FINM 58

Global Finance with Electronic Banking

CHAPTER I

MULTINATIONAL FINANCIAL MANAGEMENT: OPPORTUNITIES AND

CHALLENGES

Multinational Enterprise (MNES)

Firms both for-profit companies and not-for-profit organizations that have
operations in more than one country and conduct their business through branches,
foreign subsidiaries, or joint ventures with host country firms.

FINANCIAL GLOBALIZATION AND RISK

The International Monetary system

An economic mix of floating and managed fixed exchange rates are under
constant scrutiny.

Legal Fiscal Deficits

Including the current eurozone crisis, plague most of the major trading currencies
of the world, complicating fiscal and monetary policies, ultimately, interest rates and
exchange rates.

Balance of payments
In some cases, dangerously large deficits and surpluses, whether it be the twin
surpluses enjoyed by China, the current account surplus of Germany amidst a sea of
eurozone deficits, or the continuing account deficit of the USA, all will inevitably move
exchange rates.

Ownership, control, and governance

The publicly-traded company is not the dominant global business organization
and goals and measures of the performance vary drastically between these business
models.

Global Capital markets

Normally provide the means to lower a firm’s cost of capital, and even more
critically, increase the availability of capital, have in many ways shrunk in size, and have
become less open and accessible to many of the world’s organizations.

Emerging markets confronted with a new dilemma

 The problem of first being the recipient of capital inflows, and then of
experiencing rapid and massive capital outflows. Financial globalization has resulted in
ebb and flow of capital into out of both industrial and emerging markets, greatly
complicating financial management.

The Global Financial Market Place

Business involves the interaction of individuals and individual organizations for
the exchange of products, services and capital through markets. The global capital
markets are critical for the conduct of this exchange.

Assets
Are the debt of securities issued by the governments. These low-risk or risk free
assets form the foundation for the creation , trading, and pricing of other financial assets
like bank loans, corporate bonds and equities.

Institutions
Are the central banks, which create and control each country’s money supply; the
commercial banks, which take deposits and extend loans to businesses, both local and
global; and the multitude of other financial institutions created to trade securities and
derivatives.

Linkages
Are the interbank networks using currency? The ready exchange of currencies in
the global marketplace is the first and foremost necessary element for the conduct of
financial trading, and the global currency markets are the largest in the world.

The Market For Currencies

The prices of any one country’s currency in terms of another country’s currency
is called a foreign currency exchange.

EUROCURRENCY AND INTEREST RATES

Eurocurrencies
Are domestic currencies of one country on deposit in a second country for a
period ranging from overnight to more than a year or longer. A Eurodollar deposit is not
a demand deposit.

Eurobank
 Is a financial intermediary that simultaneously bids for time deposits and makes
loans in a currency other than that of its home currency.

Eurocurrency Interest Rates

The reference rate of interest in the eurocurrency market is the London Interbank
Offered Rate or LIBOR. LIBOR is the most widely accepted rate of interest used in
standardized quotations, loan agreements, or financial derivatives valuations.

The Theory of Comparative Advantage

Provides a basis from explaining and justifying international trade in a model
world assumed to enjoy free trade, perfect competition, no uncertainty, costless
information and no government interference.

What is the difference about international and financial management?

Concept International Domestic

Culture,History, and Each Foreign Country is Each country has a known

Institution unique and not always base case
understood by MNE
management

Corporate governance Foreign countries’ Regulations and

regulations and institutional institutions are well known
practices are all uniquely
different

Foreign exchange risk MNEs face foreign
exchange risk due to their
subsidiaries, as well as
import/ export and foreign
competitors.
Foreign exchange risk from
import/export and foreign
competition( no
subsidiaries)

Political risk MNEs face political risk Negligible political risks

because of their foreign
subsidiaries and high
profile

Modification of domestic MNEs must modify finance Traditional financial theory

finance theories theories like capital applies
budgeting and the cost of
capital because of foreign
complexities

Modification of domestic MNEs utilize modified Limited use od financial

financial instruments financial instruments such instruments and
as options, derivatives because of few
forwards,swaps, abd foreign exchange and
letters of credit political risks

Why do firms become multinational?

- Market seekers
Produce foreign markets either to satisfy local demand or to export to markets
other than their home market.

- Raw material seekers

Extract raw materials wherever they can be found, either for export or
for further processing and sale in the country in which they found the host country.

