IFI REVISION

Lecturer: Dao Mai Huong

Outlines

 PART I: Global financial environment

 Chapter 1: Global financial environment
 Chapter 2: International monetary system
 Chapter 3: Balance of payment
 PART II: Foreign exchange markets and theories
 Chapter 5: Foreign exchange markets
 Chapter 6: International parity conditions
 Chapter 7,8: Foreign Currency derivatives
Outlines
 PART III: Foreign exchange exposure
 Chapter 9: Exchange rate determination
 Chapter 10: Transaction exposure
 Chapter 12: Operating exposure
 PART IV: Financing the global firm
 Chapter 13: Global cost and availability of capital
 Chapter 14: Raising debt and equity globally
PART I: Global financial environment

 Chapter 1: Global financial environment

 Theory of comparative advantages
 Market imperfection: rationale for the existence of MNE
 Chapter 2: International monetary system
 IMF classifications of exchange rate regimes
 The choice of fixed vs. flexible exchange rates
 The impossible trinity
PART I: Global financial environment

 Chapter 3: Balance of payments

 Components of BOP: identify and distinguish different
components, debit vs. credit
 BOP interactions with other economic variables: exchange rate,
interest rate, GDP
PART II: Foreign exchange markets and
theories
 Chapter 5: Foreign exchange markets
 FOREX functions
 FOREX market participants: 5 participants
 FOREX transactions: spot vs. forward vs. swap
 FOREX rates and quotations:
 American vs. European
 Direct vs Indirect: (Home vs. foreign currency?)
 Bid vs. Ask quote
 Spot vs. forward: forward premium (point vs. %)
 Cross rate

 Locational vs. Triangular arbitrage activity

Chapter 6: Foreign exchange markets

Example: Suppose you observe the following exchange rates: €1 = $.85;

£1 = $1.60; and €2.00 = £1.00. Starting with $1,000,000, how can you
make money?
A) Start with $1m, exchange for €850,000 at €1 = $.85; exchange for
£1,700,000 at €2.00 = £1.00; exchange for dollars at £1 = $1.60.
B) Start with €1m; exchange for £500,000 at €2.00 = £1.00; exchange for
$800,000 at £1 = $1.60; exchange for euros.
C) Exchange $1m for £625,000 at £1 = $1.60; exchange for €1,250,000 at
€2 = £1.00; exchange for $1,062,500 at €1 = $.85.
D) Not enough information to determine
PART II: Foreign exchange markets and
theories

 Chapter 6: International parity conditions

 Law of one price and purchasing power parity PPP (absolute vs relative)
 Fisher effect vs International Fisher Effect (IFE)
 Interest rate Parity (IRP); Covered interest arbitrage (CIA)
(1+id) = S/F*(1+if) (with indirect quotation)
OR:
Chapter 6: International parity conditions
Chapter 6: International parity
conditions
Example: Casper Landsten is a foreign exchange trader for a bank in New
York. He has $1million (or its Swiss franc equivalent) for a short-term money
market investment and wonders if he should invest in U.S. dollars for three
months, or make a CIA investment in the Swiss franc. He faces the following
quotes:
Arbitrage funds available $1,000,000
Spot exchange rate (SFr/$) 1.2810
3-month forward rate (SFr/$) 1.2740
U.S. dollar 3-month interest rate 4.800% p.a
Swiss franc 3-month interest rate 3.200% p.a
Does the interest rate parity hold? Is there any arbitrage opportunity for
Casper? If yes, what is the strategy and profit?
PART II: Foreign exchange markets and
theories
 Chapter 7&8: Foreign Currency derivatives
 Foreign currency futures vs. Forward
 Major features: long vs. short, closing out position, margin,…
 Differentiate futures and forward
 Calculate value of futures/forward contract
 Foreign currency option:
 Major features: call, put, strike price, OTM, ATM,…
 Distinguish call vs put, long vs short: when to use what
 Calculate profit and draw profit-and-loss diagram
 Chapter 7&8: Foreign Currency
derivatives
Example: Mary Jane works as a currency speculator for Bank of America,
San Francisco. Her latest speculative position is to profit from her
expectation that the U.S. dollar will rise significantly against the Japanese
yen. The current spot rate is ¥120.00/$. She must choose between the
following 90-day options on the Japanese yen:
Option Strike Price Premium
Put on yen ¥125/$ $0.00003/¥
Call on yen ¥125/$ $0.00046/¥
a. Should Mary buy a put on yen or a call on yen?
b. What is Marys’ breakeven price on the option purchased in part (a)?

c. What is her gross profit and net profit (including premium) if the spot
rate at the end of 90 days is ¥140/$? Draw the profit-and-loss diagram for
her position.
PART III: Foreign exchange exposure

