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International Finance Introduction Today’s Objectives • Understand the syllabus and how it works • Understand my goals for this course (teaching and learning objectives) • Understand my philosophy of teaching • Understand the focus of the course • Understand FOREX transactions and the role of arbitrage Fred Thompson Learning Objectives and Philosophy • I want you to learn how to DO things – Perform codified practices such as calculating cross-exchange rates, currency and intertemporal arbitrage, currency hedging – Understand when and why to perform them, as well as how • Watch, Do, Teach Fred Thompson Our Focus • We will focus on the institutions and markets that “connect” nations’ economies, especially financial sector linkages • More specifically, we will concentrate on FOREIGN DIRECT INVESTMENT Fred Thompson Real and Financial Sectors • Real Sector: Production and sale of goods and services; acquisition and divestiture of capital assets • Financial Sector: Transactions in financial assets: currency, bank deposits, bonds, stocks, futures and options, etc Fred Thompson International Economic Integration International economic integration refers to the extent and strength of real- sector and financial-sector linkages among national economies Real-sector linkages occur through the international transactions in goods and services while the financial-sector linkages occur through international transactions in financial assets Fred Thompson The Rise of Multinational Firms • Changes our definition of comparative Advantage – Relative value-added product development, design, logistics, assembly, marketing depends less on national differences and more on firm-specific competencies and investments, although these latter reflect national differences in factor endowments – The range of a nation’s exports is equivalent to the range of its exports • Comparative Advantage in a world of multinationals – Most cross-border trade involves intermediate products, much of it takes place within the boundaries of a single firm (a single Barbie doll is made in 12 countries) Fred Thompson Evolution of the Multinational Corporation (FDI) • • • Raw materials seekers Market seekers Cost minimizers/product enhancers – Coase firms exist where they reduce transactions (search, bargaining, monitoring and enforcement costs) and logistics costs, otherwise transactions would take place through markets They internalize externalities, economies of scale and scope (which give rise to non-exhaustibility), thru creation of effective governance institutions, that would obtain in a world without organizations – Some of these potential economies can be obtained by locating operations where factor costs are lower • Flexibility, adaptability, & speed of response Fred Thompson International Financial Management: Why? • Financing & investment decisions that maximize value added by firm • Asset deployment & utilization to increase PV future cash flows – You must create value first before you can distribute it • True of Corp Finance in general, so why study IFM? What makes it different? Fred Thompson International Financial Management: Why? • Borders, different currencies • BUT, if financial markets were completely integrated, different currencies wouldn’t matter (Of course, if there were no real exchanges, you wouldn’t need financial markets.) IN NEITHER CASE WOULD WE BOTHER TO STUDY IFM! • IFM deserves a special course only because integration has gone far enough to give it meaning, but not far enough to make it just like domestic finance Fred Thompson 10 International Flow of Goods, Services, & Capital • Domestic Savings and Investment & NFF National Income (GNY) = Consumption (C) + Savings (S) National Spending (GNE) = Consumption (C) + Investment (I) GNY - GNE = S - I GNY - GNE = Exports (x) - Imports (m) S-I=x-m Net Foreign Investment = x - m Fred Thompson 43 Government Budget Deficits and NFF GNE = Household spending + Private I + Government spending = GNY - Private S - Taxes + Private I + Government spending GNE - GNY = Private (I - S) + GovDeficit/Surplus NFF = Private savings surplus - GovDeficit Fred Thompson 44 US Balance of Payments U.S TRADE AND CURRENT ACCOUNT BALANCES EXPRESSED AS A PERCENTAGE OF GDP 4% 2% 0% C/A TB -2% -4% -6% 46 50 54 Fred Thompson 58 62 66 70 74 78 82 86 90 94 98 46 Basic Premise A current account deficit must be financed by capital inflows, or it cannot be incurred in the first place FACT Over 1982-2003, U.S current account deficits have averaged $183 billion per year $4 trillion worth of assets have been transferred to foreign ownership Trade and Scale Variables I QuickTime™ and a TIFF (Uncompressed) decompressor are needed to see this picture Fred Thompson 49 Scale Variables I U.S monthly GDP: $1 trillion • Monthly goods and services exports: $130 billion = 13% • Monthly goods and services imports: $185 billion = 18.5% • Balancing item: net capital flow: $55 billion = 5.5% Fred Thompson 50 Scale Variables II U.S GDP per worker: $84,000 per year • Exports of $10,900 per year • Imports of $15,500 per year Fred Thompson 51 Result: Foreign claims on U.S assets now exceed U.S claims on foreign assets by about $2.7 trillion –Storing up purchasing power for the future –Private political risk insurance –Public political risk insurance International Investments (market value, end-2003) U.S foreign investments: Foreign investments in U.S.: Net: $7.9 trn $10.5 trn -$2.7 trn Much of this capital inflow has been portfolio investment Some has been direct investment Foreign Direct Investment (market value, end-2003) U.S DI abroad: $2.7 trillion Foreign DI in U.S.: $2.4 trillion Net: $0.3 trillion Direct Investment Positions At current market value, $ trillion U.S Direct Investment Abroad Foreign Direct Investment in U.S Fred Thompson 55 US foreign direct investment, 2001 Asia,P acific Other 11% 2% J apan U.K 18% 5% Caribbean 8% L.America 12% Europe Canada 34% 10% Fred Thompson 56 Foreign direct investment in US, 2001 Japan Other 12% 5% Caribbean 3% UK 16% Canada 8% other Europe 56% Fred Thompson 57 ... 11 FOREX Fred Thompson 12 Multinational Policymaking The International Financial Architecture International Financial Architecture • The international financial architecture is comprised of the... organizations at the center of efforts to stem international financial crises are: • The International Monetary Fund: a multinational organization the promotes international monetary policy cooperation,... create value first before you can distribute it • True of Corp Finance in general, so why study IFM? What makes it different? Fred Thompson International Financial Management: Why? • Borders, different