- Product efficiency
Produce in countries where one or more of the factors of production are
underpriced relative to their productivity.

- Knowledge seekers
Operate in foreign countries to gain access to technology or managerial
expertise.

- Political safety seekers

Acquire or establish new operations in countries that are considered unlikely to
expropriate or interfere with private enterprise.

Chapter II
 INTERNATIONAL MONETARY SYSTEM

International Monetary System

A system that determines exchange rates.

Introduction

Floating exchange rate system

Exists in countries where the foreign exchange market determines the relative
value of a currency.

Pegged exchange rate system

Exists when the value of a currency is fixed to a reference country and then the
exchange rate between that currency and other currencies is
determined by the reference currency exchange rate.

Managed and Dirty float

Exists when the value of a currency is determined by market forces, but with
central bank intervention if it depreciates too rapidly against an important reference
currency.

Brief history of international monetary system

The Gold Standard, 1876-1913, gold has served as a medium of exchange and a store
of value. One country after another set a par value for its currency in terms of gold and
then tried to adhere to the so called “rules of the game”. Later came to be known as the
“classical gold standard”.

•The Interwar Years and World War II, 1914-1944

•During this period, currencies were allowed to fluctuate over a fairly wide range
in terms of gold and each other.
•Increasing fluctuations in currency values became realized as speculators sold
short weak currencies.
•During WWII and its disordered aftermath the US dollar was the only major
trading currency that continued to be convertible .
• Bretton Woods and the International Monetary Fund, 1944. A new international
monetary system was designed in 1944 in Bretton Woods, New Hampshire.
•The goal was to build an enduring economic order that would facilitate postwar
economic growth.
 •The Bretton Woods Agreement established two multinational institutions.
•International Monetary Fund (IMF) to maintain order in the international
monetary system.
•World Bank or IBRD (International Bank for Reconstruction and Development) to
promote general economic development.
•Under the Bretton Woods Agreement
•The US dollar was the only currency to be convertible to gold, and other
currencies would set their exchange rates relative to the dollar.
•Devaluations were not to be used for competitive purposes
•A country could not devalue its currency by more than 10% without IMF
approval.
•The collapse of the Fixed Exchange Rates System, 1945 – 1973. The Bretton Woods
system relied on an economically well managed U.S.
•So, when the U.S. began to print money, run high trade deficits, and experience
high inflation, the system was strained to the breaking points.
•The Bretton Woods Agreement collapsed in 1973.
•The Floating Era, 1973-1997. exchange rates have become more volatile and less
predictable because of
•The oil crisis in 1971, the loss of confidence in the dollar after U.S. inflation
jumped between 1977 and 1978, the oil crisis of 1979, the rise in the dollar
between 1980 and 1985, the partial collapse of the European Monetary System
in 1992, the 1997 Asian currency crisis and the decline in the dollar in the mid to
late 2000s.
•A floating exchange rate system provides two attractive features; 1) monetary
policy autonomy & 2) automatic trade balance adjustments.
-• A fixed exchange rate system is attractive because: 1) of the monetary discipline it
imposes, 2) it limits speculation, 3) it limits uncertainty and 4) of the lack of connection
between the trade balance and exchange rates.
• The Emerging Era, 1997-Present. The period following the Asian Crisis of 1997 has
seen the growth in both breadth and depth of emerging market economies and
currencies. We may end up being proven wrong on this count, the final section of this
chapter argues that the global monetary system has already begun embracing a
number of major emerging market currencies, beginning with the Chinese renminbi.

IMP CLASSIFICATION OF CURRENCY REGIMES

The global monetary system is an eclectic combination of exchange rate regimes
and arrangements.

IMP EXCHANGE RATE CLASSIFICATION

Category 1: Hard Pegs

 These countries have given up their own sovereignty over monetary policy. This
category includes countries that have adopted other countries’ currencies and countries
utilizing currency board structure that limits monetary expansion to the accumulation of
foreign exchange.
Category 2: Soft Pegs
The general category is colloquially referred to as fixed exchange rates.The five
subcategories of soft peg regimes are differentiated on the
basis of that the currency is fixed to, whether that fix is allowed to change – and if so
under what conditions, what types, magnitudes, and frequencies of intervention are
allowed/used, and the degree of variance about the fixed rate.

Category 3: Floating Arrangements

Currencies that are predominantly market-driven are further subdivided into three
floating with values determined by open market forces without governmental influence
or intervention, and simple floating or floating with intervention, where government
occasionally does intervene in the market in pursuit of some rate goals or objectives.

