Presentacin de PowerPoint

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Financial Management of Multinational Companies
Gautam Goswami Graduate School of
Business Fordham University
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BASIC THEME

• Multinational Financial Managers function
• Multinational Financial Management Vs. Domestic
  Financial Management
• Examples
• - Corporate Finance
• - Investments
• - Banking (Financial Intermediation)
• - International Finance

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RATIONALE OF THE MULTINATIONAL FIRM

• Theory of Comparative Advantage
• Example
• Economic and business rationale
• Rate of Return and Risk
• Host countrys perspective
• Multinational business perspective

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RATIONALE OF THE MULTINATIONAL FIRM

• Rate of Return and Risk
• Rate of Return
• On common stock of multinational firms
• Convenient proxy for international
  diversification
• Risk Management through
• Geographic diversification
• Currency diversification

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INTRODUCTION Course Overview

• 1. Foreign Exchange Markets
• Spot, Forward, Futures, Options
• Arbitrage, Hedging and Speculation
• 2. Fundamental Theories in Corporate Finance
• - Net Present Value (NPV)
• - Capital Asset Pricing Model (CAPM)
• - Arbitrage Pricing Theory (APT)
• - Option Pricing Model (OPM)
• - Dividend Theories
• - Capital Structure Theory

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INTRODUCTION Course Overview
2. Fundamental Theories in Corporate Finance
(Cont.) - Purchasing Power Parity
(PPP) - Interest Rate Parity (IRP) - Put-Call
Parity (PCP) - Fisher Effect (FE) - Generalize
d Fisher Effect (GFE) - International Fisher
Effect (IFE)
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INTRODUCTION Course Overview
3. Financial Management Issues 3.1 Taxation
- Location Decision - Dividend
Decision - Fees Royalties Decision 3.2 Working
Capital Management 3.3 Measurement and
Management of Accounting Economic
Exposure Contractual Exposure 3.4 Trade
Financing
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INTRODUCTION Course Overview
3.5 Capital Budgeting and Cross Border
Valuation 3.6 International Financing - Euro
debt Market - Debt Financing - Equity
Financing - Swaps 3.7 Valuations for Mergers
Acquisitions
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INTRODUCTION - Fx Markets

• Why Fx markets are important?
• Who is affected by Fx markets?
• National Vs. Multinational Companies

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FOREIGN EXCHANGE MARKETS
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FOREIGN EXCHANGE MARKETS

• Mechanism to
• Transfer purchasing power
• Obtain or provide credit
• Minimize exposure to risk
• Not an organized physical marketplace
• Highly sophisticated telecommunications network

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FOREIGN EXCHANGE MARKETS

• Structure of Foreign Exchange Market
• Tiers (i) Interbank or wholesale market
• (ii) Client or retail market
• Participants
• - Bank/non-bank foreign exchange dealers
• - Individuals/firms conducting comm./ investment
  transactions
• - Speculators/arbitrageurs
• - Central banks and treasuries

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FOREIGN EXCHANGE MARKETS

• Size
• Fx Market The largest financial market in the
  world
• Most important markets (daily turnover in 1995)
• London 464 billion
• NY 244 billion
• Tokyo 161 billion
• Less important markets
• Singapore, Hong Kong, Zurich (90-115b)
• Markets
• Spot Market
• Forward Market
• Futures Market
• Options Market

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FOREIGN EXCHANGE MARKETS

• Major currencies traded in the US market
• DM 34.2
• 23.0
• 18.6
• SF 9.7
• Can 5.2
• Basic Operations
• Arbitrage Spot Markets
• Hedging Forward, Futures, Options Markets
• Speculation

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FOREIGN EXCHANGE MARKETS

• Delivery 1 or 2 business days
• Delivery of FX is not instantaneous. When you
  exchange bank drafts of western nations, delivery
  takes place after 2 days.
• In the case of a transactions involving the US
  and the Can delivery takes place after 1 day.

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EXCHANGE RATE QUOTATIONS

• Definition An exchange rate is the number of
  units of one currency that one requires in order
  to purchase one unit of another currency
• An example of a quote is US0.8/C. This means
  that you can exchange a Can for US0.80. In
  other words, you can buy a C by paying 80 US
  cents.

