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 International
Financial
Management
Eighth Edition
The McGraw-Hill/Irwin Series in Finance, Insurance, and Real Estate
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ii
 International
Financial
Management
Eighth Edition

Cheol S. Eun
Georgia Institute of Technology

Bruce G. Resnick
Wake Forest University
INTERNATIONAL FINANCIAL MANAGEMENT, EIGHTH EDITION

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Library of Congress Cataloging-in-Publication Data

Eun, Cheol S., author. | Resnick, Bruce G., author.
 International financial management / Cheol S. Eun, Georgia Institute
of Technology, Bruce G. Resnick, Wake Forest University.
 Eighth Edition. | Dubuque : McGraw-Hill Education, [2017] |
Revised edition of the authors’ International financial management, [2015]
LCCN 2016051732 | ISBN 9781259717789 (alk. paper)
 LCSH: International finance. | International business
enterprises—Finance. | Foreign exchange. | Financial institutions, International.
 LCC HG3881 .E655 2017 | DDC 658.15/99—dc23 LC record available at
https://lccn.loc.gov/2016051732

The Internet addresses listed in the text were accurate at the time of publication. The inclusion
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McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites.

mheducation.com/highered
To Elizabeth
C.S.E.

To Donna
B.G.R.

Cheol S. Eun,
Georgia Institute of Technology
Cheol S. Eun (Ph.D., NYU) is the Thomas R. Williams
Chair and Professor of Finance at the Scheller ­College
of Business, ­Georgia Institute of Technology. Before
joining ­Georgia Tech, he taught at the University of
Minnesota and the University of Maryland. He also
taught at the ­Wharton School of the University of
Pennsylvania, Korea Advanced Institute of Science
and Technology (KAIST), Singapore Management
University, and the Esslingen University of Technology
(Germany) as a visiting professor. He has published
extensively on international finance issues in such major
journals as the Journal of Finance, Journal of Financial
Economics, JFQA, Journal of Banking and Finance,
Journal of International Money and Finance, Man-
agement Science, and Oxford Economic Papers. Also,
he has served on the editorial boards of the Journal of
Banking and Finance, Journal of Financial Research,
Journal of International Business Studies, and Euro-
pean Financial Management. His research is widely
quoted and referenced in various scholarly articles and
textbooks in the United States as well as abroad.
Dr. Eun is the founding chair of the Fortis/Georgia
Tech Conference on International Finance. The key
objectives of the conference are to promote research on
international finance and provide a forum for interactions
among academics, practitioners, and regulators who are
interested in vital current issues of international finance.
Dr. Eun has taught a variety of courses at the under-
graduate, graduate, and executive levels, and was the
winner of the Krowe Teaching Excellence Award at the
University of Maryland. He also has served as a consul-
tant to many national and international organizations,
including the World Bank, Apex Capital, and the Korean
Development Institute, advising on issues relating to
capital market liberalization, global capital raising, inter-
national investment, and exchange risk management. In
addition, he has been a frequent speaker at academic and
professional meetings held throughout the world.
vi
About the Authors
Bruce G. Resnick,
Wake Forest University
Bruce G. Resnick is the Joseph M. Bryan Jr. Professor
of Banking and Finance at the Wake Forest University
School of Business in Winston-Salem, North Carolina.
He has a D.B.A. (1979) in finance from Indiana
University. Additionally, he has an M.B.A. from
the University of Colorado and a B.B.A. from the
University of Wisconsin at Oshkosh. Prior to coming
to Wake Forest, he taught at Indiana University for ten
years, the University of Minnesota for five years, and
California State University for two years. He has also
taught as a visiting professor at Bond University, Gold
Coast, Queensland, Australia, and at the Helsinki School
of Economics and Business Administration in Finland.
Additionally, he served as the Indiana University resi-
dent director at the Center for European Studies at
Maastricht University, the Netherlands. He also served
as an external examiner to the Business Administration
Department of Singapore Polytechnic and as the faculty
advisor on Wake Forest University study trips to Japan,
China, and Hong Kong.
Dr. Resnick teaches M.B.A. courses at Wake Forest
University. He specializes in the areas of investments,
portfolio management, and international financial man-
agement. Dr. Resnick’s research interests include mar-
ket efficiency studies of options and financial futures
markets and empirical tests of asset pricing models. A
major interest has been the optimal design of interna-
tionally diversified portfolios constructed to control for
parameter uncertainty and exchange rate risk. In recent
years, he has focused on information transmission in the
world money markets and yield spread comparisons of
domestic and international bonds. His research articles
have been published in most of the major academic
journals in finance. His research is widely referenced by
other researchers and textbook authors. He is an associ-
ate editor for the Emerging Markets Review, Journal of
Economics and Business, and the Journal of Multina-
tional Financial Management.
Preface

