Imad A.

Moosa
Department of Accounting and Finance
Mortash University

Boston Burr Ridge, IL Dubuque, IA Madison, Wl New York

San Francisco St. Louis Bangkok Bogota Caracas Kuala Lumpur
Lisbon London Madrid Mexico City Milan Montreal New Delhi
Santiago Seoul Singapore Sydney Taipei Toronto
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ABOUT THE AUTHOR x

PREFACE xi
ACKNOWLEDGEMENTS xii
MAJOR CHANGES IN THE THIRD EDITION xiii
TEXT AT A GLANCE xiv

1. AN OVERVIEW 1 3. THE BALANCE OF PAYMENTS AND

1.1 The Importance of International Finance 2 EFFECTIVE EXCHANGE RATE 71
1.2 International Finance and the Role of the 3.1 Definition of the Balance of Payments 72
Financial Manager 5 3.2 Australian Balance of Payments Statistics 72
1.3 Indicators of the Intemationalisation of Finance 7 3.3 The Balance of Payments and the Foreign
1.4 Post-War Economic, Financial and Exchange Market 76
Institutional Developments 8 3.4 Factors Affecting the Balance of
1.5 The Global Financial Crisis 23 Payments Position 81
3.5 The Real Effective Exchange Rate 87
Summary 29 Key Terms 29 Review Questions 30
Summary 96 Key Terms 96 Review Questions 97 Problems 97

2. THE FOREIGN EXCHANGE MARKET 33

2.1 Definition and Characteristics of the Foreign 4. EXCHANGE RATE DETERMINATION 101
Exchange Market 34 4.1 Some Stylised Facts about Exchange Rates 102
2.2 Market Participants 35 4.2 Factors Affecting Supply and Demand in
2.3 The Size and Composition of the Foreign the Foreign Exchange Market 103
Exchange Market 37 4.3 Speculation in the Spot Foreign
2.4 The Mechanics and Technology of Foreign Exchange Market 113
Exchange Trading 43 4.4 Purchasing Power Parity 115
2.5 The Spot Exchange Rate 44 4.5 The Monetary Model of Exchange Rates 122
2.6 Spot Foreign Exchange Position Keeping 57 4.6 Determination of the Bid-Offer Spread and
2.7 The Forward Exchange Rate 59 the Forward Spread 125
4.7 Factors Affecting the Australian Dollar
Summary 63 Key Terms 64 Review Questions 65 Problems 66 Exchange Rate 127
Appendix 2.1: More Foreign Exchange Jargon 68
Summary 132 Key Terms 133 Review Questions 133 Problems 135
Appendix 2.2: Types of Trading Orders 70
 THE INTERNATIONAL MONETARY 7. INTERNATIONAL BANKING REGULATION
SYSTEM AND EXCHANGE RATE AND THE BASEL ACCORDS 179
ARRANGEMENTS 137 7.1 Why Banks are Important 180
5.1 Definition and Criteria of Classification 138 7.2 The Kinds of Risk Facing Banks 181
5.2 Flexibility of Exchange Rates as a Criterion 7.3 Operational Risk 182
for Classification 138 7.4 The Pros and Cons of Banking Regulation 186
5.3 The Classical Gold Standard 144 7.5 Regulatory Functions and Forms of
5.4 The Inter-War Period 146 Regulation 187
5.5 The Bretton Woods System 146 7.6 Some Capital-Related Concepts 191
5.6 The Present System 148 7.7 The Basel Committee 195
5.7 The European Monetary System 152 7.8 The Basel I Accord 197
5.8 The Australian Dollar Exchange Rate 7.9 The Basel II Accord: Introduction 199
Arrangements 155 7.10 The Pillars of Basel II 200
5.9 Fixed versus Flexible Exchange Rates 156 7.11 A Critique of Basel II 206
5.10 The Future of the International
Monetary System 157 Summary 210 Key Terms 211 Review Questions 211 Problems 212