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EXCHANGE RATE QUOTATIONS

• Direct Quote Units of Local Currency (LC) per
  Foreign Currency (FC)
• From a U.S. Perspective, a Direct Quote is
  expressed as Dollars/Unit of Foreign Currency.
  Examples
• 1.746 /Pound 1.746 Pounds 1
• 0.6154 /DM 0.6154 DM 1
• When expressed in this fashion, the exchange
  rate is the Dollar Price of a FC, and is
  conceptually equivalent to a commodity price

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EXCHANGE RATE QUOTATIONS

• Indirect Quote Units of Foreign Currency (FC)
  per Local Currency (LC). Examples
• 0.5727 Pound/ Pounds 0.5727 1
• 1.6250 DM/ DM 1.6250 1
• To do any exchange rate calculation (appreciation
  or depreciation) you must first express the
  exchange rate as a direct quote

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WSJ/ FC newspaper copy
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EXCHANGE RATE QUOTATIONS

• Most currencies on the interbank market are
  quoted as units of Foreign Currency/Dollar. For
  example
• 1.6250 DM/ DM 1.6250 1
• 133.25 Yen/ Yen 133.25 1
• From a U.S. perspective, these quotes are
  Indirect. To convert from Indirect to Direct, use
  the relationship
• Direct 1 / Indirect

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TYPES OF EXCHANGE RATE

• Exchange rates classified by maturity
• Spot - which means the exchange rate for buying
  or selling the currency today. Denote this by
  S(t)
• Forward - which means the exchange rate for
  buying or selling the currency at some future
  date, say 3 months from now. For example, you
  could ask your bank to quote you an exchange rate
  to sell dollars for pounds for March S(t3).

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TYPES OF EXCHANGE RATE

• Exchange rates classified by maturity (cont.)
• Future Spot - This is different from the fwd rate
  because while the fwd rate is fixed (that is, the
  bank promises to make the transaction at the rate
  quoted) the future rate is only an estimate of
  what the spot rate should be 3 months from now.
  ES(t3)

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TYPES OF EXCHANGE RATE

• Exchange rates classified by type of
  transactions
• Bid-Ask
• The rate that you are quoted at which the bank
  will buy a currency from you (and you will sell
  the currency) is called the BID rate.
• The rate at which the bank will sell a currency
  to you is the ASK rate.
• (US/SFr) Bid Ask
• Spot 0.3968 0.3978

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TYPES OF EXCHANGE RATE

• Exchange rates classified by type of
  transactions
• Bid-Ask
• Example Convert indirect quote to direct quote
• Bid Ask
• (Indirect Quote) Spot SFr 2.4027/US
  2.4051/US
• (Direct Quote) Spot US 0.4158/SFr
  (1) 0.4162/SFr (2)
• (1) Bid Rate (US per SFr) 1 / Ask Rate (SFr
  per US) 1 / 2.4051
• (2) Ask Rate (US per SFr) 1 / Bid Rate (SFr
  per US) 1 / 2.4027
• Always Ask Rate Bid Rate

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TYPES OF EXCHANGE RATE

• Exchange rates classified by type of
  transactions
• Bid-Ask (cont.)

Ask Price Bid Price
x 100
Bid-Ask Spread()
Ask Price
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EXCHANGE RATE QUOTATIONS

• Point Quotation or Swap Quotation Rates quoted
  on point basis. This is because in a swap
  transaction the bank will only pay the points,
  that is, the difference between the spot and the
  forward quote.
• Example
• 0.3968/78 15/17 33/38 93/103 per SFr

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EXCHANGE RATE QUOTATIONS

• Outright QuotationThe Outright Quote is the same
  as quoting spot exchange rates. For example the
  outright forward quote on the 3-month SFr could
  have been .4001/.4016 which mean that the bank
  will buy SFr at .4001/SFr and sell it at
  .4016/SFr.
• (US/SFr) Bid Ask
• Spot 0.3968 0.3978
• 30D 0.3983 0.3995
• 90D 0.4001 0.4016
• 180D 0.4061 0.4081

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EXCHANGE RATE QUOTATIONS

• Rule of Thumb is that as we move into quotes for
  future dates the spread between the bid and the
  ask must increase. The economic intuition for
  this is that as we go further into the future,
  risk increases and thus the banks charge a higher
  rate for their services - thereby widening the
  spread.

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EXCHANGE RATE QUOTATIONS

• Cross Rate Exchange rate involving two
  currencies other than the US dollar. Generally,
  cross rates are calculated from US rates.
• For example, given the following dollar exchange
  rates
• 133.25 Yen/
• 1.6250 DM/
• The cross rate is
• (133.25 Yen/) / (1.6250 DM/) 82.00 Yen/DM

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SPOT EXCHANGE MARKET
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SPOT EXCHANGE MARKET

• Arbitrage risk free profit from explicit market
  disequilibrium (Bid Ask)
• Arbitrage across market-makers
• Two- way arbitrage opportunity
• One way arbitrage opportunity

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SPOT EXCHANGE MARKET
Example 1 No Transaction Costs Citibank quotes
DM/USD 1.6500 Chemical Bank quotes DM/USD
1.6501 - Two-Way Buy from Citibank, sell to
Chemical Bank netting USD .0001/DM - One-Way All
buyers of USD go to Citibank all sellers of USD
go to Chemical Bank To avoid arbitrage
opportunities, both quote the same price for USD
in DM
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SPOT EXCHANGE MARKET

• Example 2 With Transaction Costs (bid-ask
  spread)
• BEF/DM 20.50 X 20.55 20.61 Z 20.66
• Bid Ask Bid Ask
• BEF/DM 20.60 Y 20.65
• Bid Ask
• Quotes
• Strong arbitrage opportunities between banks X
  and Y,
• Not so between banks Z and Y.