Our Reason for Writing this Textbook

Both of us have been teaching international financial management to undergraduates
and M.B.A. students at Georgia Institute of Technology, Wake Forest University, and
at other universities we have visited for three decades. During this time period, we
conducted many research studies, published in major finance and statistics journals,
concerning the operation of international financial markets. As one might imagine, in
doing this we put together an extensive set of teaching materials that we used success-
fully in the classroom. As the years went by, we individually relied more on our own
teaching materials and notes and less on any one of the major existing textbooks in
international finance (most of which we tried at some point).
As you may be aware, the scope and content of international finance have been fast
evolving due to deregulation of financial markets, product innovations, and technologi-
cal advancements. As capital markets of the world are becoming more integrated, a solid
understanding of international finance has become essential for astute corporate decision
making. Reflecting the growing importance of international finance as a discipline, we
have seen a sharp increase in the demand for experts in the area in both the corporate and
academic worlds.
In writing International Financial Management, Eighth Edition, our goal was to provide
well-organized, comprehensive, and up-to-date coverage of the topics that take advantage
of our many years of teaching and research in this area. We hope the text is challenging to
students. This does not mean that it lacks readability. The text discussion is written so that
a self-contained treatment of each subject is presented in a user-friendly fashion. The text is
intended for use at both the advanced undergraduate and M.B.A. levels.

The Underlying Philosophy

International Financial Management, Eighth Edition, like the first seven editions, is writ-
ten based on two tenets: emphasis on the basics and emphasis on a managerial perspective.
Emphasis on We believe that any subject is better learned if one first is well grounded in the basics.
the Basics Consequently, we initially devote several chapters to the fundamental concepts of
international finance. After these are learned, the remaining material flows easily from
them. We always bring the reader back, as the more advanced topics are developed, to
their relationship to the fundamentals. By doing this, we believe students will be left
with a framework for analysis that will serve them well when they need to apply this
material in their careers in the years ahead.
We believe this approach has produced a successfuI textbook: International Finan-
cial Management is used in many of the best business schools in the world. Various
editions of the text have been translated into Spanish and two dialects of Chinese.
There is a global edition. In addition, local co-authors have assisted in preparing a
Canadian, Malaysian, Indonesian, and Indian adaptations.

vii
viii P RE FA C E

Eighth Edition Organization

International Financial Management, Eighth Edition, has been completely updated.
All data tables and statistics are the most current available when the text went to press.
Additionally, the chapters incorporate several new International Finance in Practice
boxes that contain real-world illustrations of chapter topics and concepts. In the
margins below, we highlight specific changes in the Eighth Edition.

This part lays the macroeconomic foundation

for all the topics to follow.
Part ONE
Foundations of International Financial
Recent economic developments such as the global
Management 2
financial crisis and sovereign debt crisis of Europe,
and Brexit.
1 Globalization and the Multinational
Updated coverage of monetary developments, Firm 4
including the euro zone crisis.
2 International Monetary
Updated balance-of-payments statistics.
System 27

3 Balance of Payments 62
Review of corporate governance systems in
different countries, the Dodd-Frank Act, 4 Corporate Governance Around
and managerial implications. the World 82

This part describes the market for foreign

exchange and introduces currency Part TWO
derivatives that can be used to manage The Foreign Exchange Market, Exchange
foreign exchange exposure. Rate Determination, and Currency
Derivatives 110
Fully updated market data and examples.
5 The Market for Foreign
Exchange 112
Integrated coverage of key parity conditions
and currency carry trade. 6 International Parity Relationships
and Forecasting Foreign
Exchange Rates 140
Fully updated market data and examples.
7 Futures and Options on Foreign
Exchange 173

This part describes the various types of

foreign exchange risk and discusses Part THREE
methods available for risk management. Foreign Exchange Exposure
and Management 196

Systematic coverage of foreign currency 8 Management of Transaction

transaction exposure management Exposure 198
and a new case application.
9 Management of Economic
Exposure 225
Conceptual and managerial analysis of
economic exposure to currency risk. 10 Management of Translation
Exposure 244
 P R E F A C E ix

A Managerial Perspective
The text presentation never loses sight of the fact that it is teaching students how to
make managerial decisions. International Financial Management, Eighth Edition, is
founded in the belief that the fundamental job of the financial manager is to maximize
shareholder wealth. This belief permeates the decision-making process we present
from cover to cover. To reinforce the managerial perspective, we provide numerous
“real-world” stories whenever appropriate.

