global finance -introduction a.ppt

7/23/2019 Global Finance -Introduction A.ppt

1/268

GLOBAL FINANCE:Introduction


2/268

PRIMARY GOAL OF A FIRM

Risk Reduce

Increase Profit

Maximize FirmValue (Stock Price)


3/268

FUNCTIONS OF FINANCIAL MANAGEMEN

TO MAXIMIZE STOCK PRICE

1. Financial Planning and Control Su!!orti"e #ools and

Re!orting $ Controlling

%. Financing

3. In"estment

Financing

(C&s. 11'1) In"estment(C&s. 1'1*)

Re!orting $

Controlling

(C&s. %+)

Su!!orti"e

#ools

(C&s. 1'1+)


4/268

MAJOR INTERNATIONAL

TRANSACTION

1. Foreign Investment: direct and portfolio

2. Foreign Trade: exports and imports

3. Foreign Loan


5/268

REASONS TO STUDY

INTERNATIONAL FINANCE

1.To understand a global economy in terms of:

a. Industrialization and grot! of t!e developing orld

b. Increased globalization.

2.To understand t!e effect of global finance on business

3.To ma"e intelligent personal decisions


6/268

COMPANY GOALS AND FUNCTIONS

OF FINANCIAL MANAGEMENT 1. To maximize stoc"!older ealt! #stoc" price$

al basis.

2. Functions of international financial manager:

a. Financial planning and control b. %llocation of funds #investment$ c. %c&uisition of funds #financing$


7/268

MULTINATIONALCOMPANIES AND

THEIR PERFORMANCE

M,Cs &a"e !erformed -etter t&an domestic

!erforms due to

a. ig&er risk'return tradeoff

-. Market im!erfections

c. Portfolio effect

d. Com!arati"e ad"antage

e. Internationalization ad"antages

f. /arger economies of scale

g. /arger "aluation.


8/268

AGENCY THEORY

1. M,C0s "alue is su-ect to larger agenc2cost.

%. 3genc2 t&eor2 is a t&eor2 t&at deals 4it&

t&e conflict of interest -et4een managersand stock&olders.

a. Incenti"es

-. Monitoring c. 3genc2 costs

d. 3genc2 costs are t&en com!ared


9/268

CORPORATE GOVERNANCE

1. '!are!older activism

2. (ecent c!anges in t!e )' corporategovernance

3. )' corporate governance


10/268

*+%,T-( 2

/TI0-' F/( /(L

T(%- %F/(-I4 I0-'T-T


11/268

/TI0-' F/( /(L T(%- % F/(-I4I0-'T-T

T(%- T+-/(I-' I0-'T-T T+-/(I-'

x. ,roduct Life *ycley. ,ortfolio T!eoryz. /ligopoly

u. *omparative %dvantagev. Factor -ndoment. ,roduct Life *ycle

-clectic T!eory


12/268

TRADE THEORIES

*ountries gain from trade by producingproducts t!ey !ave a comparative advantage.

*ountries gain from specializing in t!e

production and export of any good t!at useslarger amounts of t!eir on abundantfactors.

-xplain trade patterns on t!e basis of stagesin a product5s life.


13/268

INVESTMENT THEORIES

-xplain c!anges in t!e location of productionon t!e basis of states in a product5s life.

Improve its ris"6return performance by!olding an internationally diversifiedportfolio of assets.

Invest abroad to exploit t!eir &uasi6monopolyadvantages.


14/268

ECLECTIC THEORY

-xploit foreign mar"ets t!roug! exports firstand t!en invest abroad at some point in t!efuture.

Location specific advantages7 suc! asnatural resources and lo labor cost.

/ners!ip specific advantages7 suc! ascapital funds and tec!nology.

Internationalization advantages are locationand oners!ip advantages magnified byinternational investment.


15/268


16/268

PROTECTIONISM

(easons for protectionism include nationalsecurity7 unfair competition7 infant industry

argument7 domestic employment7 anddiversification.

Forms of protectionism are tariffs7 &uotas7and ot!er trade barriers.


17/268

ECONOMIC INTEGRATION

orld Trade /rganization #T/$ replaced4%TT on 8anuary 17 199.

a. ost favored nation clause: if a countrygrants a tariff reduction to one country7 itmust grant t!e same concession to all ot!erT/ countries.

b. To ;oin t!e T/7 countries must ad!ere tot!e most favored nation clause.


18/268


Trading blocs: Types of economic cooperation

a. Free trade area: no internal tariffs.

b. *ustoms union: no internal tariffs andcommon external tariffs.

c. *ommon mar"et: customs6union features< free flo of production factors.

d. -conomic union: common6mar"etfeatures it! !armonization of economicpolicy.

e. ,olitical union: economic6union features

it! political !armony


19/268


(egional economic agreements:

ort! %merican Free Trade %greement of t!e )'7*anada7 and exico on 8anuary 17 199=.

-uropean )nion of 1 countries began itsoperations it! a single *entral -uropean >an" on8anuary 17 1999. T!e -) accepted 1? nemembers on ary 17 2??=.

%sian integration efforts consist of t!e

%ssociation of 'out! -ast %sian ations #%'-%$7 T!e %sian ,acific -conomic *ooperation

#%,-*$7 and informal yen6trading bloc.


20/268

CHAPTER

THE BALANCE OF

PAYMENTS


21/268

ACCOUNTING TREATMENT

% country5s balance of payments is t!e record oftransactions beteen its residents and foreignresidents over a specified period.

T!e balance of payments is a sources6and6uses6

of6funds statement. Transactions t!at earn foreign exc!ange are

recorded as credit7 plus7 or cas! inflos#sources$7 suc! as exports of goods and services.

Transactions t!at expend foreign exc!ange arerecorded as debit7 minus7 and cas! outflos#uses$7 suc! as imports of goods and services.


22/268

Nu!"ric#$ E%#!&$"

ebits #/utflos$ *redits #Inflos$

-xample -xpend Foreign -xc!ange -arn Foreign-xc!ange

361a @3?7???361b @ 7???361c 2?7???361d 7???361e 1?7???(eserves 1?7???

Total @=?7??? @=?7???


23/268

DEFICIT OR SURPLUS

1. %utonomous transactions are t!ose t!at occurbecause of self6interests7 !ile compensatingtransactions are t!ose t!at occur to eliminate t!ebalance6of6payment imbalance.

2. 'urplus: autonomous receipts A autonomous

payments.3. eficit: autonomous receipts B autonomous

payments.=. >alance of payments is used to: a. predict pressures on foreign exc!ange rate.

b. anticipate government policy actions. c. assess a country5s credit and political ris"s. d. evaluate a country5s economic !ealt!.


24/268

BALANCE OF PAYMENTS ACCOUNTS

*urrent %ccount: 4roup %7 *onsists of:

a. 4oods

b. 'ervices

c. Income d. *urrent transfers.


25/268


*apital %ccount: 4roup >7 *onsists of:

a. *apital transfers

b. %c&uisition or disposal of nonproduced7nonfinancial assets.


26/268


Financial %ccount: 4roup *7 *onsistsof :

a Foreign direct investment

b Foreign portfolio investment c /t!er investments.


27/268


et -rrors and /missions: 4roup

T!is is a plug item designed to "eept!e balance6of6payments accounts in

balance.(eserves and (elated Items: 4roup -7

*onsists of:

a /fficial reserve assetsb )se of IF credits and loans

c -xceptional financing.


28/268


>alance of payment identity:

a. Flos of goods and services: current account. Flos of financial assets #net foreign investment$

C capital account < financial account < net errors and

omissions < reserves and related items. b. Flos of goods and services < net foreign investment C

?or current account < capital account < financial account< net errors and omissions < reserves and related items

C ?


29/268

THE ACTUAL BALANCE OF

PAYMENTS

a;or *ountries on *urrent %ccount

a T!e )' incurred massive current6accountdeficits during t!e 199?s and early 2???s.

b 8apan incurred massive current6account

surpluses during t!e 199?s and early2???s.


30/268


PAYMENTS

a;or *ountry >alances in Financial%ccount

a. T!e )' incurred massive financial6account surpluses during t!e 199?sand early 2???s.

b. 8apan incurred massive financial6account deficits during t!e 199?sand early 2???s.


31/268


PAYMENTS

T!e orld >alance of ,ayments a. T!e expansion of orld trade gre D.= percent

per year beteen 1991 and 19997 13.1 percent in2???7 ?.= percent in 2??17 and 3.? percent in 2??27

but it expected to gro by about E percent peryear from 2??3 to 2??. b. T!e expansion of orld output gre 2.= percent

per year beteen 1991 and 19997 3. percent in 2???71.2 percent in 2??17 and 1.E percent in 2??27 but itexpected to gro beteen 2 and 3 percent per yearbeteen 2??3 and 2??.

c. T!ose statistics in a and b indicate t!e relativeopenness of mar"ets and t!e ongoing integrationof t!e global economy.


32/268

INTERNATIONAL INVESTMENT

POSITION

1. International investment position is a stoc" conceptbecause it summarizes a countryGs assets andliabilities on a given date.

