MULTINATIONAL FINANCE

Barry Topf April 2014

1

INTRODUCTION

• Course Goals

• Methodology

• Organization

• Background

• Course Outline

2

COURSE GOALS

• Acquire analytical tools

• Obtain necessary knowledge and perspective

• Familiarity with basic concepts and their uses - and their limitations

• Basic quantitative and computational skills

3

Multinational Finance

• Multinational financial management is financial management conducted in more than one cultural, social, economic, or political environment

• However, in today’s world important to everyone regardless of nature of operations

• Especially clear in Israel

4

Methodology

• 3 six hour sessions – trial by ordeal

• + 3 six hour sessions With Kobi

• Textbook –Multinational Finance, Kirt C. Butler, 5th edition

• Additional Readings

• Some audiovisual enrichment

• Open format, questions, comments and discussions- and feedback- welcomed.

• Relevance from an Israeli viewpoint

5

Organization

• Schedule: Today; May 8th, May 15th

• Quizes: May 8th and May 15th at 7:30 pm; Final Quiz May 22

• Grades: Simple average of best two out of three quiz grades

• Bonus possibility for participation

6

Organization

• Session Schedule (tentative):

4:00-5:20

5:20-5:40 Break

5:40-7:00

7:00-7:30 Break

7:30-8:40

8:40-8:50 Break

8:50- 9:45

7

My Background

מנהל חדר עסקות בבנק ישראל•

י"ח בב"מנהל מחלקת מט•

י"מנהל חטיבת השווקים בב•

חבר בועדה המוניטארית בבנק ישראל•

:היום •

חבר ועדת השקעות של משקיעה מוסדי•

( IMF)יועץ לקרן המטבע הבינלאומי •

8

Course Outline

• The International Financial Environment • The Multinational Enterprise • The International Capital Market and Investment

Management • Along the way:

– Efficient Markets – Agency theory – Behavioral Finance – Regulation and macro risk – Monetary Policy and Operations – The Crisis

9

The International Financial Environment

• Chapters 1-4 Integration of the world’s markets for goods, services, and

financial instruments

Balance-of-payments statistics

Exchange rate systems – Fixed versus floating, and everything in between

Recent history of international exchange rates – Recent currency crises

– The evolving role of the IMF Regulatory environment

10

Integration of global markets for goods and services

• Global trend toward free-market economies; particularly the industrialization of the Pacific Rim

• 1991 breakup of the Soviet Union; the reunification of Germany; and the migration of central and eastern European countries toward the European Union

• 1995 creation of the World Trade Organization (WTO)

• China’s emergence in international markets, Hong Kong’s 1997 return to China, and China’s 2001 entry into the WTO

• 1999 creation of the euro and its adoption by an expanding set of European countries

11

Trade

deficit

Exports

Imports

U.S. Merchandise Trade ($ billions)

Integration of the world’s markets Balance-of-payments statistics

Exchange rate systems

Recent history of international exchange rates

The Impossible Trinity

• MONETARY INDEPENDENCE • • • • • • • • • • • •

• •

FIXED EXCHANGE RATE OPEN CAPITAL ACCOUNT

13

Capital Flows

• Open Trade Account – no restrictions on imports and exports

• Open Current Account – no restrictions on services

• Open Capital Account - no restrictions on financial flows

• Convertible Currency

• Reserve Currency

14

Capital Flows

• Foreign Exchange Controls – Outward/Inward

– FDI /Portfolio

– Residents/nonresidents

• Taxes

• Reserve Requirements

• Minimum Holding Periods

• Repatriation Limitations

• Administrative Measures

15

• Integration of financial markets

• An increase in cross-border financing

• Increasingly interdependent national financial markets, including cooperative linkages among securities exchanges

• An increasing number of cross-border mergers, acquisitions, and joint ventures

• Increased international regulation

Integration of the world’s markets Balance-of-payments statistics

Exchange rate systems

Recent history of international exchange rates

• World Bank - which now includes

–International Bank for Reconstruction and Development

–International Development Association

–International Finance Corporation

–Multilateral Investment Guarantee Agency

–Int’l Centre for Settlement of Investment Disputes

• International Monetary Fund (IMF)

–Responsible for ensuring the stability of the international financial system

–Compiles balance-of-payments statistics

• GATT/WTO

The Bretton Woods Agreement

Integration of World Markets

• GATT/WTO

• Multilateral

–Mercosur

–Caricom

–Asean

–Efta

–Nafta

• Bilateral

–US-Israel

–Australia-New Zealand

18

The U.S. Balance of Payments 2000 2010

Goods: Exports 772 1293 Goods: Imports -1224 -1937 Trade Balance -452 -644

Services: Credit 292 541 Services: Debit -219 -393

Balance on Goods & Services -379 -496

Income: Credit 353 662 Income: Debit -331 -499

Balance on Goods, Servs, & Income -357 -333

Current transfers: Net -53 -137 Current Account -410 -470

Source: IMF (www.imf.org).