This part provides a thorough discussion of international

financial institutions, assets, and marketplaces.
Part FOUR
World Financial Markets and
Institutions 262 Fully updated market data and statistics. Updated discussion on
Basel III capital adequacy standards. Updated discussion
on the causes and consequences of the global financial crisis.
11 International Banking and Money New section on ICE Libor.
Market 264

12 International Bond Market 304

13 International Equity Markets 323 Fully updated market data and examples.

14 Interest Rate and Currency

Swaps 347
New statistical presentation of market capitalizations and liquidity
15 International Portfolio measurement in developed and developing countries. Updated
Investment 365 discussion of market consolidations and mergers.

Fully updated market data and statistics. New discussion on swap

Part FIVE trading practices under new financial regulation. New International
Financial Management of the Finance in Practice box on trading swaps via a clearing-house.
Multinational Firm 402
Updated statistical analysis of international markets and
16 Foreign Direct Investment diversification with small-cap stocks.
and Cross-Border
Acquisitions 404
This part covers topics on financial management practices for the
17 International Capital Structure
multinational firm.
and the Cost of Capital 431

18 International Capital Updated trends in cross-border investment and M&A deals.

Budgeting 458 Updated political risk scores for countries.

19 Multinational Cash New analysis of home bias and the cost of capital around the
Management 477 world. Also, comparison of capital structure across countries.

20 International Trade
Finance 488

21 International Tax
Environment and Fully updated comparative national income tax rate table with
Transfer Pricing 499 updated examples. New section on tax inversion maneuvers.
 or six months), the loan is rolled over and the base lending rate is repriced to cur-
rent LIBOR over the next time interval of the loan.
Exhibit 11.5 shows the relationship among the various interest rates we have
discussed in this section. The numbers come from Exhibit 11.3. On May 20, 2016,
U.S. domestic banks were paying 0.875 percent for six-month NCDs and the prime
lending rate, the base rate charged the bank’s most creditworthy corporate clients,
was 3.50 percent. This appears to represent a spread of 2.625 percent for the bank
to cover operating costs and earn a profit. By comparison, Eurobanks will accept
six-month Eurodollar time deposits, say, Eurodollar NCDs, at a LIBID rate of
1.13 percent. The rate charged for Eurodollar credits is LIBOR + X percent, where

Key Features
any lending margin less than 2.30 percent appears to make the Eurodollar loan
more attractive than the prime rate loan. Since lending margins typically fall in
the range of 0.25 percent to 3 percent, with the median rate being 0.50 percent
to 1.50 percent, the exhibit shows the narrow borrowing-lending spreads of
Eurobankers in the Eurodollar credit market. This analysis seems to suggest that
borrowers can obtain funds somewhat more cheaply in the Eurodollar market.
However, international competition in recent years has forced U.S. commercial
banks to lend domestically at rates below prime. Examples—These are integrated
throughout the text, providing
EXAMPLE 11.1: Rollover Pricing of a Eurocredit students with immediate application of
Teltrex International can borrow $3,000,000 at LIBOR plus a lending margin the text concepts.
of 0.75 percent per annum on a three-month rollover basis from Barclays in
London. Suppose that three-month LIBOR is currently 5.53 percent. Further sup-
pose that over the second three-month interval LIBOR falls to 5.12 percent. How
much will Teltrex pay in interest to Barclays over the six-month period for the
Eurodollar loan?

Solution: $3,000,000 × (.0553 + .0075)/4 + $3,000,000 ×

(.0512 + .0075)/4 = $47,100 + $44,025
= $91,125

U.S. Lending 3.500% U.S. Prime Rate

Rates LIBOR + X%
International Finance in Practice
Rate of Interest

Rates on
Boxes—Selected chapters
1.200% LIBOR (6-month)
1.130% LIBID (6-month)
contain International0.875%
Finance
in Practice boxes. These real-
U.S. Negotiable CD Rate (6-month) INTERNATIONAL FINANCE IN PRACTICE
world illustrations offer students
0.000% FX Market Volumes Surge
a practical look at the major The FX market is growing at record levels, according to fig- and options surpassed 88,000 contracts in ADV and $8 billion

concepts presented in the chapter.
ures released by the CME Group, the largest regulated foreign
exchange market in the world.
in total notional ADV.
With foreign currency futures going from strength to
Last month the CME Group reported average daily notional
volume at a record level of $121 billion, up 82 percent com-
pared to a year earlier.
With a number of indicators at play, like the news of Greece's
credit concerns and the continued appetite for high-yielding
currencies like the Australian dollar and the Canadian dollar, the
CME saw record volumes and notional values in the euro and
Australian and Canadian dollars. Euro FX futures and options
saw total average daily volume of 362,000 contracts with total
notional ADV of slightly over $62 billion.
Australian dollar futures and options climbed to nearly
119,000 contracts in average daily volume with almost
$11 billion in total notional ADV, and Canadian dollar futures
strength, the CME Group recently published a white paper out-
lining the benefits of FX futures.
“These contracts provide an ideal tool to manage currency
or FX risks in an uncertain world,” it said. “Product innovation,
liquidity, and financial surety are the three pillars upon which
the CME Group has built its world-class derivatives market.
The CME Group provides products based on a wide range of
frequently transacted currencies, liquidity offered on the
state-of-the-art CME Globex electronic trading platform, and
financial sureties afforded by its centralized clearing system.”
Source: Global Investor, March 2010. All rights reserved. Used with permission.

