs

•  Other par'cipants in the forex market

–  Central banks
–  Mul'na'onal corpora'ons
 Why is Forex a Compe''ve Market?

•  No product differen'a'on
–  Why is that important?

•  Has been a lot of players

–  Top 4 account for over 40%
–  Top 20 over 90%

•  No signs of any clear leader in this market

 The Exchange Rate

•  Exchange rate – price of one currency in terms

of another
•  JPY107.10 = USD1
•  ¥107.10 = $1
•  ¥107.10/$1 or ¥107.10/$ (the number one is implied)
•  Note, this is the way we’re discussing it in the textbook, in
prac'ce you may see $/¥ 107.10 (I know, confusing).
•  AUD = A$ ≠ $ = USD
•  h<p://www.oanda.com/
•  h<p://www.xe.com/
 Exchange Rate Quotes
•  Direct – quo'ng domes'c currency first (in the numerator)
•  In US: $1.39/£1

•  Indirect – quo'ng foreign currency first (in the numerator)

•  In US: £0.72/$1

•  Indirect = 1/Direct
•  American - $ is in the numerator
•  European - £ is in the numerator
Currencies and Currency Symbols
 Rules to Remember
1.  Keep track of your currency units
–  Following the advice of your
lecturer, you decide to legally
download some amazing music.
You buy
•  “Where is My Mind?” by the Pixies
•  O's Redding’s “Try a Li<le
Tenderness”
•  “Tyler” by The Toadies
•  “Kiss off” by the Violent Femmes
•  For A$2.19/song for a grand total of
A$8.76
•  If today’s exchange rate is $0.77/A$,
what is the total price of these songs
in US dollars (in Australia)?
–  $0.77/A$ x A$8.76 = $6.75
–  How much would it cost you to buy
these from the US iTunes?
•  $1.29 x 4 = $5.16
•  Why the difference?
 Rules to Remember

2.  Think of buying or selling the asset in the

denominator
–  For real goods, this is easy: A can of Solo can be
quoted as A$2/can, we typically don’t quote
Australian dollars in terms of Solos: 0.5 cans/A$
–  For currency, its harder since both are currencies
(again this is how the text treats it):
•  A$/$ : How many Australian Dollars will it cost to buy a US
dollar (or how many Aussie Dollars will I get if I sell a US
Dollar)?
•  $/A$: How many US Dollars will it cost to buy an Australian
Dollar?
 Vehicle Currencies and Cross-Rates

•  Vehicle currency – a currency that is actively used in many

international financial transactions around the world
•  Used due to transaction costs of making markets in certain
currencies being too high
•  U.S. Dollar primary vehicle currency (89% of all transactions)
•  Cross-rates
•  Trading currency in the New York market where both
currencies are not expressed in U.S. dollars
•  Trend toward cross-rate transactions
What A Cross Rate Table Looks Like
 Cross Exchange Example
•  An exchange rate between two countries, computed
from the exchange rates between each of these
countries and a third country

•  If you know the exchange rate between Australian

dollar and US dollar, and also the exchange rate
between Bri'sh pound and Australian dollar, what
should be the exchange rate between US dollar and
Bri'sh pound?
–  Cross exchange rate

 Cross Exchange Example
•  The current spot exchange rate between ¥ and $ is
¥6.878/$ and the spot rate between the $ and A$ is
$0.767/A$.
•  Calculate the ¥/A$
spot exchange rate.
–  ¥/A$ = (¥/$) * $/A$
–  ¥/A$ = 6.878 * 0.767
–  ¥/A$ = ¥5.275/A$
 Equilibrium

•  Cross Exchange Rate Equilibrium:

¥/A$ = ¥/$ * $/A$ or ¥/$ * $/A$ * A$/¥ = 1

•  Triangular arbitrage
•  An arbitrage process involving three currencies
•  Keeps cross-rates in line with exchange rates quoted
rela've to a third currency (such as the Australian
Dollar or Chinese Yuan)