Summary 159 Key Terms 160 Review Questions 161

8. EXCHANGE RATE FORECASTING,
TECHNICAL ANALYSIS AND
6. THE EUROCURRENCY MARKET AND TRADING RULES 215
INTERNATIONAL BANKING 163 8.1 What is Forecasting? 216
6.1 The Eurocurrency Market 164
8.2 Why Do We Need Exchange Rate Forecasting? 216
6.2 Eurocurrencies and Eurocurrency
8.3 Econometric Forecasting Models 219
Banking Centres 164
8.4 Time Series Forecasting Models 224
6.3 The Evolution and Growth of the
Eurocurrency Market 166 8.5 Market-Based Forecasting 226
6.4 Some Features of Eurobanking 168 8.6 Judgmental Forecasting 229
6.5 Interest Rate Determination 169 8.7 Composite Forecasting 230
6.6 International Banking 171 8.8 Forecasting Performance Evaluation 231
6.7 The Organisational Set-up of 8.9 Technical Analysis 239
International Banking 172 8.10 Trading Rules 248
Summary 176 Key Terms 177 Review Questions 178 Summary 252 Key Terms 253 Review Questions 254 Problems 255
9. CURRENCY FUTURES AND SWAPS 257 12. FOREIGN EXCHANGE RISK
9.1 Currency Futures: Definition and Origin 258 AND EXPOSURE 347
9.2 Futures and the Problematic Properties of 12.1 Definition of Risk 348
Forward Contracts 258 12.2 Value at Risk 351
9.3 A Comparison of Forward and Futures Markets 266 12.3 Definition of Exposure 355
9.4 Specifications of Currency Futures Contracts 269 12.4 Volatility of the Australian Dollar
9.5 Currency and Interest Rate Swaps 270 Exchange Rates 360
9.6 Swap Terminology 278 12.5 Transaction Exposure 361
12.6 Economic Exposure 363
Summary 279 Key Terms 280 Review Questions 280 Problems 280
12.7 Translation Exposure 364
Summary 366 Key Terms 367 Review Questions 367 Problems 368
10. CURRENCY OPTIONS 283
10.1 Origin and Basic Concepts 284
10.2 Description of Currency Options Contracts 295 13. FOREIGN EXCHANGE RISK
10.3 Option Positions 296 371
10.4 Determinants of Option Premiums 305 13.1 Why Worry About Foreign Exchange Risk? 372
10.5 Exotic Options 308 13.2 Hedging Short-Term Transaction Exposure
with Forward and Futures Contracts 374
Summary 310 Key Terms 310 Review Questions 311 Problems 311 13.3 Money Market Hedging of Short-Term
Transaction Exposure 382
13.4 Option Hedging of Short-Term
11. INTERNATIONAL ARBITRAGE 313
Transaction Exposure 390
11.1 Two-Point Arbitrage 314
13.5 Hedging a Contingent Exposure 394
11.2 Three-Point and Multi-Point Arbitrage 316
13.6 Hedging Long-Term Transaction Exposure 396
11.3 Commodity Arbitrage 321
13.7 Other Techniques of Managing
11.4 Covered Interest Arbitrage 323 Transaction Exposure 397
11.5 Uncovered Interest Arbitrage 331 13.8 Managing Economic Exposure 404
Summary 340 Key Terms 341 Review Questions 341 Problems 342 13.9 Managing Translation Exposure 407
Summary 411 Key Terms 412 Review Questions 412 Problems 413
14. INTERNATIONAL SHORT-TERM 16. FOREIGN DIRECT INVESTMENT AND
FINANCING AND INVESTMENT 417 INTERNATIONAL CAPITAL BUDGETING 479
14.1 International Short-Term Financing 418 16.1 Background 480
14.2 International Short-Term Investment 422 16.2 Approaches to International Business 480
14.3 The Effective Financing Rate and Effective 16.3 Theories of Foreign Direct Investment 482
Rate of Return 422 16.4 Evaluating Direct Investment Projects 487
14.4 Introducing the Bid-Offer Spreads 427 16.5 Evaluating Foreign Direct Investment Projects 492
14.5 Implications of International Parity Conditions 429 16.6 More About Taxation 496
14.6 Introducing Probability Distributions 432 16.7 Foreign Direct Investment and Country Risk 499
14.7 Financing and Investment with 16.8 Transfer Pricing 501
Currency Portfolios 435
14.8 Centralised Versus Decentralised Cash Summary 504 Key Terms 506 Review Questions 506 Problems 507
Management 436
USEFUL WEBSITES 509
Summary 441 Key Terms 441 Review Questions 442 Problems 442
ABBREVIATIONS 511
CURRENCY SYMBOLS 513
15. INTERNATIONAL LONG-TERM LIST OF FORMULAE 514
FINANCING AND INVESTMENT 447
GLOSSARY 521
15.1 International Bank Loan Financing 448
INDEX 547
15.2 International Bond Financing 449
15.3 International Equity Financing 453
15.4 Other Sources of Long-Term Financing 454
15.5 Bond Investment 456
15.6 Equity Investment 460
15.7 The Benefits of International Portfolio
Diversification 464
15.8 International Capital Asset Pricing Model 471

Summary 474 Key Terms 475 Review Questions 476 Problems 477