CHAPTER 7 FUTURES AND OPTIONS ON FOREIGN EXCHANGE 191

EXHIBIT 7.2 Currency Contract Size

In More Depth CME Group Currency Price Quoted in U.S. Dollars CME
Futures Specifications
Australian dollar AUD100,000
European Option-Pricing Formula Brazilian real BRL100,000
In the last section, we examined a simple one-step version of binomial option-pricing British pound GBP62,500

In More Depth—Some topics are by

model. Instead, we could have assumed the stock price followed a multiplicative binomial Canadian dollar CAD100,000
process by subdividing the option period into many subperiods. In this case, ST and CT Chinese renminbi CNY1,000,000
could be many different values. When the number of subperiods into which the option Czech koruna CZK4,000,000
period is subdivided goes to infinity, the European call and put pricing formulas presented
in this section are obtained. Exact European call and put pricing formulas are:5
Euro FX
Hungarian forint
nature more complex than others. The EUR125,000
HUF30,000,000

and
Ce = Ste−riTN(d1) − Ee−r$TN(d2) (7.12) Indian rupee
Israeli shekel
chapter sections that contain such INR5,000,000
ILS1,000,000
Pe = Ee −r$T
N(−d2) − Ste N(−d1)
−riT
(7.13)
Japanese yen
Korean won
material are indicated by the section JPY12,500,000
KRW125,000,000
The interest rates ri and r$ are assumed to be annualized and constant over the term-to-
maturity T of the option contract, which is expressed as a fraction of a year.
Invoking IRP, where with continuous compounding FT = Ste(r$ – ri)T, Ce and Pe in
Mexican peso
New Zealand dollar heading “In More Depth”’ and are in MXN500,000
NZD100,00
Equations 7.12 and 7.13 can be, respectively, restated as:
Ce = [FT N(d1) − EN(d2)]e−r$T (7.14)
Norwegian krone
Polish zloty colored text. These sections may be NOK2,000,000
PLN500,000
Russian ruble RUB2,500,000
and South African rand
Swedish krona
skipped without loss of continuity, ZAR500,000
SEK2,000,000
Pe = [EN(−d2) − FT N(−d1)]e−r$T (7.15)
where
Swiss franc enabling the instructor to easily CHF125,000
Cross-Rate Futures
ln (FT /E) + .5σ2T
d1 = ________________
σ√ T
__ tailor the reading assignments
(Underlying Currency/Price Currency)
Euro FX/British pound EUR125,000
to the
and
d2 = d1 − σ√T
__
Euro FX/Japanese yen
Euro FX/Swiss franc
students. End-of-chapter Questions
EUR125,000
EUR125,000
N(d ) denotes the cumulative area under the standard normal density function from and Problems relating to the In More
Source: CME Group, www.cmegroup.com, website.
−∞ to d1 (or d2). The variable σ is the annualized volatility of the change in exchange
rate ln(St+1/St). Equations 7.14 and 7.15 indicate that Ce and Pe are functions of only
five variables: FT , E, r$, T, and σ. It can be shown that both Ce and Pe increase when σ
Depth sections of the text are also
becomes larger.
indicated by blue type. 177
EXAMPLE 7.6: The European Option-Pricing Model
As an example of using the European options-pricing model, consider the PHLX 112 Sep
EUR European call option from Exhibit 7.6. The option has a premium of 2.76 U.S. cents per
x EUR on May 20, 2016. The last day of trading in the option will be on September 16, 2016—
119 days from the quotation date, or T = 119/365 = .3260. We will use the September futures
price on May 20, 2016, as our estimate of FT ($/EUR) = $112.45. The rate r$ is estimated as
the annualized 4-month dollar LIBOR (interest rate) of 0.80 percent on the same day. The
estimated volatility is 9.682 percent and was obtained from Bloomberg.
The values d1 and d2 are:
In (112.45/112) + .5(.09682)2 (.3260)
d1 = ____________________________
_____ = .1002
 receipts and payments, especially among its own affiliates.
6. When a firm has a portfolio of foreign currency positions, it makes sense only to hedge
the residual exposure rather than hedging each currency position separately. The rein-
voice center can help implement the portfolio approach to exposure management.
7. In a perfect capital market where stockholders can hedge exchange exposure as
well as the firm, it is difficult to justify exposure management at the corporate
level. In reality, capital markets are far from perfect, and the firm often has advan-
tages over the stockholders in implementing hedging strategies. There thus exists
room for corporate exposure management to contribute to the firm’s value. 216 PART THREE

