International Financial Management

1
International Financial Management
2
Study and application of finance in the global
arena. Focus of critical attention on how
financial strategies, risk, tools, investments,
theories, and institutions work in a global
context.

• Learning Objectives
• To analyze the causes of exchange rate
  determination and develop solutions that deal
  effectively with foreign exchange risk.
• To extend the fundamental concepts of financial
  theory to international bond, equity, and
  derivatives markets.
• To apply managerial finance topics to the
  multinational firm.
• To measure and manage the risks arising from a
  firms international financial positions and
  operating activities.

3
Text

• Cheol Eun and Bruce Resnick, International
  Financial Management, Fourth Edition, McGraw-Hill
  Irwin, 2007, ISBN 0-07-299686-9

4
(No Transcript)
5
Globalization the Multinational Firm
6
What is Globalization?

• Business across Borders?
• Economic
• Technological
• Political
• Cultural
• Social
• Legal
• Environmental
• Reduction or elimination of local/national/regiona
  l asymmetries

7
Wheres the Wealth?
8
What is A Multinational Firm?

• Extension of Value Creation
• Multinational/Transnational Corporations
• Various business operations in numerous host
  countries
• Headquarters often far from operations
• Stock ownership, financial structure, and
  management are multinational

9
Extension of Value Creation Business across
Borders

• Rationales Extension of Control
• Location
• Demand
• Market proximity
• Costs
• Resource costs
• Transport costs
• Trade costs
• Trade barriers
• Foreign exchange
• Internalization
• Vertical
• Horizontal
• Technology transfer

10
Global 500
Revenues Profits
Source Fortune 2006 Global 500 List
11
Globalization and MNCsCauses or Consequences

• Expanded Opportunities
• Lower Costs
• Raise Value
• Trade liberalization
• Economic integration
• Privatization
• Global financial markets
• Expanded Challenges
• Country and Commercial Risk
• Foreign Exchange Risk
• Market Imperfections
• True for individual investors and corporations

12

• Country Risk
• Political
• Politically and socially generated change
• Government acts or general systemic instability
  due to war, occupation, riots, territorial
  claims, ideological differences, civil war,
  tribalism, income inequalities, religious
  divisions, rebellion
• Sovereign governments have the right to regulate
  the movement of goods, capital, and people across
  their borders. These laws sometimes change in
  unexpected ways.
• Economic
• Uncertainties relating to future changes in cost,
  demand, and marketplace competition
• long-term GDP decline, strikes, productivity
  costs, export earnings decline, raw material
  price increases
• Commercial Risk
• Uncertainty over willingness and ability of
  counterpart to fulfill agreed terms

13

• Foreign Exchange Risk
• The risk that foreign currency profits may
  evaporate in home currency (rupee) terms due to
  unanticipated unfavorable exchange rate
  movements.
• Suppose 1 Rs50 and you buy 1 share of IBM at
  100 per share. Paid Rs5000
• One year later the investment is worth ten
  percent more per share in dollars 110
• But, if the dollar has depreciated to 1 Rs40,
  your investment has actually lost money in rupee
  terms. Rs4400

14

• Market Imperfections
• Legal restrictions on movement of goods, people,
  and money
• Transactions costs
• Shipping costs
• Tax arbitrage

15
HOME
FOREIGN
HOME
GOODS
GOODS
GOODS
AND
AND
AND
SERVICE
SERVICES
S
SERVICES
ASSETS
ASSETS
16
The International Monetary System
17
Outline

• Evolution of the International Monetary System
• Current Exchange Rate Arrangements
• Fixed versus Flexible Exchange Rates
• European Experiences
• EMS and EMU
• Crises
• Mexico
• Asia
• Argentina

18
Evolution of the International Monetary System

• Bimetallism Before 1875
• Classical Gold Standard 1875-1914

19
Price-Specie-Flow
Foreign
Home
20
Price-Specie-Flow
Foreign
Home
Net Flow of Goods and Services
21
Price-Specie-Flow
Foreign
Home
Net Flow of Goods and Services
22
Evolution of the International Monetary System

• Bimetallism Before 1875
• Classical Gold Standard 1875-1914
• W W I
• Inter-war failures
• Post-war policy
• Bretton Woods and the dollar standard
• Current situation

23
CAD
DEM
.9250
.2732
GBP
2.40
JPY
FRF
.0028
.1800
US
DOLLAR
Par
OTHERS
ITL
35 1 oz.
.0016
GOLD
24
Movements in Parities of Currencies of
Selected Industrial Countries
120
USD, CHF, JPY
100
DEM
BEF
80
NLG
DKK
60
GBP
ITL
40
FRF
20
0
1947
1950
1955
1960
1965
1970
25
CAD
DEM
.9250
.2732
GBP
2.40
JPY
FRF
.0028
.1800
US
DOLLAR
Par
OTHERS
ITL
35 1 oz.
.0016
GOLD
26
Movements in Parities of Currencies of
Selected Industrial Countries
120
USD, CHF, JPY
100
DEM
BEF
80
NLG
DKK
60
GBP
ITL
40
FRF
20
0
1947
1950
1955
1960
1965
1970
27
Post-Bretton Woods Exchange Rate Trends
Germany Japan UK US
1990 100
28
Current Exchange Rate Arrangements

• Free Float
• The largest number of countries, about 48, allow
  market forces to determine their currencys
  value.
• Managed Float
• About 25 countries combine government
  intervention with market forces to set exchange
  rates.
• Pegged to another currency
• Such as the U.S. dollar or euro (through franc or
  mark).
• No national currency
• Some countries do not bother printing their own,
  they just use the U.S. dollar. For example,
  Ecuador, Panama, and El Salvador have dollarized.

29
How IMF Members Determine Exchange Values
30
Floating Exchange RatesThe Case For

• Monetary policy autonomy
• Changes in the supply of money used to try to
  influence the levels of output, employment, and
  prices. GDP C I G (Ex-Im)
• Symmetry
• Automatic stabilizers

31
Floating Exchange RatesThe Case Against

• Monetary discipline
• Reduces inflation premium
• Speculation
• 1992
• Trade and investment
• EEC
• Uncoordinated policy
• Inter-war period
• Illusion of autonomy
• Markets and credibility

32
Trilemma

• Exchange rate stability
• Monetary policy autonomy
• Capital mobility

33
Exchange Rate Stability
Capital Controls
Currency Board
Monetary Policy Autonomy
Free movement of Financial Capital
Floating Exchange Rates
34
European Experiences

• EMS
• EMU
• Eurozone

35
Crises

• Mexico
• Asia
• Argentina

36
Currency Crisis Explanations

• In theory, a currencys value mirrors the
  fundamental strength of its underlying economy,
  relative to other economies. In the long run.
• In the short run, currency traders expectations
  play a much more important role.
• In todays environment, traders and lenders,
  using the most modern communications, act by
  fight-or-flight instincts. For example, if they
  expect others are about to sell Brazilian reals
  for U.S. dollars, they want to get to the exits
  first.
• Thus, fears of depreciation become
  self-fulfilling prophecies.