Category 4: Residual
As one would suspect, this category includes all exchange rate arrangements
that do not meet the criteria of the previous three categories. Country systems
demonstrating frequent shifts in policy typically make up the bulk of this category.

FIXED VERSUS FLEXIBLE EXCHANGE RATES

A nation’s choice as to which currency regime to follow reflects national priorities
about all facets of the economy.

•Fixed rates provide stability in international prices for the conduct of trade. Stable
prices aid in the growth of international trade and lessen risks for all businesses.
•Fixed exchange rates are inherently anti-inflationary, requiring the country to follow
restrictive monetary and fiscal policies. This restrictiveness, however, can often be a
burden to a country wishing to pursue policies to alleviate internal economic problems
such as high unemployment or slow economic growth.
•The terminology associated with changes in currency values is also technically specific.
When a government officially declares its own currency to be worth less or more relative
to other currencies, it is termed as devaluation or revaluation respectively.
• When a currency’s value is changed in the open currency market, it is called a
deprecation (fall in value) or appreciation (with an increase in value)
THE IMPOSSIBLE TRINITY
Also referred to as the trilemma of international finance because the forces of
economics do not allow a country to simultaneously achieve all three goals: monetary
independence , exchange rate stability and full financial integration.
Exchange rate stability
The value of the currency is fixed in relationship to other major currencies, so
traders and investors could be relatively certain of the foreign exchange value of each
currency in the present and into the near future.

Full financial integration

Complete freedom of monetary flows would be allowed, so traders and investors
could easily move funds from one country and currency to another in response to
perceived economic opportunities or risks.

Monetary independence
Domestic monetary and interest rate policies would be set by each individual
country to pursue desired national economic policies, especially as they might relate to
limiting inflation, combating recessions, and fostering prosperity and full employment.

A SINGLE CURRENCY FOR EUROPE: THE EURO

A core set of European countries worked steadily towards integrating their
individual countries into one large, more efficient, domestic market.

•The original 15 members of the EU were also members of the European Monetary
System (EMS).
•The Maastricht Treaty and Monetary Union, December 1991
•European Central Bank (ECB) - Is an independent central bank that dominates the
activities of the individual countries’ central banks.
•The euro would generate a number of benefits for the participating states (1) Counties
within eurozone enjoy cheaper transaction costs, (2) Currency risks and costs related to
exchange rate uncertainty are reduced; and (3) All consumers and businesses both
inside and outside the eurozone enjoy price transparency and increased price-based
competition.

CURRENCY BOARDS
Exist when a country’s central bank commits to back its monetary base its money
supply entirely with foreign reserves at all times. It means that a unit of domestic
currency cannot be introduced into the economy without an additional unit to foreign
exchange reserves being obtained first. Eight countries utilize currency boards as a
means of fixing their exchange rates.

DOLLARIZATION
Is the use of the U.S dollar as the official currency of the country.
•A country that dollarizes removes any currency volatility (against the dollar) and would
theoretically eliminate the possibility of a future currency crisis.
•Additional benefits are expectations of greater economic integration with other dollar-
based markets, both product and financial. Several countries that are highly
economically integrated may benefit significantly from dollarizing together.
•Three major arguments against dollarization. (1) The loss of sovereignty over monetary
policy, (2) The country loses the power of seigniorage, the ability to profit from its ability
to print its own money; and (3)the central bank of the country, because it is no longer
has the ability to create money within its economic and financial system, can no longer
serve the role of lender of last result. This role carries with it the ability to provide
liquidity to save financial institutions that may be on the brink of failure during times of
financial crisis.

GLOBALIZING THE CHINESE RENMINBI

Has been carefully controlled but allowed to gradually revalue against the dollar .
It is now quickly moving towards what most think is an inevitable role as a true
international currency.

Chapter III
THE BALANCE OF PAYMENTS
Definition
Measurement of all international economic transactions that take place between the
residents of a country and foreign residents.

FUNDAMENTALS OF BOP ACCOUNTING

I. BOP Statement - statement of cash flows over an interval of time; with a
corporate income statement, but on a cash basis.
II. BOP Debit - inflow of foreign exchange to the country.
III. BOP Credit - outflow of foreign exchange.

