INTERNATIONAL FINANCIAL MANAGEMENT

International Financial Management Course Overview and Introduction to International Financial Management Course Overview  Prerequisites  BusFin 810 and/or BusFin 811  Requirements and Grading  Class participation and Cases (20%+20%)  Midterm Exam (30%)  Final Paper or Final Exam (30%)  Class Materials  Eun and Resnick, 2007, International Financial Management, Irwin McGraw-Hill, Boston, 4th Edition (3rd Edition OK)  Packet of Cases and Readings available in Uniprint Tuttle and online at http://uniprint.osu.edu/coursepackets/  Web-page: http://fisher.osu.edu/fin/faculty/werner/ Course Overview  Course Objective To provide a framework for making corporate financial decisions in an international context  Related Courses F821 Seminar in Corporate Financial Analysis F822 Security Markets F823 Special Topics in Investment Management F826 Management of Financial Institutions F829 Risk Management and Derivatives Course Overview Foreign Exchange Markets Sourcing Capital in Global Markets International Financial Management Synthesis Managing FOREX Exposure Foreign Investment Decisions Course Overview Introduction to international finance Introduction and course overview The foreign exchange market Corporate governance Parity conditions in international finance Foreign exchange derivative contracts International corporate finance issues Transactions exposure to exchange rates Translation exposure to exchange rates Operating exposure to exchange rates Course Overview International investment analysis Cost of capital International bond markets International equity markets Capital structure Corporate strategy and foreign investment analysis Offshoring/Outsourcing Project Finance Cross-border Joint Ventures Cross-border Mergers Course Overview Global Financial Crisis Bailouts and Bans Can a country go bankrupt? What is special about international finance? Foreign exchange risk E.g., an unexpected devaluation adversely affects your export market… Political risk E.g., an unexpected overturn of the government that jeopardizes existing negotiated contracts… Market imperfections E.g., trade barriers and tax incentives may affect location of production… Expanded opportunity sets E.g., raise funds in global markets, gains from economies of scale… What is money? Barter economy Search frictions Indivisibilities Transferability Commodity money Beaver pelts Dried corn Metals Fiat money Faith in government… 10 Central Banking  The U.S monetary authorities occasionally intervene in the foreign exchange (FX) market to counter disorderly market conditions  The Treasury, in consultation with the Federal Reserve System, has responsibility for setting U.S exchange rate policy, while the Federal Reserve Bank New York is responsible for executing FX intervention  U.S FX intervention has become less frequent in recent years http://www.ny.frb.org/ 27   WEDNESDAY, NOVEMBER 8, 2000 U.S INTERVENES IN THIRD QUARTER TO BUY 1.5 BILLION EUROS NEW YORK FED REPORTS NEW YORK – The U.S monetary authorities intervened in the foreign exchange markets on one occasion duri ng the third quarter, on September 22nd , buying a total of 1.5 billion euros, the Federal Reserve Bank of New York said today in its quarterly report to the U.S Congress  According to the report, the dollar appreciated 8.2 percent against the euro and appreciated percent against the Japanese yen during the three month period that ended September 30, 2000  The intervention was carried out by the foreign exchange trading desk at the New York Fed, operating in coordination with the European Central Bank (ECB) and the monetary authorities of Japan, Canada, and the United Kingdom The amount was split evenly between the Federal Reserve System and the U.S Treasury Department’s Exchange Stabilization Fund (ESF)  The report was presented by Peter R Fisher, executive vice president of the New York Fed and the Federal Open Market Committee’s (FOMC) manager for the system open market account, on behalf of the Treasury and the Federal Reserve System  The Foreign Exchange Market 28 The Spot Market The spot market involves the immediate purchase or sale of foreign exchange Cash settlement occurs 1-2 days after the transaction Currencies are quoted against the US dollar Interbank FX traders buy currency for their inventory at the bid price Interbank FX traders sell currency for their inventory at the ask price Bid price is less than the ask price Bid-ask spread is a transaction cost 29 The Spot Market – Direct Quotes  US dollar price of unit of foreign currency—$ are in the numerator (foreign currency is priced in terms of dollars)  $/€ = 1.5000 (1€ costs $1.5000)  $/£ = 2.0000 (1£ costs $2.0000)  Currency changes  Suppose that today, $/€ = 1.5000 and in month, $/€ = 1.5050  The $ has depreciated in value  Alternatively, the € has appreciated in value  Suppose that today, $/£ = 2.0000 and in month, $/£ = 1.9950  The $ has appreciated in value  Alternatively, the £ has depreciated in value 30 The Spot Market – Indirect Quotes  Foreign currency price of $1—$ are in the denominator (US dollar is priced in terms of foreign currency)  €/$ = 0.6667 ($1costs €0.6667)  £/$ = 0.5000 ($1 costs £0.5000)  Currency changes  Suppose that today, €/$ = 0.6667 and in month, €/$ = 0.6600  The $ has depreciated in value  Alternatively, the € has appreciated in value  Suppose that today, £/$ = 0.5000 and in week, £/$ = 0.5050  The $ has appreciated in value  Alternatively, the £ has depreciated in value 31 The Spot Market Conventions  Denote the spot rate as S  For most currencies, use decimal places in calculations  With exceptions: i.e S(¥/$)=109.0750, but S($/ ¥)=0.009168  If we are talking about the US, always quote spot rates as the dollar price of the foreign currency  i.e as direct quotes, S($/€), S($/C$), S($/£), etc  Increase in the exchange rate  the US dollar is depreciating  Costs more to buy unit of foreign currency  Decrease in the exchange rate  the US dollar is appreciating  Costs less to buy unit of foreign currency 32 The Spot Market Wednesday, January 8, 1997 EXCHANGE RATES     The New York foreign exchange selling rates below apply to  trading among banks in amounts of $1 million and more, as quoted  at 4 p.m. Eastern time by Dow Jones Telerate Inc. and other sources.  Retail transactions provide fewer units of foreign currency per  dollar Currency per  U.S.  $ U.S.  $  equiv Country  Wed.  Tues.  Wed.  Tues.  Argentina (Peso)  1.0012  1.0012  9988  9988  Australia (Dollar)  7805  7902  1.2812  1.2655  Austria (Schilling)  09043  09101  11.058  10.988  Bahrain (Dinar)  2.6525  2.6525  3770  3770  Belgium (Franc)  03080  03105  32.470  32.205  Brazil (Real)  9607  9615  1.0409  1.0401  Britain (Pound)  1.6880  1.6946  5924  5901      30­Day Forward  1.6869  1.6935  5928  5905      90­Day Forward  1.6843  1.6910  5937  5914      180­Day Forward  1.6802  1.6867          .5952  5929  Canada (Dollar)  7399  7370  1.3516  1.3568      30­Day Forward  7414  7386  1.3488  1.3539      90­Day Forward  7442  7413  1.3437  1.3489      180­Day Forward  7479  7450  1.3370  1.3422  Chile (Peso)  002352  002356  425.25  424.40  China (Renminbi)  1201  1201  8.3272  8.3276  Colombia (Peso)  0009985  0009985  1001.50  1001.50  Czech. Rep (Krouna)              Commercial rate  03662  03677  27.307  27.194  Denmark (Krone)  1663  1677  6.0118  5.9633  Ecuador (Sucre)              Floating rate  0002766  0002787  3615.00  3587.50  Finland (Markka)  2121  2135  4.7150  4.6841  France (Franc)  1879  1893  5.3220  5.2838      30­Day Forward  1882  1896  5.3126  5.2741      90­Day Forward  1889  1903  5.2935  5.2558      180­Day Forward  1901  1914  5.2617  5.2243  Germany (Mark)  6352  6394  1.5744  1.5639      30­Day Forward  6364  6407  1.5714  1.5607      90­Day Forward  6389  6432  1.5652  1.5547      180­Day Forward  6430  6472  1.5552  1.5450  Greece (Drachma)  004049  004068  246.98  245.80  Hong Kong (Dollar)  1292  1292  7.7390  7.7390  Hungary (Forint)  006139  006164  162.89  162.23  India (Rupee)  02787  02786  35.875  35.890  Indonesia (Rupiah)  0004233  0004233  2362.15  2362.63  Ireland (Punt)  1.6664  1.6714  6001  5983  Israel (Shekel)  3079  3085  3.2474  3.2412  Italy (Lira) 0006483 0006510 1542.50 1536.00 33 Currency U.S.  $  equiv per  U.S.  $ Country  Wed.  Tues.  Wed.  Tues.  Japan (Yen)  008639  008681  115.75  115.20      30­Day Forward  008676  008718  115.26  114.71      90­Day Forward  008750  008791  114.28  113.76      180­Day Forward  008865  008907  112.80  112.28  Jordan (Dinar)  1.4075  1.4075  7105  7105  Kuwait (Dinar)  3.3367  3.3389  2997  2995  Lebanon (Pound)  0006445  0006445  1551.50  1551.50  Malaysia (Ringgit)  4018  4002  2.4885  2.4990  Malta (Lira)  2.7624  2.7701  3620  3610  Mexico (Peso)              Floating rate  1278  1277  7.8220  7.8330  Netherland (Guilder)  5655  5699  1.7685  1.7547  New Zealand (Dollar)  7072  7106  1.4140  1.4073  Norway (Krone)  1540  1548  6.4926  6.4599  Pakistan (Rupee)  02529  02529  39.540  39.540  Peru (new Sol)  3814  3840  2.6218  2.6039  Philippines (Peso)  03800  03802  26.318  26.300  Poland (Zloty)  3460  3475  2.8900  2.8780  Portugal (Escudo)  006307  006369  158.55  157.02  Russia (Ruble) (a)  0001787  0001788  5595.00  5594.00  Saudi Arabia (Riyal)  2666  2667  3.7503  3.7502  Singapore (Dollar)  7116  7124  1.4053  1.4037  Slovak Rep. (Koruna)  03259  03259  30.688  30.688  South Africa (Rand)  2141  2142  4.6705  4.6690  South Korea (Won)  001184  001184  844.75  844.65  Spain (Peseta)  007546  007603  132.52  131.53  Sweden (Krona)  1431  1435  6.9865  6.9697  Switzerland (Franc)  7334  7387  1.3635  1.3537      30­Day Forward  7357  7411  1.3593  1.3494      90­Day Forward  7401  7454  1.3511  1.3416      180­Day Forward  7470  7523  1.3386  1.3293  Taiwan (Dollar)  03638  03637  27.489  27.493  Thailand (Baht)  03902  03906  25.625  25.605  Turkey (Lira)  00000911  00000915 109755.00 109235.00  United Arab (Dirham)  2723  2723  3.6720  3.6720  Uruguay (New Peso)              Financial  1145  1145  8.7300  8.7300  Venezuela (Bolivar)  002098  002096  476.70  477.12        ­ ­ ­        SDR  1.4315  1.4326  6986  6980  ECU 1.2308 1.2404 .          