Integration of the world’s markets

payments statistics-of-Balance Exchange rate systems

Recent history of international exchange rates

The U.S. balance of payments 2000 2010

Capital account: Net 1 0

Direct Investment Abroad -178 -346 Direct Invest from Abroad 308 194

Portfolio Investment Assets -278 -144 Portfolio Invest Liabilities 552 757 Other Investment Assets -150 -533

Other Investment Liabilities 156 293

Financial Account 409 237

Net Errors and Omissions 0 235

20

BOP: International Comparisons

GDP in GDP per Trade surplus per

billions capita GDP capita Germany $3,085 $37,900 6.6% $2,506 Australia $918 $40,800 3.2% $1,320

Korea $1,554 $31,700 2.2% $685 China $11,300 $8,400 2.1% $173 Brazil $2,284 $11,600 1.4% $158

Japan $4,389 $34,300 0.1% $48 India $4,463 $3,700 -3.4% -$127

Canada $1,389 $40,300 -0.6% -$261 U.K. $2,250 $35,900 -7.1% -$2,545 U.S. $15,040 $48,100 -5.3% -$2,568

Greece $306 $27,600 -12.8% -$3,536

21

ISRAEL CURRENT ACCOUNT

BALANCE % OF GDP1995-2012)

הלשכה המרכזית לסטטיסטיקה ועיבודי בנק ישראל: מקור

%

-4.8 -4.7

-2.9

-0.9

-1.6 -1.6 -1.6-1.1

0.5

1.6

2.9

1.4

3.8

3.1

1.3

0.3

4.7

3.2

-6

-4

-2

0

2

4

6

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

22 22

Exchange rate systems

Pegged or fixed exchange rate systems

Forges a direct link between inflation differentials and employment levels

Can result in large adjustments

Floating exchange rate systems

Allows exchange rates to adjust for inflation differences

Allows employment levels and wages to equalize through the exchange rate mechanism

Integration of the world’s markets

Balance-of-payments statistics

Exchange rate systems Recent history of international exchange rates

Floating Soft Peg Hard peg

Nigeria, S. Africa Burundi, WAEMU Djibouti AFRICA

India, Australia, Malaysia

Nepal Hong Kong ASIA

Israel, Turkey Saudi Arabia - MIDDLE EAST

Chile Argentina Ecuador AMERICAS

Sweden, UK, Eurozone

Russia,Denmark Bulgaria EUROPE

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Hard pegs: Exchange arrangements with no separate legal tender, and currency board arrangements

Soft pegs: Conventional peg arrangements, stabilized arrangements, crawling pegs, crawl-like arrangements, and pegs within horizontal bands

Floating arrangements: 'Floating' (largely market determined and without exchange rate targets) 'Free floating' (market determined with very infrequent intervention)

Major events in the history of FX rates

1946 Bretton Woods Conference

IMF and World Bank created

1971Exchange rate turmoil begins the modern era of floating exchange rates

Jamaica Agreement (1976)

European Exchange Rate Mechanism (1979)

1991Treaty of Maastricht

Introduction of the euro (1999)

Euro begins public circulation (2002)

Integration of the world’s markets

Balance-of-payments statistics

Exchange rate systems Recent history of international exchange rates

Major events in the history of FX rates

• 1946 Bretton Woods Conference

– Dollar is convertible into gold at $35/ounce

– Other currencies are pegged to the dollar

– The IMF and the World Bank also were created

Integration of the world’s markets

Balance-of-payments statistics

Exchange rate systems Recent history of international exchange rates

Major events in the history of FX rates • 1971—Exchange rate turmoil

– U.S. dollar falls off the gold standard

– Most currencies float on world markets

• 1976—Jamaica Agreement

– Floating rates are declared “acceptable”

• 1979—European Monetary System (EMS)

– European Exchange Rate Mechanism (ERM) established to maintain EEC currencies within a 2.25% band around central rates

– European currency unit (ECU) created

Integration of the world’s markets

Balance-of-payments statistics

Exchange rate systems Recent history of international exchange rates

Major events in the history of FX rates

• 1991—Treaty of Maastricht

– EC members agree to a broad agenda of economic, financial and monetary reforms

– A single European currency is proposed as the ultimate goal of monetary union

• 1999—Introduction of the euro

– Emu-zone currencies pegged to the euro

– European bonds convert to the euro

• 2002—Euro begins public circulation

– The euro is now a major international currency

Integration of the world’s markets

Balance-of-payments statistics

Exchange rate systems Recent history of international exchange rates

Israel’s ER Regimes

• 1985 – Peg to dollar

• 1986 –Peg to basket • 1989-1991 Horizontal Bands

• Adjustments of central rate

• Adjustments of width

• 1991-present – Crawling Bands • Adjustments of central rate

• Adjustments of width

• Adjustments of slope

• Asymmetric slopes

• “internal Bands”