BOP has 3 major sub-accounts:

● Current account - includes all international economic transactions with income or
payment flows occurring within the year, the current period. Moreover, there are
four subcategories of current account which are:

1. Goods trade - it is the export and import of goods.

2. Services trade - the export and import of services.
 3. Income - associated with investments made in previous periods.
4. Current transfers - a financial settlement associated with the change in
ownership of real resources or financial items.
● Capital account & *Financial account - made up of transfers of financial assets
and the acquisition and disposal of non produced/non financial assets.
Financial account has four components:
1. Direct Investment - an investment that has a long-term life or maturity and
which the investor exerts some explicit degree of control over the assets.
2. Portfolio investment - both short-term in maturity and an investment.
Investor has no control over the assets.
3. Net financial derivatives - an instrument whose value is derived from the
value of one or more underlying, which can be commodities, precious
metals, currency, bonds, stocks, stocks indices, etc. Four most common
examples of derivative instruments are Forwards, Futures, Options and
Swaps.
4. Other Asset Investment - final component of the financial account consists
of various short-term and long-term trade credits, cross border loans from
all types of financial institutions, currency deposits and bank deposits, and
other accounts receivable and payable related to cross-border trade.
Others:

● Official reserves account - total reserves held by official monetary authorities

within a country.
● Net errors and omissions account - Current and financial account entries are
collected and recorded separately, errors or statistical discrepancies will occur.
The net errors and omissions of the account ensures that the BOP actually
balances.

BOP IMPACTS ON KEY MACROECONOMICS RATES

1. Fixed Exchange Rate Countries - gov’t bears the responsibility to ensure that the
BOP is near zero.
2. Floating Exchange Rate Countries - gov’t of a country has no responsibility to
peg its foreign exchange rate.
3. Managed Floats - often seek to alter the market’s valuation of their currency by
influencing the motivations of market activity, rather than through direct
intervention in the foreign exchange markets.

Chapter IV
FINANCIAL GOALS AND CORPORATE GOVERNANCE
Types of Ownership

Business Ownership:
1. Business, Firm, Company, or Enterprise
a. Public Enterprise - owned by the gov’t or state.
A.1 owned by the state - can be operated for profit or non-for-profit.
A.2 publicly traded shares - both public and private enterprises may have
a portion of their ownership publicly traded. Public shares often represent less than 50%
ownership.
b. Private Enterprise - owned by a private individual or organization.
B.1 (A.2) publicly traded shares
B.2 Privately held - businesses may be owned in whole or in part by
families, and may be operated for profit or non-for-profit.

THE GOAL OF MANAGEMENT

● The Shareholder Wealth Maximization (SWM) Model
○ Anglo-American markets have a philosophy that a firm’s objective should
follow SWM.
○ The firm should strive to maximize the return to shareholders, as
measured by the sum of capital gains and dividends, for a given level of
risk. Alternatively, the firms should minimize the risk to shareholders for a
given rate of return.
■ Risk is defined as the added probability of varying returns that the
firm’s shares bring to a diversified portfolio.
• The Operational Risk is the risk associated with the business line
of the individual firm, which can be eliminated through portfolio
diversification by investors.
• The Unsystematic Risk is the risk of the individual security,
should not be a prime concern for management unless it increases
the possibility of bankruptcy.
• The Systematic Risk is the risk of the market in general, cannot
be eliminated through portfolio diversification and is risk that the
share price will be a function of the stock market
● Operational Goals
○ • It is one thing to state that the objective of leadership is to maximize
shareholder value, but it is another to actually do it.
○ Management is attempting to maximize current income, capital
appreciation or both.
 ○ The return to a shareholder in a publicly traded firm combines current
income in the form of dividends and capital gains from the appreciation of
share price: D2/P1 + P2-P1/P1

Public Versus Private Ownership

Organizational State-Owned Publicly Traded Privately Held
Characteristic

Entrepreneurial No NO; stick to core Yes, do anything the

competencies owners’ wish

Long-term / Short-term Long-term focus/ Short-term focus on Long-term focus

focus political cycles quarterly earnings

Focused on profitable No Yes; growth in No, needs defined by

growth earnings is critical owners earnings need

Adequately financed Country-specific Good access to Limited in the past but

capital and capital increasingly available
markets

Quality of leadership Highly variable Professional; hiring Highly variable; family-

from both inside run firms are lacking
and outside

Profits Earnings may Earnings to signal Earnings to support

constitute funding the equity markets owners and family
for gov’t

Leadership are owners Caretakes, NOT Minimal interests; Yes, ownership and
owners some have stock management often one
options and the same

Corporate Governance

Definition
The system of rules, practices, and processes by which an organization is directed and
controlled.