KEY WORDS contingent exposure, 208 hedging through invoice reinvoice center, 211
cross-hedging, 208 currency, 210 transaction
economic exposure, 198 lead/lag strategy, 211 exposure, 198
exposure netting, 211 money market hedge, 203 translation
forward market options market exposure, 198
PROBLEMS

www.mhhe.com/er8e
hedge, 200 hedge, 203

QUESTIONS 1. How would you define transaction exposure? How is it different from economic
exposure? Questions and Problems—Each
2. Discuss and compare hedging transaction exposure using the forward contract ver-
sus money market instruments. When do alternative hedging approaches produce
the same result?
chapter contains CaHset
A P Tof
ERQuestions
8 and OF TRANSACTI
MANAGEMENT
216 PART THREE 3. Discuss
FOREIGN and EXPOSURE
EXCHANGE
contracts.
compare the AND costs of hedging by forward contracts and options
MANAGEMENT
Problems. This material can be used
4. What are the advantages of a currency options contract as a hedging tool compared
PROBLEMS with the forward
The spreadsheet contract? may be used in solving parts of problems 2, 3, 4, and 6.
TRNSEXP.xls by students on their own to test their
www.mhhe.com/er8e

understanding of the material, or5.asSuppose that Baltimor

5. Suppose
1. Cray your company
Research has purchased to
sold a supercomputer a put
theoption on the euro
Max Planck to manage
Institute exchange
in Germany on

www.mhhe.com/er8e
exposure
credit andassociated
invoiced €10 withmillion
an account
payablereceivable denominated
in six months. in that
Currently, thecurrency.
six-month In
this case,exchange
forward your company rate iscan be saidand
$1.10/€ to have an “insurance”
the foreign exchange policy on its
adviser forreceiv-
Cray
able. Explain
Research in what
predicts that sense thisrate
the spot is so.
is likely to be $1.05/€ in six months. the Swiss client a choi
6. a.
Recent
Whatsurveys of corporate
is the expected exchange
gain/loss from arisk management
forward hedge? practices indicate that homework exercises assigned by the
instructor. Questions and Problemsa. In the example, Balti
many
b. U.S.were
If you firmsthe simply do not
financial hedge. How
manager of Craywould you explain
Research, wouldthis
youresult?
recommend
7. Should a firm
hedging thishedge? Why or why
euro receivable? Whynot?or why not?
8. c.
Using an example,
Suppose
the same
discuss
the foreign the possible
exchange
as the exposure
forward exchange
effect
adviser of hedging
predicts
ratethequoted
on future
that the a firm’sspot
today.ofWould
tax rate
obligations.
will be
you recommend buy up to $10,000 us
relating to the In More Depth sections of
9. Explain contingent and discuss advantages using currency options
hedging this
to manage in this
typecase? Why or exposure.
of currency why not?
10. Explain cross-hedging and discuss the factors determining its effectiveness.Would
d. Suppose now that the future spot exchange rate is forecast to be $1.17/€.
b. If the spot exchang
you recommend hedging? Why or why not?
2. IBM purchased computer chips from NEC, a Japanese electronics concern, and the text are indicated by blue type. the Swiss client w
was billed ¥250 million payable in three months. Currently, the spot exchange rate

option for the Swis

is ¥105/$ and the three-month forward rate is ¥100/$. The three-month money
market interest rate is 8 percent per annum in the United States and 7 percent per
annum in Japan. The management of IBM decided to use a money market hedge

c. What is the best wa

to deal with this yen account payable.
218 PART THREE FOREIGN EXCHANGE EXPOSURE AND MANAGEMENT
a. Explain the process of a money market hedge and compute the dollar cost of
meeting the yen obligation.
b. Conduct a cash flow analysis of the money market hedge.
Bankware, a Boston-based company specializing in banking-related softwares,
6. Princess Cruise Comp