29

30

After a few years the Band became irrelevant

Formally eliminated in 2005

Ten years of non-intervention

During crisis of 2008, resumed intervention

2010 – Discretionary policy introduced

Chronology of the Transition

31

Exchange-Rate Regime

• 1985-1989: Fixed Exchange Rates

• 1989-1991: Horizontal Exchange-Rate Band

• 1991-2001: Crawling Exchange-Rate Band

• 2005: Band eliminated • 2008: Resume Intervention

Trading System

1985-1990: Fixing

1990-1995: Multilateral Trade

1995-2001: Continuous Bilateral Trade

The FX Regime and the FX Market

Israel’s Transition

32

Bank

Bank

Bank

Bank

Surplus

Units Environment: Regime, Supervision, Authorities

Infrastructure: Communications, Computer

Systems, Clearing Systems

Surplus

Units

Deficit

Units Broker

4-The Foreign Exchange Market: Interbank Trading Ingredients of Transition

33

(July 85 - May 89)

1.20

1.30

1.40

1.50

1.60

1.70

1.80

1.90

2.00

2.10

2.20

III IV I II III IV I II III IV I II III IV I II

10%

5%

8% 3%

3%

basket

USdollar

shekels

1985 1986 1987 1988 1989

NIS

Peg to USD

Peg to Basket

The FX Regime Israel’s Transition

34

1.80

1.90

2.00

2.10

2.20

2.30

2.40

2.50

2.60

2.70

2.80

2.90

I II III IV I II III IV I II III IV I II

1989 1990 1991 1992

shekels

3%

3%

3%

3%

5%

5%

5%

5% 5%

5%

6%

6%

10%

6%

(Jan 89-Mar 92)

NIS /Basket

Multilateral

Trade

The FX Regime

adjustment

Hurt the specs

artificial

Israel’s Transition

35

(Oct91 - May01)

2.00

2.50

3.00

3.50

4.00

4.50

5.00

5.50

6.00

6.50

10/9

1

03/9

2

09/9

2

03/9

3

09/9

3

03/9

4

09/9

4

03/9

5

09/9

5

03/9

6

09/9

6

03/9

7

08/9

7

02/9

8

08/9

8

02/9

9

08/9

9

02/0

0

08/0

0

02/0

1

08/0

1

5%5%

5%

5%5%

5%

7%

7%

14%

14%

07/08/98

6% slope

6% slope

4% slope

6% slope

6% slope

2% slope

8% slope

9% slope6% slope

Broker Bilateral

Trade

The FX Regime

Differential slopes Internal

band

End of Intervention

Israel’s Transition

36

The FX Regime

Israel’s Transition

2.00

2.50

3.00

3.50

4.00

4.50

5.00

5.50

6.00

6.50

10/9

1

03/9

2

09/9

2

03/9

3

09/9

3

03/9

4

09/9

4

03/9

5

09/9

5

03/9

6

09/9

6

03/9

7

08/9

7

02/9

8

08/9

8

02/9

9

08/9

9

02/0

0

08/0

0

02/0

1

08/0

1

5%5%

5%

5%5%

5%

7%

7%

14%

14%

07/08/98

6% slope

6% slope

4% slope

6% slope

6% slope

2% slope

8% slope

9% slope6% slope

Recent currency crises

•Mexican peso crisis of 1995

•Asian contagion of 1997

–Korea, Indonesia, and Thailand

•Russian ruble crisis in 1998

•Brazilian real crisis in 1998

•Argentinian peso crisis of 2002

Integration of the world’s markets

Balance-of-payments statistics

Exchange rate systems

✓ Recent history of international exchange rates

Recent currency crises ✓

Causes and consequences

Countries in crisis

Currency crises and the IMF

Currency crises

• Contributing factors in each crisis

–A fixed or pegged exchange rate system that overvalued the local currency

–A large amount of foreign currency debt

• Consequences of currency crises

–Currency crises have a pronounced negative short-term impact on the local economy

–A market-based exchange rate can have an invigorating long-term impact on the local economy and on the local stock market

Balance-of-payments statistics

Exchange rate systems

Recent history of international exchange

rates

Stock market (Dec 1995 = 1.00; in rupiah)

Indonesian rupiah ($/rupiah)

Indonesia’s 1997 currency crisis

Integration of the world’s markets

Balance-of-payments statistics

Exchange rate systems

history of international exchange ratesRecent

International Regulatory Regime

• Bank Supervision :Basel I, II, III

– ECB Supervision

• Anti-Money Laundering (AML), anti-terrorist, sanctions

• IOSCO

• Insurance

40