International Finance

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International Finance

• Session 1 Introduction
• Dick Sweeney

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Introduction

• Whats different about International Finance?
• Multiple currencies, exchange rates , , , ,
  baht, rupiah, yuan, krona, krone,
• International financial markets--everywhere and
  nowhere (London, Tokyo, BahrainChp. 4, on
  reserve)
• Multiple governments, laws, languages, cultural
  environments (e.g., U.S., Indonesia2nd half)
• Exponential complexity
• Not 10 x 2, but 10 2

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Introduction (cont.)

• Open exchange rate positions are risky
• Whats the risk-return trade off?
• Deposit in Euros vs. in USD
• ?St1/St ieur,t vs. iusd,t
• ?St1/St ieur,t - iusd,t excess return
• E ?St1/St ieur,t - iusd,t expected excess
  return
• E ?St1/St ieur,t - iusd,t ?t (E RM,t -
  iusd,t)
• E ?St1/St ieur,t iusd,t ?t (E RM,t -
  iusd,t)

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Introduction (cont.)

• How to survive the complexity? Ask
• Whats the same? Same tools are used
• Net present value
• Portfolio analysis (mean-variance analysis)
• Asset pricing models (one example CAPM)
• Option theory
• Tools are flexible ? use them flexibly
• Primacy of Intuition ? experience

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Comparison of Stocks and Exchange Rates

• Stocks Exchange Rates
• Prices look like Prices look like
• random walks random walks
• Returns are pretty Returns are pretty
• close to random close to random
• Systematic risk, Systematic risk,
• Non-systematic risk Non-systematic
  risk

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Comparison of Stocks and Exchange Rates (cont.)

• Stocks Exchange Rates
• Returns depend on Returns depend on
• betas, risk factors betas,
  risk factors
• Average market beta unity Average market
  beta zero
• Typical stocks beta Typical
  exchange rates beta
• fluctuates around unity fluctuates around
  zero
• Standard deviation U.S. Standard deviation
  USD,
• stock market, 4.33 to 2.9 to 3.5 per
  month for
• 5.77 per month most currencies

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Exchange-Rate Risk

• How big is FX risk?
• Sigma (?)? ? 3.3 per month?
• Beta (?)? 0.0? ? 0.10? ? 0.20?
• Which risk matters for you? for client?
• What can you do about risk?
• Hedge ? eliminate risk
• Portfolio choices (diversification) ? reduce risk
  on average
• Valuation How to handle FX risk?

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What do firms do about risk?

• Derivatives used by 59 of large firms, 13 of
  small firms in U.S.survey
• FX derivatives 76 of derivative users
• Which FX derivatives? 75 forwards, 50 options
• Contractual exposure 86 forwards, 7 options

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Goals of Course

• Know the basics about FX markets, how they are
  organized and work
• Know the basics of FX risk management
• Know how to analyze international
  capital-budgeting problems, or valuation problems
• Know how to analyze FX problems
• Know how to choose which tools to use
• Know how to solve FX problems

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Topics and Time Allocation 1
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Topics and Time Allocation 2
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Role of Concepts
Numbers
Decision
Concepts, Theory
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Analytical Techniques
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Parity ConditionsParity ConditionsPercent of
What You Should Know
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The Euro A First Look

• Born Jan. 1, 1999--rocky 6 years
• Euro as currency started Jan. 1, 2002
• What can be expected?
• In concrete, quantitative terms in next month?
• In general terms over next several years?
• Look at history of DEM during float
• Large ups and downs
• Euro looks normal compared to history

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USD/DEM Appreciation Rate