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3. You plan to visit Geneva, Switzerland, in three months to attend an international
INTERNET
business conference. You expect to incur a total cost of SF5,000 for lodging, exported its software for automatic teller machines (ATM) to Oslo Commerce tryBank,for 500 million yen
$0.60/SF and the three-month Questions
forward rate is $0.63/SF. You with
can buy the Excel
meals, and transportation during your stay. As of today, the spot exchange rate is

month call option on SF with an exercise price of $0.64/SF for the premium of
three- Software—An icon in which
EXERCISES
is trying to modernize its operation. Facing competition from European soft-
ware vendors, Bankware decided to bill the sales in the client’s currency, Norwegian one-year forward rate
theinterest
as the forward rate. The three-month margin rate is 6 percent
United States and 4 percent per annum in Switzerland.
indicates
$0.05 per SF. Assume that your expected future spot exchange rate is the same
per annum in the that the end-of-chapter
WWW
krone 500,000, payable in one year. Since there are no active forward currency markets
for the Norwegian currency, Bankware is considering selling a euro or British 8 percent
pound in the Unite
question
a. Calculate your expected dollar
by a call option on SF.
cost of buying SF5,000 is linked
if you choose to hedge to an Excel program created amount forward for cross-hedging purpose. Assess the hedging effectiveness the
the euro versus pound amount forward to cover the company’s exposure to the Norwe-
strike
of selling price of $.00
by the authors. See the Ancillary Materials
b. Calculate the future dollar cost of meeting this SF obligation if you decide to
hedge using a forward contract. gian currency. In solving this problem, consult exchange rate data availablea.
following website: www.federalreserve.gov/releases/H10/hist. You may consult other
fromCompute
the the futur
c. At what future spot exchange rate will you be indifferent between the forward
and option market hedges?section for more information on the software.
d. Illustrate the future dollar cost of meeting the SF payable against the future
websites. market and forward
b. Assuming that the
spot exchange rate under both the options and forward market hedges.
4. Boeing just signed a contract to sell a Boeing 737 aircraft to Air France. Air France

rate, compute the e

will be billed €20 million payable in one year. The current spot exchange rate is $1.05/€
and the one-year forward rate is $1.10/€. The annual interest rate is 6 percent in the MINI CASE Airbus’ Dollar Exposure
United States and 5 percent in France. Boeing is concerned with the volatile exchange
rate between the dollar and the euro and would like to hedge exchange exposure. Airbus sold an A400 aircraft to Delta Airlines, a U.S. company, and billed $30 million the pay- option hedge is
a. It is considering two hedging alternatives: sell the euro proceeds from the sale
forward or borrow euros from Crédit Lyonnaise against the euro receivable.
able in six months. Airbus is concerned about the euro proceeds from international sales
Which alternative would you recommend? Why?
b. Other things being equal, at what forward exchange rate would Boeing be
and would like to control exchange risk. The current spot exchange rate is $1.05/€ c.
six-month forward exchange rate is $1.10/€. Airbus can buy a six-month put option on U.S.
andAt the what future sp

dollars with a strike price of €0.95/$ for a premium of €0.02 per U.S. dollar. Currently,option and forward
CFA Questions—Many chapters include
indifferent between the two hedging methods? six-
month interest rate is 2.5 percent in the euro zone and 3.0 percent in the United States.

problems from CFA Program Curriculum study 1. Compute the guaranteed euro proceeds from the American sale if Airbus7. Consider a U.S.-based
decides to hedge using a forward contract.
pany expects to receiv
materials. These CFA problems, indicated with 2. If Airbus decides to hedge using money market instruments, what action does
the
Airbus need to take? What would be the guaranteed euro proceeds from the payment will be i
the CFA logo, show students the relevancy American sale in this case?
decline in the value o
of what is expected of certified professional 3. If Airbus decides to hedge using put options on U.S. dollars, what would be the
“expected” euro proceeds from the American sale? Assume that Airbusfree regards rate is 2 percent, a
analysts. rates are expected to r
the current forward exchange rate as an unbiased predictor of the future spot
exchange rate.
is $0.5974.
4. At what future spot exchange do you think Airbus will be indifferent between
the option and money market hedge?
a. Indicate whether th
to hedge currency
Case
218
Applications
PART THREE
—Case Applications
FOREIGN EXCHANGE EXPOSURE AND MANAGEMENT
CASE
APPLICATION
Richard May’s Options b. Calculate the no-a
forward contract th
It is Tuesday afternoon, February 14, 2012. Richard May, Assistant Treasurer at American
are incorporated within selected Digital Graphics (ADG), sits in his office on the thirty-fourth floor of the building that domi-
nates Rockefeller Plaza’s west perimeter. It’s Valentine’s Day, and Richard and his wife
chapters throughout Bankware, thea Boston-based
text in order company specializing in banking-related softwares, have dinner reservations with another couple at Balthazar at 7:30. I must get this c. hedg-
It is now 30 days si
www.mhhe.com/er8e