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SPOT EXCHANGE MARKET
Example 3 3-Point Arbitrage Opportunity
Bid Ask DM/ 2.4520 2.4530 /Pound 1.3840
1.3850 DM/Pound 3.3901 3.3920
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SPOT EXCHANGE MARKET
Example 3 (cont.) Find Cross Rate from 2 quotes
and compare with 3rd one
DM DM
x
Cross Rate

Pound Pound
Bid Rate Ask Rate 2.4520 x 1.3840 2.4530 x
1.3850 3.3950 3.3974
B
B
A
A
3.3901
3.3920
3.3935
3.3974
Buy
Sell
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FORWARD/FUTURE EXCHANGE MARKETS
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FORWARD/FUTURE EXCHANGE MARKETS

• Forward Rate The forward rate is the rate that
  is contracted today for the delivery of a a
  currency at a specified date in the future, at a
  price agreed upon today.
• Forward rate reflects the markets risk-adjusted
  expectations about the future spot rate
• Implications for - Financial reporting
• - Pricing for exports
• - Firms invoicing and risk-
  management policies

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FORWARD/FUTURE EXCHANGE MARKETS

• Forward Premium/Discount Difference between a
  N-day forward price and the spot price expressed
  as percent per annum.
• General Formula

FW Spot
360
x
Spot
N
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FORWARD/FUTURE EXCHANGE MARKETS

• Forward or Future Contract Agreement to buy or
  sell a specified quantity of an asset as a
  specified price at a specified time and place
• Difference
• Forward Spot Cost of Carry Model
• F(0,T) S(0) 1 is x T

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FORWARD/FUTURE EXCHANGE MARKETS

• How to hedge with Forward Contract

Buy For.
Long FC
ST
ST
Sell For.
Short FC
Sell For.
Buy For.

0
0
-
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FORWARD/FUTURE EXCHANGE MARKETS

• Future Contract
• RISK Must be delivered or settled (obligation)
• Payoff Schedule

Receive FC
Future Spot Rate
1.6
1.7
Sell Forward
Spot Rate 1.6/BP Exporter Sell
Forward Forward Rate 1.7/BP Importer Buy
Forward
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FORWARD/FUTURE EXCHANGE MARKETS

• Special Features of Future Markets
• - Clearing House Guarantees contract performance
  by taking opposite side of the contract
• Independent Corporation member clearing
  firm
• - Margin Requirement Post margin money with a
  member clearing firm
• Reduction of Credit Risk
• Initial Margin Vs. Maintenance Margin

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FORWARD/FUTURE EXCHANGE MARKETS

• Special Features of Future Markets (cont.)
• - Daily Resettlement Marking to Market
• Traders realize looses or gains daily
• Example
• Contract Size SF125,000 Futures Price
  0.694/SF
• Todays Price 0.70/SF
• Tomorrow 0.72/SF
• Holder gains 125,000 (0.70 - 0.694) 750
• 125,000 (0.72 - 0.7) 2,500

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FORWARD/FUTURE EXCHANGE MARKETS

• Special Features of Future Markets (cont.)
• - Daily Price Limit
• Up Limit and Down Limit
• Position Limit ( of contracts)
• - Delivery Terms
• Cash settlement
• OR
• Reversing Trades

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FORWARD/FUTURE EXCHANGE MARKETS

• Special Features of Future Markets (cont.)
• - Executing Trades Commission Broker Vs. Locals
• Locals Scalpers
• Day Traders
• Position Traders

(client)
(own)
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FORWARD/FUTURE EXCHANGE MARKETS

• Comparison of Forward and Futures Contract

Criteria
Forward
Future
Phone/Telex Self-regulating 90
delivered Tailor made (larger) Any date
1. Trading 2. Regulation 3. Delivery 4.
Size 5. Date
Trading Floor C.F.T.C. 5 delivered Fixed Few
dates
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FORWARD/FUTURE EXCHANGE MARKETS

• Comparison of Forward and Futures Contract
  (cont.)

