Theory and Practice of International Financial Management

Review

What to Remember in 5 Years

1. Governments are important:

- governments print money

- governments intervene in foreign exchange markets

- governments tax

2. Interest rates reflect anticipated exchange rate changes:

- international capital budgeting recognizes this relationship implicitly (decentralized) and explicitly (centralized)

- expected currency borrowing costs will depend on this, particularly on an after-tax basis

- risks associated with interest-bearing exposures will account for this co-movement

What to Remember in 5 Years3. Prices will reflect realized exchange rate changes:

- the law of one price will hold in the short-run for homogeneous commodities

- any goods that are tradable will face similar arbitrage pressures in the long-run

- economic risks that are linked to both exchange rates and prices must recognize for this relationship

4. International capital markets are segmented:

- investors prefer local investments

- different investors value different risks differently

- borrowing costs and required returns on equity depend on country of lenders and investors

What to Remember in 5 Years

5. Only risks which cannot be diversified are important:

- valuations given by international capital budgeting will depend on what risks are systematic to shareholders

- measurement of foreign exchange exposure risks must recognize that positions may naturally offset or diversify

- risk management activities are only useful if they increase expected returns or reduce risks systematic to shareholders portfolios or managers’ careers.