Special Drawing Rights (SDR) are based on exchange rates for  the U.S., German, British, French, and Japanese currencies. Source:   International Monetary Fund.      European Currency Unit (ECU) is based on a basket of community  currencies.      a­fixing, Moscow Interbank Currency Exchange.  US dollar price: S($/£)=1.6880 £1 costs $1.6880 UK pound price: S(£/$)=0.5924 $1 costs £0.5924 And note that S ($ / £)  S (£/$) The Spot Market • The current exchange, S($/€)=1.5000 In month, it is S(€/$)=0.6689 – Has the US dollar appreciated or depreciated? – By what % has the exchange rate changed? • Convert S(€/$)=0.6689 to: 1/S(€/$)=S($/€)=1.4950 – Now we see that the exchange rate has decreased  US dollar has appreciated – The % change per month is: 1.4950 - 1.5000  0.33% 1.5000 34 Cross Exchange Rates • The exchange rate between currencies where neither currency is the US dollar • We know the dollar rates What if we want to know other rates, i.e S(€/£) ? – Calculate cross-rates from dollar rates – S($/€)=1.5000 and S($/£)=2.0000 What is S(€/£), i.e the € price of £?   $ 1.3333    2.0000  £ $ £ 1.5000 £1  S ( / £) 1.3333 35 Cross-Exchange Rates • Cross-rates must be internally consistent; otherwise arbitrage profit opportunities exist • Suppose that:   $   £ $ £ • A profit opportunity exists Either S(€/£) is too high or S(€/$) or S($/£) is too low • How does this work? • Sell high and buy low 36 Cross-Exchange Rates Example Bank1: S($/¥)=0.0084; Bank2: S($/ €)=1.0500; Bank3: S(€/¥)=0.0081 The implied cross rate between Bank and is: S(€/¥)=0.0080 You have ¥1,250,000 What should you do?  Go to Bank Sell ¥ high! Convert ¥1,250,000 to €10,125.00 @ 0.0081  Go to Bank Convert €10,125 to $10,631.25 @ 1.0500  Go to Bank Buy ¥ low! Convert $10,631.25 to ¥1,265,625.00 @ (1/0.0084) The initial ¥1,250,000 becomes ¥1,265,625 You earn a risk-free profit of ¥15,625, or 1.25% 37 The Forward Market Forward market involves contracting today for the future purchase or sale of foreign exchange Forward prices are quoted the same way as spot prices Denote the forward price maturing in N days as FN i.e F30($/£), F180($/€), F90(€/ ¥), etc The forward dollar price of the euro can be: Same as the spot price Higher than the spot price (euro at a premium) Lower than the spot price (euro at a discount) 38 Wrap-Up  The foreign exchange market is by far the largest financial market in the world  Currency traders trade currencies for spot and forward delivery  Exchange rates are by convention quoted against the U.S dollar, but cross-rates can easily be calculated from bilateral rates  Triangular arbitrage forces the cross-rates to be internally consistent  The euro has enhanced trade within Europe, and the currency has the potential of becoming a major world currency 39 Assignment  Suppose you are Professor Paul Krugman (Princeton University Economics Professor and NYT columnist (Op-Ed Page))  On October 13, 2008, at 5am you receive a phone call from the Royal Swedish Academy informing you that you have been awarded the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for your work on international trade and economic geography  After first thinking this is a practical joke – “that is surely a fake Swedish accent” - the news sink in and you realize you have a small problem  The prize will be awarded at a ceremony on December 10 th in Stockholm, at which time you will receive the a medal, a diploma, and a prize check for SEK 10,000,000 or US$ 1,394,136 at the current spot rate (SEK 7.1729US$)  What should you do? 40 Nobel Prize Problem… 41 ... corporate financial decisions in an international context  Related Courses F821 Seminar in Corporate Financial Analysis F822 Security Markets F823 Special Topics in Investment Management F826 Management. .. F826 Management of Financial Institutions F829 Risk Management and Derivatives Course Overview Foreign Exchange Markets Sourcing Capital in Global Markets International Financial Management Synthesis... (30%)  Final Paper or Final Exam (30%)  Class Materials  Eun and Resnick, 2007, International Financial Management, Irwin McGraw-Hill, Boston, 4th Edition (3rd Edition OK)  Packet of Cases