2. T!e )' is t!e largest net debtor nation in t!e orld7

!ile 8apan is t!e largest net creditor nation in t!eorld.3. Foreign direct investment #FI$ in t!e )' accounts for

3 percent of foreign assets in t!e )'7 but FI in 8apanaccounts for 1? percent in foreign assets in 8apan.

=. T!e )'Gs ot!er investment #mostly s!ort6term capitalflos$ accounts for 3? percent of its total foreignassets7 !ile 8apanGs ot!er investment amounts tomore t!an = percent.


33/268

HO' TO REDUCE A TRADE DEFICIT

1. eflate t!e economy t!roug! tig!t monetary and fiscalpolicies.2. evalue t!e currency.3.-stablis! public control.=.86*urve

a. 86curve is a t!eory designed to explain !y acurrency depreciation may not improve t!e balance oftrade.

b. T!e 86curve effect !olds t!at a country5s currencydepreciation causes its trade balance to deteriorate for as!ort time7 folloed by a flattering out period7 and

t!en a significant improvement occurs for an extendedperiod.


34/268

CHAPTER (

THE INTERNATIONAL MONETARY

SYSTEM


35/268

FL-HI>L- -H*+%4- (%T-

1. Flexible exc!ange rates are exc!ange rates7!ic! fluctuate according to mar"et forces.

2. %dvantages: a. %llo countries to maintain independent

economic policies. b. ,ermit a smoot! ad;ustment to external s!oc"s. c. on5t need to maintain large international

reserves.

3. isadvantages: a. Flexible exc!ange rates are !ig!ly unstable sot!at flos of foreign trade and investment maybe discouraged.

b. T!ey are in!erently inflationary.


36/268

FIH- -H*+%4- (%T-'

1. Fixed exc!ange rates are exc!ange rates !ic! do notfluctuate or !ic! c!ange it!in a predetermine band.

2. Fixed exc!ange rates provide t!e stability of exc!angerate7 but t!eir disadvantages include:

a. Too rigid to ta"e care of ma;or up!eavals. b. eed large reserves to defend t!e fixed exc!ange rate.

c. ay cause destabilizing speculations most currencycrises too" place under a fixed exc!ange system.

3. *urrency board is a monetary institution t!at onlyissues currency to t!e extent if it is fully bac"ed byforeign reserves t!is system is a rat!er rigid form offixed exc!ange rates.


37/268

MAR)ET E*UILIBRIUM

1. T!e e&uilibrium exc!ange rate and

&uantity are determined at t!e point!ere t!e demand curve for and t!esupply curve of foreign exc!ange areintersected.


38/268

MAR)ET E*UILIBRIUM

2. %ssuming t!at t!e )' dollar is a domesticcurrency and t!e >ritis! pound is a

foreign currency7 t!e demand curve for aforeign currency could be s!ifted to t!e

rig!t because of:

a. % !ig!er inflation rate in t!e )' b. Loer interest rates in t!e )'

c. %n increase in t!e )' income level d. )' government purc!ase of >ritis!

pounds.


39/268

MAR)ET E*UILIBRIUM

3. T!e supply curve for a foreign currencycould be s!ifted to t!e rig!t because of:

a. % !ig!er inflation in >ritain

b. Loer interest rates in >ritain

c. %n increase in t!e >ritis! income level

d. >ritis! government sale of )' dollars.


40/268

HISTORY OF INTERNATIONAL

MONETARY SYSTEM

191= >rea"don of gold standard andmonetary disorder began.

193= )' dollar pegged at @3 per ounceof gold.

19== *onference of >retton oods7 e+amps!ire establis!ed a fixed

exc!ange system based on t!e )'dollar. IF and orld >an" created.

19 -uropean -conomic *ommunityestablis!ed.


41/268


MONETARY SYSTEM

19D3 T!e )' levied JInterest -&ualization TaxJon foreign borroings in )' capital

mar"ets.19D3 T!e )' imposed voluntary controls on

capital outflos from )' ban"s andcompanies.

19D T!e )' imposed mandatory controls onforeign investment by )' companies.

19E? 'pecial draing rig!ts #'(s$ created.


42/268


MONETARY SYSTEM

19E1 /n %ugust 17 t!e )' dollar floated t!econvertibility of t!e )' dollar eliminated animport surc!arge imposed./n ecember 1E7 'mit!sonian %greement

reac!ed t!e )' dollar devalued from @3per ounce of gold to @3.19E2 % sna"e #2.2K$ it!in a tunnel #=.K$

establis!ed.

19E3 T!e )' dollar devalued from @3 to @=2.22 inarc!.19E3 /rganization for ,etroleum -xporting

*ountries #/,-*$ imposed oil embargo7eventually &uadrupling orld prices of oil.


43/268


MONETARY SYSTEM

19ED IF meeting in 8amaica7 "non asJ8amaica %greement7J legalized t!eexisting floating system.

19E T!e --* establis!ed t!e -uropeanonetary 'ystem !ic! officially replaceda sna"e it!in a tunnel. T!is is a ;ointfloating system.

192 Latin %merican debt crisis began.19 4roup of Five countries reac!ed J,laza%greementJ to reduce t!e value of t!e )'dollar.


44/268


MONETARY SYSTEM

19E a;or industrialized countries reac!edJLouvre %ccordJ to support stability and exc!angerates around t!eir current levels.

1992 +ig! 4erman interest rates caused Jt!e'eptember 1992 currency crisis in -urope.J Italyand t!e )nited ingdom it!dre from t!e-uropean onetary 'ystem.

1993 T!e 8uly 1993 currency crisis in -uropeforced t!e --* to iden alloable deviation band

to


45/268


MONETARY SYSTEM

199= exican peso suffered ma;or devaluation#=?K$ and began to float.

199E In 8uly 199E7 currency turmoil erupted in

T!ailand and spread to Indonesia7 'out!orea7 and ot!er 'out! %sian countries.

1999 /n 8anuary 17 19997 11 -uropeancountries launc!ed a single -uropean

currency called t!e euro7 it! a commonmonetary policy establis!ed by anindependent -uropean *entral >an".


46/268


47/268

INTERNATIONAL MONETARY FUND

*reated in 19==7 its ob;ectives are:

a. To promote international monetarycooperation.

b. To facilitate t!e balanced grot! oforld trade.

c. To promote exc!ange stability.

d. To eliminate exc!ange restrictions.

e. To create standby reserves.


48/268

',-*I%L (%I4 (I4+T' #'(s$

',-*I%L (%I4 (I4+T' #'(s$

1. IF created '(s in 19D9.

2. 19E?619E=: '(5s value tied it! t!e )' dollar.

3. 19E=6191: '(5s value tied it! a bas"et of 1Dcurrencies.

=. 'ince 19997 '(5s value tied it! t!e )' dollar78apanese yen7 >ritis! pound7 and euro.

. IF use '(s in a variety of transactions andoperations. In addition7 '(s are used as means todetermine a reference interest rate7 an internationalreserve asset7 and a unit of account.


49/268

NE' INTERNATIONAL MONETARY

SYSTEM

1. -xc!ange rates are said to be JvolatileJ if t!eirfluctuations are ide and unpredictable. T!e orld !asexperienced more volatile exc!ange rates since t!e>retton ood 'ystem collapsed in 19E3.

2. any economists recommend Jcraling bandJ66acombination of a craling peg and a ider band as a nemonetary system:

a. *raling peg is a regular modification of parvalue7 and a ider band is used to mean a band

!ic! is ider t!an a =.K alloed under'mit!sonian %greement.3. %dvantages: t!is system ill provide a discipline but a

flexibility to accommodate divergent economies.


50/268

*+%,T-(

F/(-I4 -H*+%4-%(-T


51/268

E+CHANGE MAR)ET PARTICIPANTS

1. %ctual participants are ban"s7 central

ban"s7 multinational companies7 nationalgovernments7 individual investors7 andot!er financial institutions.

E+CHANGE MAR)ET


52/268

E+CHANGE MAR)ET

PARTICIPANTS

2. ,urpose of ,articipation: a. %rbitragers: to cover t!e ris" of loss from

foreign currency proceeds in ta"ing advantagesof differences of interest rates among countries.

b. Traders: eliminate t!e ris" of loss from export or

import orders denominated in foreign currencies.c. +edgers: to protect t!e !ome6currency value offoreign6currency denominated balance6s!eet items.

d. 'peculators: expose t!emselves to currencyris"s. T!e first t!ree actually use foreign currency in

t!eir operations7 but speculators never use it in t!eiroperations. e. In most cases7 t!e term J!edgersJ are used to

mean functions of bot! traders and !edgers.


53/268

SPOT E+CHANGE *UOTATIONS

1. 'pot rate is a foreign exc!ange rate paidfor immediate deliver of a currency.

2. irect &uote and indirect &uote: a. irect &uote is a !ome currency price per

unit of a foreign currency7 suc! as @1.per M for a )' resident.

b. Indirect &uote is a foreign currency priceper unit of a !ome currency7 suc! as

M?.DE per @ for a )' resident.


54/268


3. *ross rate is an exc!ange rate beteento non6!ome currencies7 suc! as

ex@D.=? per M for a )' resident.

=. easuring a percentage c!ange in spotrates: a. irect &uote:

K c!ange C #ending rate 6 beginning

rate$Nbeginning rate. b. Indirect &uote:K c!ange C #beginning rate 6 ending

rate$Nending rate.