 Triangular Arbitrage
•  How Does it Work?
–  If ¥/$ * $/A$ * A$/¥ < 1 then either ¥/$, $/A$, or
A$/¥ must rise. The currency in denominator is
too low rela've to the currency in the numerator
•  Buy each currency in the denominator with currency in
numerator
–  If ¥/$ * $/A$ * A$/¥ > 1 then either ¥/$, $/A$, or
A$/¥ must fall. The currency in denominator is
too high rela've to the currency in the numerator
•  Sell each currency in the denominator with the
currency in the numerator
 Triangular Arbitrage Example
•  Let’s say you find the following exchange rates:
–  ZAR11.5/$
–  ¥9/ZAR
–  $0.01/¥

•  ZAR/$ * ¥/ZAR * $/¥ = 1.035 > 1

–  Sell $1 for 11.5 rands
–  Sell 11.5 rands for 103.5 yen
–  Sell 103.5 yen for $1.035

•  Profit = $1.035 - $1 = 3.5 cents

–  or 3.5% of the ini'al amount
 Bid-Ask Spreads and Bank Profits

•  Bid-ask spreads
•  Bid – rate at which banks will
buy the base currency
•  Ask – rate at which banks will
sell base currency
•  What banks make on FX
transac'ons
•  100 * (Ask-bid)/ask

 Magnitude of bid-ask spreads

•  Interbank market
–  Within 5 pips (fourth decimal point in a currency quote)
–  0.05% - 0.07% for major currencies
–  Lower for extremely liquid currencies like U.S. dollar (i.e., 0.03%
for $/€ exchange rate quote)
–  Higher for less liquid currencies
•  Physical exchange
–  3% or more
•  Banks have to have inventory, which means it is not interest bearing
•  Banks must transact with brokers
–  Use credit cards or prepaid cards to exchange when in another
country
•  Differs across the day
 Bid-Ask Spread Example
•  Sell the Australian Dollars back for Yuan:
•  The bid rate is ¥5.00/A$, the ask rate is ¥5.60/A$
and the percentage spread is:
•  [(¥5.60/A$) – (¥5.00/A$ )]/(¥5.60/A$ ) = 10.71%
•  You bought A$5 million at ¥5.60/A$, the cost
would have been: A$5 million * (¥5.60/A$) = ¥28
mil.
•  Selling back: A$5 million * (¥5.00/A$ ) = ¥25 mil.,
or a loss of ¥3 million on the two transac'ons:
10.71% of ¥28 million.
 Communica'on Systems
•  Thankfully, given electronic communica'on systems, currency trades no longer need
to be made in person in dark alleys

•  Society of Worldwide Interbank Financial Telecommunica'ons (SWIFT) – links more

than 7500 banks in 200 countries
•  Others include:
•  CHIPS – clearing house in U.S. for dollars
•  Fedwire – links computers of more than 7500 ins'tu'ons that have deposits with the U.S. Federal
Reserve
•  TARGET – Euro counterpart to Fedwire
 Cross-currency se<lement (Hersta<) risk
•  The risk that a financial ins'tu'on may not deliver the
currency on one side of a completed transac'on
•  How this risk is addressed
–  Bank of Interna'onal Se<lements (BIS)
encourages the voluntary restric'on of
transac'on amounts to limit this form of risk
–  Simultaneity of both transac'ons – Con'nuous
Linked Se<lement acts as a global clearing house
–  Ne€ng arrangements
Ne€ng Arrangements
Ne€ng Arrangements (cont.)
 Describing Changes in Exchange Rates

•  Appreciate/depreciate – the value of a currency increases/
decreases in terms of another
•  Devalue/Revalue – the value of a currency is changed by
the domes'c government
•  Rate: (new – old)/old
–  Is referring to the currency in the denominator of the exchange
rate (for $/£ - we’re talking about £)
–  Rate will not necessarily be the same if you calculate the rate for
the £ and the rate for the $ due to perspec've (i.e., the
denominators are different)
 Homework
•  Chapter 1, Ques'ons 1, 5, 6, 11
•  Chapter 2, Ques'ons 3, 10
•  Chapter 2, Problems 1-6
–  Your tutor will check to see if you a<empted these
in your tutorial
–  You will also work on two (modified past exam)
problems as groups in tutorials

•  Read Chapters 3 & 5