Lecture 32

Review of International Finance

Topics

• International Financial Management

• International Flow of Funds and BoP

• International Financial Markets

• Foreign Exchange Rate and Types

• Government Intervention in Exchange Rates

Topics

•  Inflation, Exchange and Interest Rate

• Risk Management of Exchange Rates

• Managing Economic, Transaction & Translation

Exposure

• Direct Foreign Investment

MULTINATIONAL COMPANIES

• Goals of MNCs

• Agency Problems

• Centralized vs. Decentralized System

• Theories of International Business

Common methods to conduct international business– International trade, – Licensing, – Franchising, – Joint ventures, – Acquisitions of existing operations, – Establishing new foreign subsidiaries

Investment opportunities Financing opportunities Marginal Returns and Marginal Costs

• Capital Account (Flow of funds; one country to

other)

– Direct Foreign Investment

– Portfolio Investment

– Capital Investment

• Trade volume is different

• Over all the World is developing

• Trade Agreements

– NAFTA, GATT, EU

• Trade Disagreements

– Tariffs, Quotas, Job loss

– Rules are different (Child labor, Bribe, etc)

– Outsourcing

• Economic Factors Affecting Trade

– Inflation

– Impact of National Income

– Government Restrictions

– Foreign Exchange Rates

• International Capital Flows

• Factors Affecting International Trade flows

• Factors affecting DFI

• Factors Affecting Portfolio Investment

• Agencies that Facilitate International Trade

Motives to use International Market

• Economic Conditions

• Exchange Rate

• International Diversification

Foreign exchange Market

Gold Standard

Fixed Exchange Rate

Floating Exchange Rate

• Spot Market• Bid/Ask Spread• Direct & Indirect Quote• Future Market • Forward Market • Attributes of Banks• Options– Put option – Call Option

• Domestic Money Market

• Domestic & International Money Market• Standardization of Banking Regulations• Single European Act

– Basel Accord I– Basel Accord II

• Syndicated Loans• International Credit Market

– International Bond Markets

• International Stock Markets

– Transaction Costs

– Information Costs

– Exchange Rate Risk

• International Stock Diversification

• Exchange Rates

• Depreciation and Appreciation of Currency

• Exchange Rate Equilibrium

• Liquidity

• Factors that affect Exchange Rates

• Relative Interest Rate

• Relative Income Level

• Expectations

• Speculating on Anticipated Exchange

Rates

• Exchange Rate System

– Fixed Exchange Rate – Freely Floating – Managed Float– Pegged

• Currency Boards– Investors Confidence– Argentinean Economy and Currency Boards

• Dollarization (e.g. Ecuador)

• Single European currency

– Impact on Monetary & Fiscal Policy

– International trade

– International flows

– Impact on Exchange Rate Risk

– Government Intervention

• Reliance on Reserves

• Direct Intervention

– Sterilized

– Non Sterilized

• Indirect intervention

– Inflation, interest rates, income level,

government controls, expectations

• Arbitrage

• Locational Arbitrage

– Banks/Individuals

• Triangular Arbitrage

• Covered Interest Arbitrage

• Interest Rate Parity

• Transaction Costs

• Political Risk

• Differential Tax Laws

• MNCs need exchange rate forecasts for their

– Hedging Decisions,

– Short-term Financing Decisions,

– Short-term Investment Decisions,

– Capital Budgeting Decisions,

– Earnings Assessments

• Long-term financing decisions

• Forecasting Techniques

Technical, Fundamental, Market-based Mixed.

• Forecasting Error• Forecasting Services• Forecasting Bias• Diversification Argument• Types of Exposure– Transaction – Economic – Translation– Source: Adopted from South-Western/ Thomson Learning 2006

– Identify degree of transaction exposure.

– Decide whether to hedge this exposure.

– Choose a hedging technique if it decides to

hedge part or all of the exposure.

• Hedging Techniques

– Futures hedge,

– Forward hedge,

– Money market hedge, and

– Currency option hedge.

Management of Exposures

• Transaction

– Identify the degree

– Decision

– Hedging

• Economic

– Restructuring

• Translation

Direct Foreign Investment

• Motives

– Revenues– Costs

– Issues

•Source: Adopted from South-Western/ Thomson Learning 2006