55/268


. >id6%s" (ates:

a. >id price is t!e price at !ic! t!e ban" is

ready to buy a foreign currency. b. %s" price is t!e price at !ic! t!e ban" is

ready to sell a foreign currency.

c. >id6as" spread is t!e difference beteenbid and as" rates.

d. 'pread in direct &uote C #as" price 6 bidprice$Nas" price.


56/268

FOR'ARD E+CHANGE *UOTATION

1. Forard rate is a foreign exc!ange ratefor a currency to be delivered at somefuture date.

2. Forard premium or discount

a.Ouote in points:

/ne point is e&ual to ?.?1 percent or

@?.???1. Forard &uote in point C forard rate 6

spot rate.


57/268


2. Forard premium or discount

b.

n

360

ratespot

ratespot-rateforwardday-ndiscountorPremium =


58/268


=. Forard exc!ange transactions are used toeliminate possible exc!ange losses on foreign6currency denominated obligations.

. 'peculating in t!e spot mar"et:'peculators buy a foreign currency at today5s spotrate7 ill !old it for some time7 and ill resell it at a!ig!er spot rate.

D. 'peculating in t!e forard mar"et:'peculators buy a foreign currency forard today7ill !old it for some time7 and ill resell it at a !ig!erspot rate.

INTERNATIONAL PARITY


59/268


CONDITIONS

1.,urc!asing poer parity:

T!e spot rate for t!e currency of a countryit! a !ig!er inflation t!an its tradingpartner ill depreciate in t!e long run.


60/268



61/268


CONDITIONS

3. International Fis!er effect:

a. T!e spot rate for t!e currency of a

country it! a !ig!er interest rate t!an itstrading partner ill depreciate in t!e longrun.

b. >ut t!e spot rate for t!e currency of a

country it! a !ig!er interest rate t!an itstrading partner ill appreciate in t!es!ort run.



62/268


CONDITIONS

=. Interest parity:

T!e forard rate for t!e currency of acountry it! a !ig!er interest rate t!anits trading partner ill fall7 t!erebyresulting in a forard discount.

. If t!e above four t!eories !old7 t!enforard rates ill be unbiasedpredictors of future spot rate.


63/268

COVERED INTEREST ARBITRAGE

1. efinition: t!e movement of s!ort6termfunds beteen countries to ta"e advantage

of interest differentials it! exc!ange ris"covered by forard contracts.

2 Interest parity line indicates t!at t!ere are

no incentives for arbitrage transactionsbecause on t!is line7 t!e interestdifferential is e&ual to t!e forard premiumor discount.


64/268


3. %ny point above t!e parity line suc! aspoint % !as t!e to features:

a. >orro in t!e !ome country7 !ic! is t!efirst step in t!e arbitrage process.

b. %rbitrage outflos7 !ic! means moneyill move from t!e !ome country to t!eforeign country.


65/268


-xample 612: Interest differential C 2K

Forard discount C 1K

a. 'teps 1 and 2 ill increase t!e forarddiscount of 1K toard 2K.

b. 'teps 3 and = ill reduce t!e interestdifferential of 2K toard 1K.

c. T!us7 t!e forard discount and t!einterest differential ill meet some!erebeteen 1K and 2K7 !ic! ill be a point

on t!e interest parity line.


66/268


=. %ny point belo t!e parity line suc! aspoint > !as t!e to features:

a. >orro in t!e foreign country.

b. %rbitrage inflos.


67/268

CURRENCY FUTURES

AND OPTIONS

CHAPTER ,


68/268

CURRENCY FUTURES

1. % currency futures contract is a contract to buyor sell a specified amount of a foreign currencyfor delivery at some future date.

2.

a. argin is some sort of deposit to ensure t!ateac! party fulfills its commitment. b. Initial argin is t!e amount mar"et participants

must deposit at t!e time of a futures contract. c. aintenance margin is a fixed minimum margin

customers must maintain in t!eir account all t!etime7 and it is about E?6?K of t!e initial margin.d. argin calls are re&uests for additional deposits.


69/268

CURRENCY FUTURES

3. ,ositions

a. '!ort66agreement to sell somet!ing.

If an %merican !as yen receivables7s!e is li"ely to !ave a s!ort position.

b. Long66agreement to buy somet!ing.

If an %merican !as yen payables7!eis li"ely to !ave a long position.


70/268

CURRENCY FUTURES

=. T!ree ma;or differences beteen futuresand forards:

a. Futures are available in a predeterminedamount7 !ave four maturity dates per

year7 and are !andled by exc!anges.

b. Forards are available in any amount

tailored to customer needs7 mature on anydate7 and are !andled by ban"s #/T*:over6t!e6counter$.


71/268

CURRENCY OPTIONS

CURRENCY OPTIONS

1. *urrency option is t!e rig!t to buy

#call$ or sell #put$ a specified amount ofa foreign currency at some future date.

2. ,remium or purc!ase price C intrinsic

value < time value.


72/268

CURRENCY OPTIONS

3. Intrinsic value #I0$ is t!e difference beteenexc!ange rate and stri"e price but cannot be loert!an zero #?$.

a. In t!e money: If options !ave positive I0 frominvestors5 viepoints7 t!ey are in t!e money.

b. %t t!e money: If options !ave zero I0 frominvestors5 viepoints7 t!ey are at t!e money.

c. /ut of t!e money: If options !ave negative#t!eoretical or mat!ematical$ I0 from investors5viepoints7 t!ey are out of t!e money


73/268

CURRENCY OPTIONS

.0alue of 0olatility

a.0olatility affects bot! time value andintrinsic value.

b.0olatile currency options !ave !ig!erpremiums.

D./ptions premiums are alays !ig!ert!an t!e intrinsic value7 because of t!etime value and value of volatility.


74/268

CURRENCY OPTIONS

)-(I*%L -H%,L-

/n /ctober 237 t!e closing exc!angerate of >ritis! pounds as @1.E?. *alls!ic! ould mature t!e folloing8anuary it! a stri"e price of @1.Eere traded at @?.?.

CURRENCY OPTIONS


75/268

CURRENCY OPTIONS

3. If t!e exc!ange rate of >ritis! pounds risesto @1.2 prior to t!e 8anuary optionexpiration date7 !at is t!e percentage returnon investment for an investor !o purc!aseda call on /ctober 23P

#1.2 6 1.E 6 ?.?$N?.? C ?.=? or =?K

=.!at is t!e brea"6even exc!ange rate for

>ritis! poundsP >rea"6even point C 1.E < ?.? C @1.? per

pound.


76/268


77/268

CHAPTER -

FINANCIAL S'APS


78/268

/(I4I /F T+- '%, %(-T

1.% sap is an agreement beteen to partiest!at exc!anges sets of cas! flos over aperiod of time in t!e future.

2.% parallel loan is a loan !ic! involves an

exc!ange of currencies beteen four parties7it! a promise to re6exc!ange t!e currenciesat a predetermined exc!ange rate at somefuture date.

3.% bac"6to6bac" loan is identical it! t!eparallel loan except t!e fact t!at it involvesonly to parties rat!er t!an four parties.


79/268

ORIGIN OF THE S'AP MAR)ET

=.rabac"s of parallel loans: a. It is difficult to find counterparties

it! matc!ing needs.

b. /ne party is still obligated to complyit! suc! an agreement even if

anot!er party fails to do so.

c. 'uc! loans s!o up on t!e boo"s oft!e participating parties.

,L%I 0%ILL% '%,'


80/268

,L%I 0%ILL% '%,'

1.T!e plain vanilla sap is t!e simplest"ind of a sap.

2.'ap ban"s:

a. % counterparty to bot! end6users.

b. >ro"er acts as an agent beteenbuyers and sellers.

c. ealer actually transacts for its onaccount to !elp complete t!e sap.

,L%I 0%ILL% '%,'


81/268

,L%I 0%ILL% '%,'

3. Interest rate sap:

a. Interest rate sap is an agreement beteen toparties to exc!ange interest payments.

b.To parties agree to exc!ange fixed interest ratesfor floating interest rates or floating exc!ange ratesfor fixed exc!ange rates.

c. otional principal is t!e principal value on !ic!interest payments are based.

d. ,arties % and > may agree on a sap in t!e samecountry it! t!e same currency7 in t!e to differentcountries it! t!e to different currencies7 and inot!er variants.

,L%I 0%ILL% '%,'


82/268

,L%I 0%ILL% '%,'

=.*urrency saps usually involves t!ree setsof cas! flos:

a. 'pot transaction: to parties sap

to currencies no. b. /nly net interest payments are made.

c. Forard transaction: to parties

resap t!e to currencies in t!e future.

MOTIVATIONS


83/268

MOTIVATIONS

1. *urrency ris" management:

a. 4eneral otors #4$ !as yen

accounts receivable. b. Toyota !as dollar accounts

receivable.

c. 4 and Toyota sap yen anddollars it! eac! ot!er.

MOTIVATIONS


84/268

MOTIVATIONS

2.*ommercial needs:a.T!e sap may be used to eliminate t!e

interest rate ris". %ssume a company !asfixed rate assets and floating rate liabilities. Ifinterest rates rise7 t!is company ill face t!einterest rate ris".

b.T!e company can eliminate t!e interest rateris" by: #1$ transforming fixed rate assets intofloating rate assets and #2$ transformingfloating rate liabilities into fixed rateliabilities.