 Chapter 10: Transaction exposure

 Distinguish transaction exposure vs. operating exposure
 Problems: hedging exchange rate risk of A/R or A/P denominated
in foreign currency using
 Money market hedge
 Forward/futures hedge
 Option hedge
→ Rules:
Chapter 10: Transaction exposure
 Bobcat Company, U.S.-based manufacturer of industrial equipment, just
purchased a Korean company that produces plastic nuts and bolts for heavy
equipment. The purchase price was Won7,500 million. Won1,000 million
has already been paid, and the remaining Won6,500 million is due in six
months. The current spot rate is Won1,110/$, and the 6-month forward
rate is Won1,175/$. The six-month Korean won interest rate is 16% per
annum, the six-month US dollar rate is 4% per annum. Bobcat can invest at
these interest rates, or borrow at 2% per annum above those rates. A six-
month call option on won with a 1200/$ strike rate has a 3.0% premium,
while the six-month put option at the same strike rate has a 2.4%
premium.
 Bobcat can invest at the rates given above, or borrow at 2% per annum
above those rates. Bobcat's weighted average cost of capital is 10%.
Compare alternate ways that Bobcat might deal with its foreign exchange
exposure. What do you recommend and why?
 Chapter 10: Transaction exposure
Purchase price of Korean manufacturer, in
Korean won 7,500,000,000

Less initial payment, in Korean won (1,000,000,000)

Net settlement needed, in Korean won, in six
months 6,500,000,000

Current spot rate (Won/$) 1,110

Six month forward rate (Won/$) 1,175

Bobcat's cost of capital (WACC) 10.00%
Options on Korean won: Call Option Put Option

Strike price, won 1,200.00 1,200.00

Option premium (percent) 3.000% 2.400%
United States Korea
Six-month investment (not borrowing) interest
rate (per annum) 4.000% 16.000%
Six-month borrowing rate (per annum) 6.000% 18.000%
PART III: Foreign exchange exposure

 Chapter 12: Operating exposure

 Measuring operating exposure: scenario analysis
 Strategic management of operating exposure
 Diversifying Operation
 Diversifying Financing
 Proactive management strategies/policies:
 Matching currency cash flows
 Risk-sharing agreements
 Back-to-back or parallel loans
 Currency swaps
Chapter 12: Operating exposure

 Hurte-Paroxysm Products, Inc. (HP) of the United States exports computer

printers to Brazil, whose currency, the reais (symbol R$) has been trading at
R$3.40/US$. Exports to Brazil are currently 50,000 printers per year at the
reais equivalent of $200 each. A strong rumor exists that the reais will be
devalued to R$4.00/$ within two weeks by the Brazilian government. Should
the devaluation take place, the reais is expected to remain unchanged for
another decade. Accepting this forecast as given, HP Products faces a pricing
decision which must be made before any actual devaluation: HP Products may
either (1) maintain the same reais price and in effect sell for fewer dollars, in
which case Brazilian volume will not change, or (2) maintain the same dollar
price, raise the reais price in Brazil to compensate for the devaluation, and
experience a 20% drop in volume. Direct costs in the U.S. are 60% of the U.S.
sales price. What would be the short-run (one-year) implication of each
pricing strategy? Which do you recommend?
Chapter 12: Operating exposure
DeMagistris Fashion Company, based in New York City, imports leather coats from
Acuña Leather Goods, a reliable and longtime supplier, based in Buenos Aires,
Argentina. Payment is in Argentine pesos. When the peso lost its parity with the U.S.
dollar in January 2002 it collapsed in value to Ps 4.0/$ by October 2002. The outlook
was for a further decline in the peso’s value. Since both DeMagistris and Acuña
wanted to continue their longtime relationship they agreed on a risk-sharing
arrangement. As long as the spot rate on the date of an invoice is between Ps3.5/$
and Ps4.5/$ DeMagistris will pay based on the spot rate. If the exchange rate falls
outside this range they will share the difference equally with Acuña Leather Goods.
The risk-sharing agreement will last for six months, at which time the exchange rate
limits will be reevaluated. DeMagistris contracts to import leather coats from Acuña
for Ps8,000,000 or $2,000,000 at the current spot rate of Ps4.0/$ during the next six
months.
a. If the exchange rate changes immediately to Ps6.00/$, what will be the dollar cost
of 6 months of imports to DeMagistris?
b. At Ps6.00/$, what will be the peso export sales in Acuña Leather Goods to
DeMagistris Fashion Company?
PART IV: Financing the global firm

 Chapter 13: Global cost and availability of capital

 Market liquidity and segmentation and their effect on cost of
capital: MCC comparisons
 WACC calculation: cost of debt, cost of equity (CAPM, ICAPM)
PART IV: Financing the global firm

 Chapter 14: Raising debt and equity globally

 Strategies: roles of investment bankers
 Raising equity globally: alternative instruments
 IPO
 Euroequity
 Directed public issue
 Private placement
 Raising debt globally: alternative instruments
 Bank loans and syndications
 Euronote market
 International bond market
PART V: International portfolio
management
 Chapter 16:
 International diversification and risks
 Internationalizing domestic portfolios
 Efficient frontier, Optimal domestic portfolio, Optimal international
portfolio
 Calculation of expected return and risk of 2-asset portfolio
 Market Performance Adjusted for Risk: The Sharpe and Treynor
Performance Measures
Final exam

 Format (to be revised):

 20 MCQs = 40 points
 Coverage: Chapter 3, 6, 7, 8, 10, 12, 13, 14
 4 short-answer questions = 20 points
 Coverage: Chapter 6, 7, 8, 10, 12, 13, 14
 2 problems = 40 points
 Coverage: Chapter 6, 7, 8, 10, 12, 13

 Time: 2 hours
 Formula sheet: provided
 Remember to bring with you pen, pencil, eraser and
calculator.
GOOD LUCK WITH YOUR EXAM!