THE GOAL OF CORPORATE GOVERNANCE

 ● The objective of corporate governance is the optimization over time of the returns
to shareholders.
● Good governance should focus the attention of the board of directors of the
corporation on this objective by developing and implementing a strategy for the
corporation that ensures corporate growth wand equity value creation.
● It should ensure an effective relationship with stakeholders.

FIVE PRIMARY AREAS OF GOVERNANCE

1. Shareholder rights
- Are the owners of the firm, and their interests should take precedence
over other stakeholders.
2. Board Responsibilities
- The board of the company is recognized as the individual entity with final
full legal responsibility for the firm, including proper oversight of
management.
3. Equitable treatment to shareholders
- It is specifically targeted toward domestic versus foreign residents as
shareholders, as well as majority and minority interests.
4. Stakeholder rights
- Governance practices should formally acknowledge the interests of other
stakeholders – employees, creditors, community and government.
5. Transparency and disclosure
- Public and equitable reporting of firm operating and financial results and
parameters should be done in a timely manner, and should be made
available to all interests equitably.
 THE STRUCTURE OF CORPORATE GOVERNANCE

COMPARATIVE CORPORATE GOVERNANCE REGIME

THE GROWING CONSENSUS ON GOOD CORPORATE GOVERNANCE

POTENTIAL RESPONSES TO SHAREHOLDER DISSATISFACTION

 Chapter V

THE FOREIGN EXCHANGE MARKET

THE FOREIGN EXCHANGE MARKET

● Provides the physical and institutional structure through which the money of one
country is exchanged for that of another country.
● Foreign exchange means the money of a foreign country; that is, foreign
currency bank balances, bank notes, checks and drafts.
● Foreign exchange transactions is an agreement between a buyer and seller that
a fixed amount of one currency will be delivered for some other currency at a
specified rate.
● There are three functions of money:
(1) as a unit of account, (2) as a store of value and (3) as a medium of
exchange.
- The transfer of purchasing power is necessary because
international trade and capital transactions normally involve parties
living in countries with different national currencies.
- Because the movement of goods between countries takes time,
inventory in transit must be financed.
- The foreign exchange market provides “hedging” facilities for
transferring foreign exchange risk to someone else who is more
willing to carry risk.
● Many large international banks operate foreign exchange trading rooms in each
major geographic trading center in order to serve both their customers and
themselves (so-called proprietary trading) on a 24-hour-a-day basis.

GLOBAL CURRENCY TRADING

TRADING PLATFORM - TRADINGVIEW

– TRADING PLATFORM – MT4

MARKET PARTICIPANTS

● Two major groups of Market Participants

• Liquidity seekers – those trading currency for commercial purposes
• Profit seekers – those trading for profit
● Five broad categories of institutional market participants that operates in
the market
• Bank and non-bank foreign exchange dealers
• Individual and firms conducting commercial or investment transactions
• Speculators and Arbitragers
• Central banks and treasuries
• Foreign exchange brokers

SPOT TRANSACTIONS
Is the purchase of foreign exchange with delivery and payment between banks
taking place normally on the second following business days.

FOREIGN EXCHANGE TRANSACTIONS AND SETTLEMENT

FORWARD TRANSACTIONS
- Requires delivery at a future value date of a specified amount of one currency for
a specified amount of another currency.

SWAP TRANSACTIONS
- Is the simultaneous purchase and sale of foreign exchange for two different
value dates. Both purchase and sale are conducted with the same counterparty.
● Spot Against Forward. The dealer buys a currency in the spot market (at the
spot rate) and simultaneously sells the same amount back to the same bank in
the forward market (at the forward exchange rate).
● Forward-Forward Swaps. The difference between the buying price and selling
price is equivalent to the interest rate differential between the two currencies.
Thus, a swap can be viewed as a technique for borrowing another currency on a
fully collaterized basis.
● Nondeliverable Forwards (NDFs). Possess the same characteristics and
documentation requirement as traditional forward contracts, except they are
settled only in USD; the foreign being sold forward or brought forward is not
delivered.

FOREIGN EXCHANGE RATES AND QUOTATION

CURRENCY NICKNAMES