MOTIVATIONS


85/268

MOTIVATIONS

3. *omparative %dvantage:

a. 4 borros dollars at a loer rate and

transfers t!e funds to a >ritis! firm.b. >ritis! firm borros pounds at a loerrate and transfer t!e funds to 4.

c. T!is sap is possible because of mar"et

imperfections or different ris"s.


86/268

CHAPTER .

E+CHANGE RATE

FORECASTING

F/(-*%'TI4 --' /F T+-


87/268

F/(-*%'TI4 --' /F T+-)LTI %TI/%L */,%Q

0irtually all aspects of *s may beinfluenced by c!anges in exc!ange rates.T!ey include t!e !edging decision7or"ing capital management7long6terminvestment analysis7long6term financing

decision7 and ot!er decisions.

EFFICIENT E+CHANGE MAR)ETS


88/268


1. %ssumptions for efficient exc!angemar"ets are:

a. 0ery large number of sellers and

buyers

b. 'tandard product

c. 4iven price

d. Free entry into and exit out of t!emar"et.



89/268


2. *onse&uences:

a. 'pot rates reflect all currentinformation and ill c!ange in

response to Jrandom nes.J b. Impossible for any mar"et analyst to

consistently beat t!e mar"et.

c. %ll currencies are fairly priced.



90/268


3.Forms of -fficient -xc!ange ar"et

a. ea"6form efficiency: !istorical datais useless.

b. 'emi6strong form efficiency: currentinformation is useless.

c. 'trong6form efficiency: insideinformation is useless.



91/268


=. If foreign exc!ange mar"ets areperfectly efficient7 exc!ange rateforecasting is impossible

because:

%ll currencies are fairly priced

and exc!ange rates ill c!angein response to Jrandom nes.J

F/(-*%'TI4 FL/%TI4


92/268

-H*+%4- (%T-'

1. Fundamental analysis:

a. Fundamental analysis depends on

fundamental economic conditions7suc! as inflation rate7 interest rate7 andt!e rate of grot! in money supply.

b. -xamples of t!is tec!ni&ues are ,,,and multiple regression analysis.

F/(-*%'TI4 FL/%TI4


93/268

-H*+%4- (%T-'

2. Tec!nical analysis:

a. Tec!nical analysis depends on pastprices and volume movements.

b. -xamples of t!is tec!ni&ue arec!arting and mec!anical rules.

F/(-*%'TI4 FL/%TI4


94/268

-H*+%4- (%T-'

3.ar"et6based forecasts:

a. % mar"et6based forecast is a forecastbased on mar"et indicators suc! as

forard rates. b. -xamples of t!is tec!ni&ue are spot

rates7 forard rates7 and interest rates.

c. Forecasting !orizons are a fe days for

spot rates7 a fe mont!s for forard rates7and a fe years for interest rates.

FORECASTING FI+ED E+CHANGE


95/268

RATES

1. 'tep one is to identify t!ose countries!ose balance of payments are in

fundamental dise&uilibrium.

To identify t!ese countries7 ones!ould loo" at:

a. International reserves

b. T!e balance of trade

c. Inflation rates

d. oney supply.



96/268

RATES

2. 'tep to is to measure t!e magnitudeof re&uired ad;ustment.

T!e degree of re&uired ad;ustment

can be measured by:

a. T!e application of ,,,

b. Forard premium or discount

c. Free mar"et or blac" mar"et rates.



97/268

RATES

3.T!ird step is to determine t!e timing ofad;ustment.

T!e timing of ad;ustment depends on:

a. T!e overall amount of internationalreserves

b. %bility to borro !ard currencies.



98/268

RATES

=.Fourt! step is to predict t!e type ofcorrective policies.

*orrective policies include: a. %dopt tig!t monetary and fiscal

policies

b. Institute strict exc!ange controls.



99/268

RATES

. % country ill devalue its currency ifvarious corrective policies prove

economically ineffective orpolitically unacceptable.


100/268

CHAPTER /

%%4I4 T(%'%*TI/-H,/')(- % -*//I*-H,/')(-

TRANSACTIONS THAT ARE SAID TO


101/268

TRANSACTIONS THAT ARE SAID TO

BE E+POSED

1. T!ey are denominated in

foreign currencies.2. T!ey are translated at

current exc!ange rates.

BASIC NATURE OF FOREIGN


102/268

E+CHANGE E+POSURES

1. Foreign exc!ange exposure refers to

t!e possibility t!at a firm ill gain orlose because of c!anges in exc!angerates. T!ree types of exc!ange

exposures are translation7 transaction7 aneconomic.

BASIC NATURE OF FOREIGN


103/268

E+CHANGE E+POSURES

2. T!e exc!ange exposure managementre&uires an * to:

#1$ evelop exposure management strategy7#2$ Forecast t!e degree of exposure7

#3$ evelop a reporting system to monitorexposure and exc!ange rate

movements7 #=$ %ssign responsibility for !edgingexposure7 and #$ select appropriate!edging tools.

TYPES OF E+POSURES


104/268

TYPES OF E+POSURES

1. %ccounting or translation exposure ist!e effect of an exc!ange rate c!angeon financial statement items.

2. Transaction exposure is t!e effect of

an exc!ange rate c!ange onoutstanding obligations7 suc! asimports and exports.

TYPES OF E+POSURES


105/268

TYPES OF E+POSURES

3. -conomic exposure is t!e effect of anexc!ange rate c!ange on t!e net presentvalue of expected net cas! flos fromdirect investment pro;ects.

=. Translation exposure does not involveactual cas! flos7 but transaction

exposure involves actual cas! outflos7and economic exposure involves potentialcas! flos.

T(%'%*TI/ -H,/')(-


106/268

%%4--T F/( % )' FI(

RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRTec!ni&ues ,ound ,ayables

,ound (eceivables

Futures #forard$ long position #buy$ s!ort position #sell$

/ptions call putFutures options call putRRRRRRRRRRRR

1. Forard mar"et !edge involves t!e exc!ange of onecurrency for anot!er at a fixed rate one on some futuredate to !edge transaction exposure.

T(%'%*TI/ -H,/')(-


107/268

%%4--T F/( % )' FI(

2. oney mar"et !edge:

a. If a )' firm !as pound payables from imports7 t!efirm borros dollars7 converts t!e proceeds into

pounds7 buys >ritis! Treasury bills7 and pays t!eimport bill it! t!e funds derived from t!e sale oft!e Treasury bills. T!e firm5s dollar loan is notsub;ect to exc!ange rate ris".

b. If a )' firm !as pound receivables7 t!e firm borrospounds7 converts t!e proceeds into dollars7 andbuys )' Treasury bills. %t maturity7 t!e firm usespound receivables to pay off its pound loan andredeems t!e Treasury bills in dollars.

T(%'%*TI/ -H,/')(-


108/268

%%4--T F/( % )' FI(

3. )nder t!e options6mar"et !edge7 t!e purc!ase of acall option allos a )' firm to loc" in a maximumdollar price for its foreign currency payables t!epurc!ase of a put option allos a )' firm to loc" in a

minimum dollar price for its foreign currencyreceivables.

=. 'ap mar"et !edge involves an exc!ange of cas!flos in to different currencies beteen tocompanies.

. )se futures or forards !en t!e &uantity of foreigncurrency cas! flos is "non.

)se options !en t!e &uantity of a foreign currencycas! flos is un"non.

T(%'%*TI/ -H,/')(-%%4--T F/( % )' FI(


109/268

%%4--T F/( % )' FI(

D. *ross !edging !edges exposure in one currency by t!euse of futures or ot!er contracts on anot!er currencyt!at is correlated it! t!e first currency.

E. % variety of sap agreements can be used for transaction

exposure management:a. *urrency sap is a simultaneous spot andforard transaction.

b. *redit sap is a simultaneous spot and forard

transaction but involves a ban".c. Interest rate sapd. >ac"6to6bac" loans

e. *redit 'ap

-H%,L- 96E


110/268

9

#1$. T!e cost of direct loan is 2?K.

#2$. T!e cost of credit sap is 3?K.

#3$. !ic! one to c!ooseP

irect Loan *redit 'apRRRRR

2??7???y < #17???7???y 6 =7???7???$ C 2??7???y < =??7??? y C =.=

-H%,L- 96E


111/268

If y C =.=7 direct loan C 172?7??? s!e"els credit sap C 172?7??? s!e"els

T!us7 bot! alternatives are e&ually costly7

but t!e credit sap is safer.

If y C =7 direct loan C ??7??? s!e"els

credit sap C 172??7??? s!e"els

T!us7 t!e direct loan is c!eaper7 but ris"iert!an t!e credit sap.

-H%,L- 96E


112/268

-H%,L- 9 E

If y C 7 direct loan C 27???7??? s!e"els

credit sap C 17=??7??? s!e"els

(ational decision6ma"ers s!ouldc!oose t!e credit sap because it isc!eaper and less ris"y.

-*//I* -H,/')(-%%4--T


113/268

%%4--T

1.To broad !edging tec!ni&ues are financialand operational.