INTERNET
toEXERCISES
enhance specific exported its software for automatic teller machines (ATM) to Oslo Commerce Bank,
which topics
is trying toand modernize help its operation. Facing competition from European soft-
ing memo done, thinks May, and get out of here. Foreign exchange options? I had better
get the story straight before someone in the Finance Committee starts asking questions. spot rate is $0.55.
Let’s see, there are two ways in which I can envision us using options now. One the is to U.S. company’
ware vendors, Bankware decided to bill the sales in the client’s currency, Norwegian
students apply theories and concepts
krone 500,000, payable in one year. Since there are no active forward currency markets
hedge a dividend due on September 15th from ADG Germany. The other is to hedge our

toWWW“real-world” situations.
for the Norwegian currency, Bankware is considering selling a euro or British pound
amount forward for cross-hedging purpose. Assess the hedging effectiveness of selling
the euro versus pound amount forward to cover the company’s exposure to the Norwe-
gian currency. In solving this problem, consult exchange rate data available from the
following website: www.federalreserve.gov/releases/H10/hist. You may consult other
websites.
8. Suppose that you are
upcoming payment to Matsumerda for their spring RAM chip statement. With the yen at
78 and increasing I’m glad we haven’t covered the payment so far, but now I’m getting
nervous and I would like to protect my posterior. An option to buy yen on Junedom. 10 might You expect the
be just the thing.
Before we delve any further into Richard May’s musings, let us learn a bit about over ADGthe next 30 days
pany engaged in, among other things, the development, manufacture, and marketing goods in 30 days an
and about foreign exchange options. American Digital Graphics is a $12 billion sales com-

free rate is 5.5 perce

are expected to rema
MINI CASE Airbus’ Dollar Exposure Mini Cases—Almost every chapter is $1.50.
Airbus sold an A400 aircraft to Delta Airlines, a U.S. company, and billed $30 million pay-
able in six months. Airbus is concerned about the euro proceeds from international sales
includes a mini case for student a. Indicate whether y
and would like to control exchange risk. The current spot exchange rate is $1.05/€ and the analysis of multiple concepts covered currency risk.
six-month forward exchange rate is $1.10/€. Airbus can buy a six-month put option on U.S.
dollars with a strike price of €0.95/$ for a premium of €0.02 per U.S. dollar. Currently, six- throughout the chapter. These Mini b. Calculate the no-a
month interest rate is 2.5 percent in the euro zone and 3.0 percent in the United States.
1. Compute the guaranteed euro proceeds from the American sale if Airbus
Case problems are “real-world” in tract that expires in
decides to hedge using a forward contract. nature to show students how thec. Move forward 10
2. If Airbus decides to hedge using money market instruments, what action does
Airbus need to take? What would be the guaranteed euro proceeds from the theory and concepts in the textbook Calculate the value
American sale in this case?
3. If Airbus decides to hedge using put options on U.S. dollars, what would be the
relate to the everyday world. d. Using the text so
“expected” euro proceeds from the American sale? Assume that Airbus regards Exhibit 8.8.
the current forward exchange rate as an unbiased predictor of the future spot
exchange rate.
4. At what future spot exchange do you think Airbus will be indifferent between
the option and money market hedge?

Richard May’s Options

CASE
APPLICATION It is Tuesday afternoon, February 14, 2012. Richard May, Assistant Treasurer at American
xi
Digital Graphics (ADG), sits in his office on the thirty-fourth floor of the building that domi-
nates Rockefeller Plaza’s west perimeter. It’s Valentine’s Day, and Richard and his wife
have dinner reservations with another couple at Balthazar at 7:30. I must get this hedg-
ing memo done, thinks May, and get out of here. Foreign exchange options? I had better
 Required=Results
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Ancillary Materials
To assist in course preparation, the following instructor ancillaries are within the
Instructor Library in Connect:
•• Solutions Manual—Includes detailed suggested answers and solutions to the
end-of-chapter questions and problems, written by the authors.
•• Lecture Outlines—Chapter outlines, learning objectives, and teaching notes
for each chapter.
•• Test Bank—True/false and multiple-choice test questions for each chapter
prepared by Courtney Baggett, Butler University. Available as Word documents
and assignable within Connect.
•• PowerPoint Presentations—PowerPoint slides for each chapter to use in
classroom lecture settings, created by John Stansfield, University of Missouri.
The resources also include the International Finance Software that can be used with
this book. This Excel software has four main programs:
•• A currency options pricing program allows students to price put and call
options on foreign exchange.
•• A hedging program allows the student to compare forward, money market
instruments, futures, and options for hedging exchange risk.
•• A currency swap program allows students to calculate the cash flows and
notional values associated with swapping fixed-rate debt from one currency
into another.
•• A portfolio optimization program based on the Markowitz model allows for
examining the benefits of international portfolio diversification.
The four programs can be used to solve certain end-of-chapter problems (marked with
an Excel icon) or assignments the instructor devises. A User’s Manual and sample
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Acknowledgments
We are indebted to the many colleagues who provided insight and guidance throughout
the development process. Their careful work enabled us to create a text that is current,
accurate, and modern in its approach. Among all who helped in this endeavor for the
Eighth Edition:
Richard Ajayi Jaemin Kim
University of Central Florida San Diego State University
Lawrence A. Beer Yong-Cheol Kim
Arizona State University University of Wisconsin, Milwaukee
Nishant Dass Yen-Sheng Lee
Georgia Institute of Technology Bellevue University
John Hund Charmen Loh
Rice Univèrsity Rider University
Irina Khindanova Atsuyuki Naka
University of Denver University of New Orleans
Gew-rae Kim Richard L. Patterson
University of Bridgeport Indiana University, Bloomington
P R E F A C E xv

