Chapter 22 - International Business Finance

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Chapter 22 - International Business Finance
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Todays agenda and learning goals

• Using exchange rates.
• What is exchange rate risk?
• Managing exchange rate risk?
• Jerry Springer Minutes What have we learned?
• Top 10 List revisited
• 3 key course things to remember.

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Got to get some beer!

• Moe opens a new bar in Springfield called Moes
  International Drinking Emporium and needs to
  convert dollars into other currencies buy some
  imported brews.
• He is considering buying 500 cases of Cuatro
  Equis beer from Mexico for 300,000 pesos and 500
  cases of King Homers Mead from England for 3,000
  pounds.
• How many dollars would Moe need to convert to
  complete each of these transactions?

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Exchange Rates

• Direct Quote number of units of home currency
  needed to acquire a unit of a foreign currency.
• Indirect Quote number of units of a foreign
  currency needed to acquire a unit of the home
  currency.
• Direct and Indirect quotes are reciprocals of
  each other.
• /peso rate 0.1080 peso/ rate 9.259
• S/pound rate 1.4506 pound/ rate 0.689

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Back to Moe

• Cost of Cuatro Equis 0.108/peso x 30,000 pesos
  3,240
• Cost of King Homers Mead 1.4506/pound x 3,000
  pounds 4,351.80
• Question How many pesos would it take to buy
  King Homers Mead?
• 4,351.80 x 9.259 pesos/ 40,293 pesos
• The peso/pound exchange rate is
  40,293pesos/3,000pounds or 1.4506/pound x 9.259
  pesos/ 13.4311 This is called a cross rate.

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Exchange Rate Risk

• Imagine Moe is considering entering into a
  contract to purchase 1,000 cases of Alp Yodel Ale
  in 3 months for 40,000 Swiss Francs.
• What will be Moes dollar cost?
• Dont know for sure. This is an example of
  transaction risk.
• Lets investigate.

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Moes exchange rate risk

• Currently 0.607/franc (known as spot price),
  which makes todays cost 0.607/franc x 40,000
  francs 24,280.
• However, in 3 months the exchange rate could be
  0.65/franc, making Moes cost 26,000. Ouch!
• If Moe wants to know his future cost with
  certainty, how could he hedge this risk?
• Franc futures, options? Too small of an amount
  here.
• Solution a 3-month forward contract with Bank of
  Springfield.

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Moes Forward Hedge

• With this forward contract, the bank agrees to
  sell Moe Swiss Francs in 3 months at an exchange
  rate agreed to today.
• Todays 3-month forward rate is 0.6075/franc.
• This makes Moes cost of Alp Yodel Ale
  0.6075/franc x 40,000 francs 24,300.
• Thanks to the forward contract Moes future cost
  is fixed (locked in).

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Forward to spot premium

• Annualized Premium(Discount) (F
  S)/S x 12/n x 100
• Where F forward rate
• S spot rate (todays exchange rate)
• n of months
• From our 3-month forward example
• (.6075 - .0607)/.0607 x 12/3 x 100 0.33 Swiss
  Franc forward premium.

10

• TOP
• 10
• LIST
• (revisited)

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Top 10 questions we will answer in Finance 254
this semester.

• 10. What is the goal of the firm?
• 9. Why there is no such thing as a free lunch?
• 8. How do you figure out loan payments?
• Why do bond and stock prices tend to fall when
  inflation or interest rates go up?
• 6. Why Microsoft deserves its legal troubles.

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Top 10 questions we will answer in Finance 254
this semester.

• 5. Why is Homer Simpson so dumb?
• 4. How do you calculate a P/E ratio? (Anna
  Kournikova guest lecturer)
• 3. Why do they call them coupon payments?
• 2. How does a rookie futures trader turn a 1000
  into 100,000 by playing the cattle futures
  market? (Guest lecturer Hillary Clinton)
• 1. How to make a million dollars and not pay
  taxes.

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The 3 key things to remember from Fin 254!

• The goal of the firm is to maximize the owners
  (shareholders) wealth.
• Asset prices and interest rates move in opposite
  directions.
• Choose investments that have positive NPV!