2.,roblems of economic exposure management: a. -conomic exposure covers t!e life of t!e

pro;ect and all aspects of operations.

b. T!e above to factors ma"e it very difficult

for *s to find economically ;ustifiablefinancial !edging tec!ni&ues7 suc! asfutures7 forards7 and options.

-*//I* -H,/')(-


114/268

%%4--T

3. +edging Tec!ni&ues

a. ost *s use operational !edging

tec!ni&ues "non as strategic#operational$ met!ods suc! asdiversification in production7 mar"eting7 andfinancing.

b. T!e biggest problem it! t!ediversification strategy is t!e loss ofeconomies of scale.

*)((-*Q -H,/')(-%%4--T ,(%*TI*-'


115/268

%%4--T ,(%*TI*-'

1. T!e relative importance of different exc!angeexposures from t!e amount of attention given toeac! exposure and !edging preference for eac!exposure are

#1$ transaction exposure7 #2$ economic exposure7

#3$ translation exposure.

2. T!e most commonly used instrument to manageforeign exc!ange ris"s as forard contract7folloed by cross6currency saps7 interest ratesaps7 currency saps7 and futures.

*)((-*Q -H,/')(-%%4--T ,(%*TI*-'


116/268

%%4--T ,(%*TI*-'

3. Financial !edging instruments7

"non as derivatives7 suc! asfutures7 options7 and saps aregenerally considered safe fors!ort6term purposes7 but t!ey

are not ris"6free eit!er.

*)((-*Q -H,/')(-%%4--T ,(%*TI*-'


117/268

%%4--T ,(%*TI*-'

'ome !ave incurred large6derivative relatedlosses7 !ic! include:

'!oa '!ell of 8apan #@1.= billion in 1993$7

etallgesellsc!aft of 4ermany #@1.3 billion in 199=$7>arings >an" of >ritain ##@1.= billion in 199$7aia >an" of 8apan #@1.1 billion in 199$7'umitomo *orp of 8apan #@1. billion in 199D$7/range *ounty of *alifornia7 t!e )'#@1.E billion in 199=$7

Long6Term *apital anagement of t!e )'#@3 billion in 199$.


118/268

CHAPTER 01

MANAGING TRANSLATION

E+POSURE

TRANSLATION RULES


119/268

S O U S

1. Translation exposure measures t!eeffect of an exc!ange rate c!ange onpublis!ed financial statements of afirm.

2. ifferences beteen current rate7temporal7 monetaryNnonmonetary7 andcurrent N noncurrent met!ods.

TRANSLATION RULES


120/268

RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR*urrent onetaryN *urrentN

Item (ate Temporal onmonetary oncurrentInventory at price exposed exposed not exposed exposedInventory at cost exposed not exposed not exposed exposed

et fixed assets exposed not exposed not exposed not exposedLong6term debt exposed exposed exposed not exposed

ST!ose items t!at are translated at !istorical rates are not exposed. T!ose items t!at are translated at current rates are exposed.

FASB 2. 3TEMPORAL METHOD4 VS5 FASB 267

3CURRENT RATE METHOD4


121/268


1. To ma;or complaints about F%'> include:

a. F%'> re&uires firms to s!o allgains and losses in t!eir current

income statement.

b. F%'> re&uires firms to usedifferent rates for different balance6

s!eet items.




122/268


2. )nder F%'> 2:

a. %ll gains and losses are treated as

net ort!. b. %ll items are translated at current

exc!ange rate except net ort!.




123/268


3. In 1927 4 earned @9D3 million and !ad atranslation gain of @3= million7 !ile Ford lost @Dmillion and !ad a translation loss of @22? million.192 as t!e year t!at )' companies ere alloed

to use eit!er F%'> 2 or .

4 used F%'> to include a translation gain of@3= million in its income statement7 !ile Ford

used F%'> 2 to exclude a translation loss of @22?million from its income statement.

HEDGING TECHNI*UES FOR

TRANSLATION E+POSURE


124/268


1. )nder t!e balance s!eet !edge7 acompany maintains t!e same mount

of exposed assets and liabilities in aparticular currency.

+ard currencies are t!ose currencies!ose value is li"ely to appreciate7 andsoft currencies are t!ose currencies!ose value is li"ely to depreciate.




125/268


#1$ Increase !ard6currency assets forexample7 increase dollar6denominatedreceivables.

#2$ ecrease !ard6currency debts forexample7 pay off dollar6denominateddebts.

#3$ ecrease soft6currency assets forexample7 reduce peso6denominated

receivables.#=$ Increase soft6currency debts forexample7 increase peso6denominateddebts.




126/268


2. Indirect Fund %d;ustment et!ods

a. -xpose netting allos a firm to netcertain exposures from different operations

so t!at it may !edge only its nextexposure.

b. Leading and lagging allos a firm to payor collect early #leading$ and to pay or

collect late #lagging$. c. Transfer pricing can ad;usted to avoid

foreign currency exposure.


127/268

CHAPTER 00

INTERNATIONAL

FINANCIAL MAR)ETS

EUROCURRENCY

3EURODOLLAR4 MAR)ETS


128/268


1. -urocurrency #-urodollar$ mar"et consists of ban"st!at accept deposits and ma"e loans in foreigncountries outside t!e country of issue.

2. efinitions of -urodollars.

a. arro definition: dollars ban"ed in -urope. b. >road definition: dollars ban"ed outside of t!e

)'.

c.-urocurrency is any currency ban"ed outside itscountry of origin. d.T!e term J-urodollarJ fre&uently refers to t!e entire

-urocurrency mar"et because dollars account formost of t!e -urocurrency mar"et.

EUROCURRENCY



129/268


!y are deposit rates !ig!er and lending ratesloer in t!e -urodollar mar"et t!an in t!e )'P

a. -uro ban"s are free of reserve re&uirements. b. -uro ban"s !ave very little regulatory expenses.

c. -urodollar loans are made to ell "non borroers in!ig! volumes.

d. -urodollar loans are made in tax !aven countries. e. -urodollar loans are not made at concessionary rates.

EURONOTE ISSUE FACILITIES

3EIF84


130/268

3EIF84

1. -IF' are notes issued outside t!e countryin !ose currency t!ey are denominated.

2. -uro notes are s!ort6term debt instrumentsunderritten by a group of international

ban"s.3. -uro commercial papers are unsecured

s!ort6term promissory notes sold bycompanies.

=. -uro6medium6term notes are medium6termfunds guaranteed by financial institutionsit! t!e s!ort6term commitment by investors.

EUROCURRENCY INTERBAN)

MAR)ET


131/268

MAR)ET

1. T!e Interban" mar"et consists of depositsand loans among ban"s and accounts formost of t!e entire -urocurrency mar"et.

2. (is"s of participating ban"s include: a. *redit or default ris" b. Li&uidity ris"

c. 'overeign ris" d. Foreign exc!ange rate ris" e. 'ettlement ris".


MAR)ET


132/268

MAR)ET

3. a;or concerns of t!e interban"mar"et by regulators and analysts:

a. To ma;or concerns are

#1$ no collateral and#2$ inade&uate central ban" regulations.

b. %bove to ma;or factors may create a

Jcontagion effect.J ,roblems at one ban"may affect ot!er ban"s in t!e mar"et.


MAR)ET


133/268

MAR)ET

=. inimum standards of international ban"s

a. *entral ban" governors of 461? countriesand t!e >an" for International 'ettlements

establis!ed a minimum standard in 19. b. 4lobally active ban"s maintain capital

e&ual to at least K of t!eir assets.

. T!ree *s of central ban"ing are consultation7cooperation7 and coordination.


MAR)ET


134/268

MAR)ET

D. T!e role of ban"s in corporate governance

a. Traditionally7 t!e corporate governanceof t!e )' used to be a mar"et6based

system t!e corporate governance of8apan used to be a ban"6based system.

b. In recent years7 !oever7 t!e role ofban"s in t!e )' corporate governance

became stronger7 !ile t!e role of ban"sin 8apan5s corporate governance becameea"er.

ASIAN CURRENCY MAR)ET


135/268

1. In 19D7 an %sian version of t!e-urodollar came into existence it!

t!e acceptance of dollar6denominateddeposits by ban"s in 'ingapore.

2. 1? ban"s !ave licenses from t!egovernment of 'ingapore to operate%sian *urrency )nits #%*)s$.

ASIAN CURRENCY MAR)ET


136/268

3. %n %*) is a section it!in a ban"it! aut!ority for %sian currencymar"et operations.

=. T!is %sian currency mar"et rivals t!e

International >an"ing Facilities of t!e)' and t!e 8apan /ffs!ore ar"et.

INTERNATIONAL BOND MAR)ET


137/268

1. efinition of international bonds:bonds7 !ic! are initially sold

outside t!e country of t!e borroer.

2. Foreign bonds are bonds sold in aparticular country by a foreign

borroer.

3. -urobonds are bonds soldsimultaneously in many countriesoutside t!e country of t!e borroer.



138/268

=. 4lobal bonds are bonds sold inside as ell asoutside t!e country of t!e borroer.