Criteria
Forward
Future
Between bank customer on any date European Bid-A
sk spread Not Required High
6. Settlement 7. Quotes 8. Transaction Cost 9.
Margins 10. Credit Risk
Trough Excges Clearing house Marked to Market
Required Low
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FORWARD/FUTURE EXCHANGE MARKETS

• Forward and Money Market Relationship
• Buy/Sell in Futures Market

Buy FC spot 1/St
HCt
FCt
Sell FC spot St
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FORWARD/FUTURE EXCHANGE MARKETS

• Forward and Money Market Relationship
• Borrow/Invest in Money Market

HCt
t 0
Borrow 1/ 1rt,T
Invest 1rt,T
HCt
t T
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FORWARD/FUTURE EXCHANGE MARKETS

• Forward and Money Market Relationship

Buy FC spot 1/St
HCt
FCt
Sell FC spot St
Borrow 1/ 1rt,T
Invest 1rt,T
Borrow 1/ 1rt,T
Invest 1rt,T
Buy Forward FCt 1/Ft,T
FCt
HCt
Sell Forward FCt Ft,T
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FORWARD AND MONEY MARKET RELATIONSHIP

• Interest Rate Parity

FT 1 rh So 1 rf

IRP
1 rh
FT
Forward Price
So

1 rf
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OPTIONS CURRENCY MARKETS
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OPTIONS CURRENCY MARKETS

• Option Right to buy (Call) or sell (Put) foreign
  currency or currency futures
• Call Option Right to purchase underlying asset
  (e.g. foreign currency or common stock) at a
  certain strike price any time prior to or on a
  specified expiration date
• Buy a Call Option Pay a Premium
• Write a Call Option Receive a Premium

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OPTIONS CURRENCY MARKETS

• Put Option Right to sell underlying asset (e.g.
  foreign currency or common stock) at a certain
  strike price any time prior to or on a specified
  expiration date
• Buy a Put Option Pay a Premium
• Write a Put Option Receive a Premium
• European option can be exercised only at maturity
• American option can be exercised at any time

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OPTIONS CURRENCY MARKETS

• Strike or Exercise Price (X) Price at which I
  have the right to buy or sell
• Future Spot Rate (S1)
• Call Payoff (CT) (S1 X), 0
• Put Payoff (PT) (X S1), 0

Maximum payoff
Minimum payoff
Maximum payoff
Minimum payoff
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OPTIONS CURRENCY MARKETS

• Option is not an obligation, it is a right
• Downward risk is limited to premium
• Break even point for call Exercise Premium
• Break even point for put Exercise Premium

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OPTIONS CURRENCY MARKETS

• Elementary Positions

Long Put

Long Call
S T
Short Put
Short Call
A call option on the FC can be considered a put
option on the HC
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OPTIONS CURRENCY MARKETS

• Hedged Positions

Long fwd
Net payoff
Write two calls 2 for 1
If Long (receive) Fx Buy a Put OR Sell
forward OR Sell Future If Short (pay) Fx Buy
a Call OR Buy Forward OR Buy Futures
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THEORIES OF EXCHANGE RATE
Put-Call Parity
Buy a Put
Long (Sell) Forward Buy a Put Sell a Call
X
T
Sell a Call
T Future Exchange Rate X Exercise Price of
the option
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THEORIES OF EXCHANGE RATE

• Put-Call Parity (1)
• Pt Ct
• Put-Call Parity (2)
• Pt Ct

X - FT
1 rT
X
So
-
1 rhT
1 rfT
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THEORIES OF INTERNATIONAL FINANCE
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THEORIES OF INTERNATIONAL FINANCE

• Purchasing Power Parity Condition (PPP)
• Absolute Version Law of one price
• e0 Ph / Pf
• Relative Version Changes in the price levels
  will be reflected in currency values
• et/ef

Pho(1 ih)/Pfo
(1 ih)
Pfo(1 if)/Pfo
(1 if)
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THEORIES OF INTERNATIONAL FINANCE

• Generalized Fisher Effect (FE)
• (1 r) ( 1 a) (1 i)
• (1 nominal int. rate) (1 real int. rate)
  x (1 inflation)
• International Fisher Effect (IFE)
• Real returns are equalized across countries

ih if
rh -rf

1 if
1 rf
1 S0
rh -rf

S0
1 rf
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THEORIES OF INTERNATIONAL FINANCE

• Interest Rate Parity (IRP)
• Unbiased forward rate hypothesis E(1) F
• Exchange Rate Forecasting
• - Using PPP
• - Using IFE

rh -rf
F1 S0

S0
1 rf
1 Ius

ET
E0
1 If
1 Rus(T)

ET
E0
1 Rf(T)