Pertemuan 7

21 November 2012

By:

David Parlindungan Siregar

INTERNATIONAL FINANCING

Terminology

• Cross rate

• Eurobond

• Eurocurrency

• Foreign Bonds

• LIBOR (London Interbank Offer Rate)

• Swap

– Currency

– Interest rate

Foreign Exchange Markets and Exchange Rates

• Exchange rate

– Direct Quotation

– Indirect Quotation

• Cross-Rates and Triangle Arbitrage

Types of Transactions

• Spot Trade

– Spot Exchange Rate

• Forward Trade

– Forward Exchange Rate

Purchasing Power Parity

• Definition

– Exchange rates adjusts to keep purchasing power constant among currencies

• Type

– Absolute Purchasing Power Parity

– Relative Purchasing Power Parity

Absolute PPP

• Assumption:

– No transaction cost (transportation, insurance, spoilage, etc.)

– No barriers (tariffs, taxes, etc.)

– Identical goods

Absolute PPP

• Example:

• P$ = dollar price standard community basket

• P£ = pound price standard community basket

• If

– P$ = $225

– P£ = $150

• Exchange rate = $1,5/ £

Relative PPP

• Main relation : relative inflation rate

• Tells what determines the change in the exchange rate over time, not the absolute level of the exchange rates

Relative PPP

• Example:

• Inflation rate in France is 3%, where US has 5%. The expected spot currency rates for the next year is 1,20 €/USD and today spot rate is 0.70 €/USD. Explain whether PPP relatives hold or not?

Interest Rate Parity

• Definition

• Covered Interest Arbitrage

– The condition applied

• Formula for interest rate parity

• Forward rates determination based on IRP

Example

• r$ = 2.24%

• r€ = 2.70%

• S = 1.2017 €/$

• F = 1.19854 €/$

Assume we invest $1000. Illustrate whether interest rate parity is hold or not?

Fisher Effect

• Fisher effect state that real interest rates are equal across the world

• Uncovered Interest Parity – Condition stating that the expected percentage

change in the exchange rate is equal to the difference in interest rate

• Combination of PPP, IRP, and UFR (unbiased forward rates condition stating that the current forward rate is an unbiased predictor of the future spot exchange rate

Fisher Effect

International Capital Budgeting

• 2 methods for counting the NPV of such capital budgeting:

– The home currency approach

– The foreign currency approach

Home Currency Approach

• Convert all the foreign currency cash flow to functional currency and discount the cash flow with local discount rate

Foreign Currency Approach

• Determine the required return on foreign investments and discount the foreign cash flow with the foreign required return. Finally, convert the NPV into the functional currency

Exchange Rate Risk

• Short-Run Exposure

– Use forward or other derivatives

• Long-Run Exposure

– Use fundamental hedging

• Translation exposure

– Just accounting matter

Latihan Soal

• Diandra Corp, sebuah perusahaan AS sedang mengevaluasi pilihan investasinya senilai € 30 juta untuk membuka operasi di Perancis. Investasi ini akan memberikan perusahaan cash inflow sebesar €12 juta selama 4 tahun. Diketahui nilai tukar spot untuk euro adalah €0,5 dan return US T-Bill dan risk free aset di Perancis adalah 5% dan 8%. WACC perusahaan adalah sebesar 12%. Hitung NPV dari investasi ini!