. *urrency denominations in international bonds

include currencies of most industrial countries. ultiple currency bonds are

#1$ currency option bonds t!at allo investors toc!oose one among several predeterminedcurrencies and

#2$ currency coc"tail bonds t!at are denominatedin a standard currency bas"et of severalcurrencies suc! as '(s.



139/268

D. /t!er types of international bondsinclude:

a. 'traig!t bonds

b. Floating6rate bonds

c. *onvertible bonds

d. >onds it! arrants e. Uero6coupon bonds.

INTERNATIONAL E*UITY MAR)ET


140/268

e trends in stoc" mar"ets:

a. 'toc" mar"et alliances: some 1? stoc" exc!angesin t!e orld scramble to align it! eac! ot!er.

b. *ross listing: a recent increase in cross bordermergers compel firms to cross list t!eir stoc"s ondifferent exc!anges around t!e orld.

c. 'toc" mar"et concentration: 'toc" mar"ets !ave

become more integrated in recent years mainly dueto t!e -uropean )nion7 mar"et alliances7 cross6listing7 and ot!er reasons.



141/268

,rivatization

a. ,rivatization is a situation in !ic!

government6oned assets are sold toprivate individuals or groups.

b. !y privatizeP To develop capital

mar"ets7 iden s!are oners!ip7 raisemoney7 and c!ange corporate governance.



142/268

Long6term capital flos to developing countriesa. Long term capital flos to developingcountries !ave declined since 199 mainly due to t!e%sian financial crisis

of 199E and t!e recent slodon of t!e globaleconomy.

b. Long term capital flos s!ifted from debt to e&uity

in recent years.


143/268

CHAPTER 07

INTERNATIONAL BAN)ING

ISSUES AND COUNTRY

RIS) ANALYSIS

DIFFERENCES BET'EEN

DOMESTIC AND FOREIGN LOANS


144/268

1. Foreign loans are sub;ect to foreignexc!ange fluctuations and controls.,ossible solutions include forard andfutures contracts7 saps7 and bac"6to6bac" loans.

2. T!ere are no legal systems and no

ultimate arbitrators for possible disputesbeteen borroers and lenders. ,ossiblesolutions include prior agreements andinsurance purc!ases.

INTERNATIONAL DEBT CRISIS

OF THE 0/.18


145/268

OF THE 0/.18

1.a. exico defaulted in %ugust 192.

b. >razil and %rgentina folloed.

c. 2 countries faced similar problems by193.

d. @D billion sing by /,-* beteen 19?and 192.

In 19?7 /,-* contributed @=2 billion toloanable funds7 but in 192 it!dre @2Dbillion from loanable funds.


OF THE 0/.18


146/268

OF THE 0/.18

2. *auses of t!e crisis include:

a. 4lobal economic dislocations and mismanagementby t!e debtor countries.

b. 4rot! opportunities in t!ese countries7 !ic!motivated t!em to borro too muc! too fast.

c. T!e 19E36E= oil s!oc" t!at increased oil prices byfour times.

d. Large balance of payments deficits by debtor

countries. e. Large capital flig!ts7 !ic! are defined as t!e

transfer of capital abroad in response to fears ofpolitical ris".


OF THE 0/.18


147/268

OF THE 0/.18

3. 'olutions: a. Lenders7 borroers7 and international

organizations or"ed toget!er t!ey usedresc!eduling7 refinancing7 additional loans7forgiveness7 and restrictive economic policies.

b. Lenders increased e&uity6capital base7 increasedloan6loss reserves7 reduced ne loans7 and soldexposed assets.c. >orroers depended on increased exports7reduced imports7 more foreign investment7 restrictiveeconomic policies7 and debt6e&uity saps.

d. ,artial debt relief as provided by creditors andorld financial institutions.


OF THE 0/.18


148/268

=. >rady >onds

a. T!e above four measures ere not sufficient tosolve t!e debt crisis completely.

b. In 1997 )' Treasury 'ecretary >rady offered toconvert t!e creditors5 loans into ne guaranteedloans it! a reduced interest rate of D. percent. T!isplan !as come to be called J>rady bonds.J

c. In 19927 2? debtor countries !ad converted @1??billion in ban" debt into >rady bonds.

d. T!ese >rady bonds are largely credited it!solving t!e debt crisis of t!e 19?s

OF THE 0/.18

THE ASIAN FINANCIAL CRISIS

OF 0//-


149/268

OF 0//-

1. T!ailand faced a currency crisis in 8uly199E due to a !uge foreign debt7 tradedeficits7 and a ban"ing system ea"ened

by t!e !eavy burden of unpaid loans.

2. % T!ai crisis spread to ,!ilippines7alaysia7 Indonesia7 and orea

because investors and companiesin t!ese countries s!ared all of

T!ailand5s problems.


OF 0//-


150/268

OF 0//-

3. In t!e =t! &uarter of 199E7 t!e IF arranged rescuepac"ages of @1 billion for T!ailand7 @=3 billion forIndonesia7 and @ billion for orea.

=. >y t!e end of 1997 t!e %sian crisis spread to(ussia7 >razil7 and many ot!er countries. %gain7t!e IF arranged bailout pac"ages of @23 billionfor (ussia and @=2 billion for >razil.

. T!e %sian crisis !ad pus!ed one6t!ird of t!e globeinto recession during 199.


OF 0//-


151/268

OF 0//-

D. *auses of t!e %sian *risis: fundamental vie vs.panic vie

a. T!e fundamental vie !olds t!at t!e %siancrisis as caused by t!e maturity mismatc!and t!e currency mismatc!66 t!e use of s!ort6term debt for fixed assets by crisis countries andt!eir un!edged external debt.

b. T!e panic vie states t!at problems inT!ailand ere turned into an %sian crisis becauseof international investors5 irrational be!avior.


OF 0//-


152/268

OF 0//-

'everal factors support t!e panic vie:

#1$ no arning signs ere visible

#2$ international ban"s madesubstantial loans to private firms

#3$ even viable exporters it!confirmed sales could not get credit

#=$ t!e sudden it!draal of funds fromt!e region triggered t!e crisis.


OF 0//-


153/268

OF 0//-

,olicy (esponsesa. -xternal payments ere stabilized by IF6led rescue

pac"ages7 t!e resc!eduling of s!ort6term loans7and reductions in foreign borroings t!roug!increased exports and reduced imports.

b. *risis countries closed many ailing ban"s7cleaned up non6performing loans7 and compelledban"s to meet t!e capital ade&uacy ratio set by t!e >I'.

c.*orporate sector reforms included debt reduction7removal of excess capacity7 reorientation ofconglomerates on core businesses7 and en!ancedcorporate governance.

'QI*%T- L/%'


154/268

% syndicated loan is a credit in !ic! agroup of ban"s ma"es funds available

on common terms and conditions to aparticular borroer.

'QI*%T- L/%'


155/268

2. T!is type of loan is popular because of:

a. T!e increasing size of individual loans b. T!e need to spread ris"s in large loans c. T!e attractiveness of management fees d. T!e publicity for participating ban"s

e. T!e need to form profitable or"ingrelations!ips it! ot!er ban"s.

COUNTRY RIS)


156/268

1. *ountry ris" is t!e possibility of default on foreign loans.

2. +o to assess country ris":

a. ebt ratios by t!e orld >an" in 2??3:

RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR'everely Indebted

oderately Indebted*ountries *ountries

ebt (atio *ritical 0alue *ritical 0alue

ebt 'ervice to 4, ?K =K ebt 'ervice to -xport 22? 132 ? countries =1 countriesRRRRRR

COUNTRY RIS)


157/268

b. 'ome publications7 suc! as Euro!on"97determine overall creditort!iness ofmost countries around t!e orld.

/verall creditort!iness depends on

economic factors7 political factors7 andforeign relations.

c. oody5s Investor 'ervice and 'tandard V,oor5s assign letter ratings to indicate t!e

&uality of bonds issued by mostsovereign governments.


158/268

*+%,T-( 13

FI%*I4 F/(-I4

T(%-

/>8-*TI0-' /F /*)-T%TI/


159/268

1. (emove non6completion ris" suc! asno or delayed delivery and no ordelayed payments.

2. -liminate exc!ange rate ris" t!roug!forard contracts and ot!ers.

3. ocuments enable ban"s to financeforeign trade

TYPES OF DOCUMENTS


160/268

1. raft is an order to pay.

a. Trade acceptance is a draft accepted by

a company and it is non6negotiable.

b. >an"ers5 acceptance is a draftaccepted by a ban" and it is negotiable.

TYPES OF DOCUMENTS


161/268

2. % bill of lading is a s!ippingdocument and is simultaneously a:

a. (eceiptb. *ontract

c. ocument of title.

TYPES OF DOCUMENTS


162/268

3. Letters of credit are t!e ban"5sguarantee of payment.

=. T!ree additional documents includecommercial invoice #description oft!e merc!andise$7 insurance

documents7 and consular invoices#documents issued by t!e consulateof t!e importing country$.

COUNTERTRADE


163/268

1. *ounter trade refers to orld trade arrangementst!at are variations on t!e idea of a barter.

2. 'imple barter is t!e exc!ange of goods andservices it!out money.

3. )nder a clearing arrangement7 any accountimbalances at t!e end of an agreed6upon period of

time are cleared by a !ard currency payment or byt!e transfer of additional goods.

COUNTERTRADE


164/268

=. )nder sitc! trading7 a t!ird party7called Jsitc! trader7J purc!ases anyaccount imbalances beteen t!e to

countries at t!e end of an agreedupon period of time.

. )nder counter purc!ase7 t!eexporter agrees to a return purc!ase.

COUNTERTRADE


165/268

D. )nder compensation7 payment ismade by products arising out of t!eoriginal sale.

E. /ffset agreement !olds t!at t!eseller is re&uired to use goods and

services from t!e buyer country int!e final product.

PRIVATE SOURCES OF E+PORT

FINANCING


166/268

1. %ccounts receivable financing a. /pen account7 accounts payable7 is

based on pre6establis!ed accounts.

b. ,romissory notes7 notes payable7are notes t!at officially evidence t!edebt.

c. Trade acceptances are draftsaccepted by a company.


FINANCING


167/268

d. In receivable financing7 pledging uses receivables ascollateral and factoring means outrig!t sales ofreceivables.

a;or differences beteen t!e to are:

RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR,ledging Factoring

/ners!ip does not c!ange /ners!ip from borroer tolender

Lender !as recourse Lender !as no recourse

onnotification to borroer5s customers otification toborroer5s customers


FINANCING


168/268

2. Letters of credit.

3. >an"ers5 acceptances.

=. '!ort6term ban" loans.


FINANCING


169/268

. -xport trading companies of t!e )':

a. T!e -xport Trading *ompany %ct of 192relaxed t!e ban"ing !olding company

act and anti6trust las for export tradingcompanies.

b. T!e %ct enabled export6trading companies

to provide one6stop compre!ensiveservices for exporters and buyNsell on

t!eir on accounts for exports.


FINANCING


170/268

D. Factoring: factors7 suc! as financialinstitutions7 buy accounts receivableon a non6recourse basis.

E.Forfaiting:

a. 'imilar to factoring.

b. )sed to finance sales of big6tic"etitems.

c. Lender !as no recourse.

d. Involve t!ree to five years.

T+- )' 4/0-(-T '/)(*-'/F -H,/(T FI%*I4


171/268

1.-xport6Import #-xim$ >an": triad demandedby exporters are:

a. /fficial loans

b. Loan guarantees c. Insurance.

2. ,rivate -xport Funding *orporation is

supported by t!e )' Treasury epartmentand t!e -xim >an" its members!ip includes= ban"s7 E manufacturers7 and oneinvestment ban"er.

T+- )' 4/0-(-T '/)(*-'/F -H,/(T FI%*I4


172/268

3. Foreign *redit Insurance %ssociationinsured all ris"s in exports7but ent out

of business in 193 t!e -xim >an" too"over its functions.


173/268

CHAPTER 0(

FINANCING FOREIGN

INVESTMENT

INTERNAL SOURCES OF FUNDS


174/268

1. Internal sources of funds from parentsinclude:

a. -&uity contributions are necessary toon and control foreign operations.

b. irect loans from parents to t!eirsubsidiaries are popular because of taxconsiderations and easy repatriations.

c. T!e parent5s loan guarantees enablesubsidiaries to borro from local ban"s.



175/268

2. Internal sources of funds fromoperations include:

a. ,rofits

b. epreciation or ot!er non6cas!outlays.



176/268

3. Internal sources of funds fromsubsidiary include:

a. Loans from sister subsidiaries

b. /ne subsidiary can increase its cas!discount from 2N1? to 3N1? to its sistersubsidiary.

c. /ne subsidiary can extend its credit

terms from net 3? to net =? to its sistersubsidiary.

E+TERNAL SOURCES OF FUNDS


177/268

1. -xternal sources of funds from commercialban"s include:

a. /verdrafts b. )nsecured s!ort6term loans

c. >ridge loans

d. *urrency saps

e. Lin" financing.



178/268

2. -dge %ct and %greement *orporations oft!e )'

a. Located in t!e )' but engage in

offs!ore ban"ing operations.b. -dge %ct *orporations are c!arteredby t!e Fed (eserve >oard7 and

%greement *orporation are c!arteredby individual states.



179/268

d. Functions are:

International ban"ing7 !ic! includes deposits7loans7 letters of credits7 and ot!er normal ban"ingoperations.

International financing7 !ic! includes long6termfinancing suc! as investment in stoc"s of non6ban"financial institutions and development ban"s.

+olding company7 !ic! ons s!ares of foreignban"ing subsidiaries and affiliates.



180/268

3. International >an"ing Facilities oft!e )' are:

a. % popular innovation in off6s!oreban"ing

b. o p!ysical facilities needed

c. o permission needed

d. Free from most regulations

e. '!ould not do business it! )'residents.



181/268

=. 'trategic alliances:

a. % strategic alliance is any collaborativeagreement beteen to companies t!at is

designed to attain some strategic goal.b. Types of strategic alliance are:

. Licensing agreements

. ar"eting arrangements ormanagement contracts. 8oint ventures.



182/268

.,ro;ect financea. ,ro;ect finance refers to an arrangement !ere a

pro;ect sponsor finances a long6term capital pro;ect#i.e.7 %las"a oil pipeline or -uro isney$ on a non6recoursebasis.

b. ,ro;ect finance is eit!er a build6operate6on contract#>//$ or build6operate6transfer #>/T$ pro;ect.In a >// contract7 t!e sponsor assumes oners!ip of t!epro;ect at t!e end of t!e contract life.

In a >/T pro;ect7 oners!ip of t!e pro;ect is transferred tot!e !ost government.



183/268

E. 4uidelines for ade&uate capitalization a. 'everal ratios can be used to determine an

optimum mix of debt and e&uity for overseaspro;ects.

T!e investor5s on resources s!ould besufficient to cover its fixed costs.

-&ual amounts of debts and e&uity investments

s!ould be used to finance overseas pro;ectsT!e pro;ected earnings from t!e overseas pro;ects!ould be a substantial multiple of its annualfinancing costs.



184/268

. evelopment >an"s are:

a. -stablis!ed to support t!e economic

development of developing countries. b. International: i.e.7 orld >an"(egional: i.e.7 Inter6%mericanevelopment >an"

ational : i.e.7 %gency forInternational evelopment.


185/268

CHAPTER 06

INTERNATIONAL'OR)ING CAPITAL

MANAGEMENT

BASIC CONCEPT OF 'OR)ING

CAPITAL MANAGEMENT


186/268

1. -conomic constraints of or"ingcapital management include:

a. Foreign exc!ange constraints

b. (egulatory constraints

c. Tax constraints.


CAPITAL MANAGEMENT


187/268

2. a. T!e ability to ad;ust fund flos among1? countries is one of t!e biggest

advantages to *s.

b. any fund transfer tec!ni&ues are&uestionable and t!ere are many conflictsof interest.

c. ,ositioning of funds involves t!e c!oice

of location and t!e c!oice of currencydenomination.


CAPITAL MANAGEMENT


188/268

3. %rbitrage opportunities:

a. Tax arbitrage: different tax las allo*' to reduce tax burden by s!ifting

profits from country to country. b. Financial mar"et arbitrage: different

financial mar"ets allo *s to earnmore from investment and to reduce

costs from financing. c. (egulatory arbitrage: different

regulations allo *' to circumventexc!ange and price controls.

DIFFERENT CHANNELS TO

MOVE FUNDS


189/268

1. ultilateral netting is a met!od to reduce foreignexc!ange cost t!roug! consolidation of accountspayable and accounts receivable among relatedentities.

2. Leads and lags are payments of financialobligations earlier #leads$ or later #lags$ t!an areexpected or re&uired.

3. *s can ad;ust transfer prices up or don toavoid financial problems or improve financialconditions.


MOVE FUNDS


190/268

=. (einvoicing centers are establis!ed in tax!aven countries and ta"e titles to all goodssold to one corporate unit to ot!er affiliates

or independent customers.

. Intracompany loans #as compared it!

e&uity investments$ provide *s it! taxbenefits and easy repatriation.


MOVE FUNDS


191/268

D. ,ayment ad;ustments can be madet!roug!:

a. Fees are compensations for managerialservices and tec!nical assistance.

b. (oyalties are paid to use certain

tec!nologies7 patents7 and trademar"s.


MOVE FUNDS


192/268

E. )nbundling international fund transfers:

a. *ategorization of remittances for eac!

purpose ma"es it easier for *s torecover funds from t!eir affiliates.

b. )nbundling fund transfers is useful for

business operations in countries !ereinterest and dividend profits areconsidered unfavorable.

CASH MANAGEMENT


193/268

1. /b;ectives are :

a. To optimize cas! flo movements

b. To invest excess funds.

CASH MANAGEMENT


194/268

2. Floats are used to reduce opportunitycost and exc!ange rate ris" by

s!ortening t!e folloing types of floats.

a. Invoicing float b. ail float

c. ,rocessing float

d. Transit float e. isbursing float.

CASH MANAGEMENT


195/268

3. To maximize cas! availability7 *s must acceleratecollections and delay payments.

a. To accelerate collections7 *s use loc"boxes7 cable remittances7 electronic fund

transfers7 and 'IFT.

b. To delay payments7 *s use mail7 morefre&uent re&uisitions7 and floats.

c. *s use cas! centers to invest more profitably7reduce overall financing costs7 and reduce t!e totalpool of cas! it!out any loss in t!e level of production.

INVESTING E+CESS FUNDS


196/268

1. ,ortfolio management:

a. )nder ,olicy 17 "non as zero portfolio7access funds are used to pay t!e

parent5s s!ort6term debt because anyportfolio investment ill earn less t!ant!e parent cost of s!ort6term loans.

b. )nder ,olicy 27 *s centralize cas!management at !ead&uarters.

c. )nder ,olicy 37 *s centralize cas!management in a fe regions.

INVESTING E+CESS FUNDS


197/268

2. ,ortfolio guidelines include:

a. iversification

b. ar"etability c. aturity d. 'afety

e. aily revie.

ACCOUNTS RECEIVABLE

MANAGEMENT


198/268

1. Important considerations are tradeoffs beteencurrency denomination and credit terms.

a. If sales are denominated in a ea" currency7!ig!er prices and s!orter credit terms are

expected.

b. If sales are denominated in a strong currency7loer prices and longer credit terms areexpected.

ACCOUNTS RECEIVABLE

MANAGEMENT


199/268

2. *redit policy: a. *redit standards are used to determine t!e

acceptability of loan applications and credit limits.*redit standards depend on five *5s of credit factors:

c!aracter7 capital7 collateral7 capacity7 and economic

condition. b. *redit terms !ave to do it! cas! discount and credit

period7 suc! as 2N1?7 net 3?: t!e opportunity cost ofterms 2N1?7 net 3? C 2N#1?? 6 2$ x 3D?N2? C 3EK.

c. *ollection policy !as to do it! overdue accounts. To collect overdue accounts7 *s use letters #fax and

cables$7 p!one calls7 personal visits7 and last resorts

#forgiveness7 legal action7 and use of collectionagency$.

ACCOUNTS RECEIVABLE

MANAGEMENT


200/268

3. +o to avoid currency value problems:

a. For intrafirm sales7 *s use leadingand lagging.

b. For sales to independent customers7

*s use currency denominationsand factors.

INVENTORY MANAGEMENT


201/268

1. T!e basic purpose is to minimize t!einvestment on inventory.

2. %dvance purc!ases and stoc"piling are

necessary:

a. From abroad: if devaluation and importrestrictions are imminent.

b. From local sources: if inflation andtermination of price controls are li"ely.


202/268

CHAPTER 0,

INTERNATIONAL

PORTFOLIO INVESTMENT

TERMINOLOGIES


203/268

1. 'ystematic ris" #undiversificible ris"$cannot be reduced or eliminated

t!roug! diversification.

)nsystematic ris" #diversifiable ris"$

can be reduced or eliminated t!roug!diversification.

TERMINOLOGIES


204/268

RRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRRR Tyof (is" omestic InternationalRRRRRR

'ystematic *ommon to all firms: *ommon to all countries:

-x.66a country5s tax las7 -x.66orldide ars7 energy

recessions7 inflation situations7 recessions

)nsystematic To a particular firm: To a particular country:

-x66a firm5s ildcat stri"e7 -x.66a country5s recessions7

ne competitor currency control7 inflation

TERMINOLOGIES


205/268

2. ar"et portfolio is a fully diversifiedgroup of ris"y securities suc! as o

8ones Industrial %verages7 'tandard V,oor5s ?? stoc"s7 or t!e i""ei Indexof 8apan.

CAPITAL ASSET PRICINGMODEL 3CAPM4

1 If capital mar"ets are perfectly efficient t!en


206/268

1. If capital mar"ets are perfectly efficient7 t!en

expected rate of return C re&uired rate of return.

a. 'ecurity mar"et line "; C (f < #(m 6 (f$

; #seeFigure 1D62$

b. If mar"ets are not perfectly efficient7 t!en emay !ave undervalued stoc"s or overvalued stoc"s:

)ndervalued stoc"s: If "; A (f < #(m 6 (f$

; #seeFigure 1D62$

/vervalued stoc"s: If "; B (f < #(m 6 (f$

; #see

Figure 1D62$

c. >eta coefficient: ; C W#"; 6 (f$N#(m 6 (f$X



207/268

2. %ggressive vs efensive 'toc"s:

If ;A1: aggressive stoc". If ;B1: defensive stoc".


3 *orrelation coefficients:


208/268

3. *orrelation coefficients:

a *orrelation coefficient is t!e degree ofcorrelation beteen to securities and rangefrom zero #no correlation or independent$ to Y1

#perfect correlation$. b iversification is most effective under

conditions of perfectly negative correlation#correlation coefficient C 61$.

c iversification does not reduce ris" at all underconditions of perfectly positive correlation#correlation coefficient C


209/268

1. -fficient portfolio is a portfolio t!at gives t!e!ig!est return for a given level of ris" #see point in Figure 1D63$ or t!e smallest ris" for a given levelof return #see point % in Figure 1D63$.

2. -fficient frontier is a locus of all efficient portfolios#see curve % in Figure 1D63$.

3. /ptimal portfolio is t!e tangency point beteent!e security mar"et line and t!e efficient frontier

#see point in Figure 1D6=$.

BENEFITS OF INTERNATIONAL

DIVERSIFICATION 3ID4


210/268

1. Intercountry correlations are lo becausecountries !ave different geograp!ic locations7independent economic policies7 and differentendoments of natural resources.

2.Lo intercountry correlations imply t!at muc!of t!e stoc" mar"et ris" in an individualcountry is unsystematic and so can bereduced by I #see Figure 1D6$.

3. I could allo investors to earn more moneyat loer ris" because of lo intercountrycorrelations #see Figure 1D6D$.

METHODS OF INTERNATIONAL

DIVERSIFICATION FOR US INVESTORS


211/268

1. International mutual funds are mutual fundst!at contain securities of foreign companies.

2.%merican depository receipts7 traded in )'

stoc" exc!anges7 are t!e oners!ip ofunderlying foreign stoc"s !ic! are !eld incustody by t!e ban" t!at issue t!em.

3.+edge funds are private partners!ips t!at bet

on cross6border mergers and ac&uisitions7securities7 or currencies.

METHODS OF INTERNATIONAL

DIVERSIFICATION FOR US INVESTORS


212/268

=.irect purc!ases of foreign securities..Investment in )' multinational

companies.

D.4lobal investing: % domestic fundmanager !as ;ust one ay to beat t!ecompetition7 by ma"ing better stoc"pic"s7 but an international fund manager

!as t!ree ays to add value7 by pic"ingcountries7 by pic"ing currencies7 and bypic"ing stoc"s.


213/268

CHAPTER 0-

CORPORATE STRATEGYAND FOREIGN DIRECT

INVESTMENT

BENEFITS OF FOREIGN DIRECTINVESTMENT


214/268

1. *ompany benefits include oligopoly6created advantages7 suc! as proprietarytec!nology7 management "no6!o7

international distribution netor"7 andaccess to scarce ra materials7economies of scale7 and strong brand or

trade name.

BENEFITS OF FOREIGN DIRECTINVESTMENT


215/268

2. *ompany benefits of foreign investmentclassified by Ferdos include t!ose t!atare intangible #i.e.7 ideas from foreign

researc! centers$ and tangible #i.e.7 loages$.

3. +ost6country benefits include transfer of

tec!nology7 !ig!er employment7learning management s"ills7 andincreased tax revenues and exports.

MODES OF FOREIGN INVESTMENT


216/268

1. *onstruction of ne plants #internal grot!$

2. ergers and ac&uisitions #external grot!$

3. 8oint ventures

=. Licensing agreement

. Franc!ising agreement

D. *ontract manufacturing

DIRECT INVESTMENT IN THE THIRD

'ORLD


217/268

1. Investment in t!e T!ird orld fell since 2??1 because of:

a. In 2??37 *!ina for t!e first time attracted more foreign

investment t!an t!e )'7 but t!e overall investment fellbecause of a slodon in privatization and mergers6and6ac&uisitions transactions.

b. T!e dip in foreign investment flos in 2??3 as almostentirely due to t!e decline in t!e flos to Latin %mericaand t!e *aribbean.


218/268

CROSSBORDER MERGERS ANDAC*UISITIONS


219/268

1.

a. Internal grot! is natural andeconomical7 but it is too slo.

b. -xternal grot!66mergers andac&uisitions66is an alternative

to internal grot!.



220/268

2. ergers and corporate governance

a. T!e mar"et6based system of corporategovernance used in t!e )' disciplines

inefficient management t!roug! eit!erfriendly ta"eovers or !ostile ta"eoversbecause t!is system is c!aracterized by

a !ig!ly diversified e&uity oners!ip7 alarge portion of public debt and e&uitycapital7 and an independent managementteam.



221/268

b. In t!e ban"6based system of corporategovernance used in 8apan7 !ostileac&uisitions are almost non6existent due tot!e concentration of e&uity oners!ip in t!e

!ands of t!e main ban" and ot!er "eiretsumembers.

c. *ross6!oldings in 8apan are ea"ening

because t!e netor"s of mutuals!are!oldings !ave turned from benefit to

burden.


7/23/2019 Global Finance -Introduction A.pp

global finance -introduction a.ppt

Documents