Adrian Shopp H. Douglas Witte

Metropolitan State University of Denver Missouri State University
John Wald
University of Texas at San Antonio
Many people assisted in the production of this textbook. At the risk of o­ verlooking
some individuals, we would like to acknowledge Brian Conzachi for the ­outstanding
job he did proofreading the entire manuscript. Additionally, we thank Yusri Zaro for
his hard work c­ hecking the accuracy of the solutions manual. Rohan-Rao Ganduri,
Kristen Seaver, Milind Shrikhande, Jin-Gil Jeong, Sanjiv Sabherwal, Sandy Lai,
Jinsoo Lee, Hyung Suk Choi, Teng Zhang, Minho Wang, and Victor Huang provided
useful inputs into the text. P
­ rofessor Martin Glaum of the Giessen University (Ger-
many) also provided valuable comments.
We also wish to thank the many professionals at McGraw-Hill Education for
their time and patience with us. Charles Synovec, executive brand manager; Noelle
Bathurst, senior product developer; and Tara Slagle and Debra Boxill, content project
managers have done a marvelous job guiding us through this edition, as has Melissa
Leick, as content project manager.
Last, but not least, we would like to thank our families, Christine, James, and
Elizabeth Eun and Donna Resnick, for their tireless love and support, without which
this book would not have become a reality. Special thanks go to Christine Eun who
came up with an excellent design for the book cover.
We hope that you enjoy using International Financial Management, Eighth E ­ dition.
In addition, we welcome your comments for improvement. Please let us know either
through McGraw-Hill Education, c/o Editorial, or at our e-mail addresses provided
below.

Cheol S. Eun
cheol.eun@scheller.gatech.edu
Bruce G. Resnick
resnickbg@wfu.edu
Contents
in Brief

PART ONE Foundations of International Financial Management

1 Globalization and the Multinational Firm, 4
2 International Monetary System, 27
3 Balance of Payments, 62
4 Corporate Governance Around the World, 82

PART TWO The Foreign Exchange Market, Exchange Rate

Determination, and Currency Derivatives
5 The Market for Foreign Exchange, 112
6 International Parity Relationships and Forecasting Foreign
Exchange Rates, 140
7 Futures and Options on Foreign Exchange, 173

PART THREE Foreign Exchange Exposure and Management

8 Management of Transaction Exposure, 198
9 Management of Economic Exposure, 225
10 Management of Translation Exposure, 244

PART FOUR World Financial Markets and Institutions

11 International Banking and Money Market, 264
12 International Bond Market, 304
13 International Equity Markets, 323
14 Interest Rate and Currency Swaps, 347
15 International Portfolio Investment, 365

PART FIVE Financial Management of the Multinational Firm

16 Foreign Direct Investment and Cross-Border Acquisitions, 404
17 International Capital Structure and the Cost of Capital, 431
18 International Capital Budgeting, 458
19 Multinational Cash Management, 477
20 International Trade Finance, 488
21 International Tax Environment and Transfer Pricing, 499

Glossary, 521
Index, 528

xvi
Contents
PART ONE Foundations of International Financial Management
CHAPTER 1 What’s Special about International Finance?, 5
Globalization and the Foreign Exchange and Political Risks, 5
Multinational Firm, 4 Market Imperfections, 6
Expanded Opportunity Set, 7
Goals for International Financial Management, 8
Globalization of the World Economy:
Major Trends and Developments, 10
Emergence of Globalized Financial Markets, 10
Emergence of the Euro as a Global Currency, 11
CHAPTER 2 Evolution of the International Monetary System, 27
International Bimetallism: Before 1875, 28
Monetary System, 27 Classical Gold Standard: 1875–1914, 28
Interwar Period: 1915–1944, 30
Bretton Woods System: 1945–1972, 31
The Flexible Exchange Rate
Regime: 1973–Present, 34
The Current Exchange Rate Arrangements, 36
European Monetary System, 41
The Euro and the European Monetary Union, 43
A Brief History of the Euro, 43
What Are the Benefits of Monetary Union?, 44
CHAPTER 3 Balance-of-Payments Accounting, 62
Balance of Balance-of-Payments Accounts, 64
Payments, 62 The Current Account, 64
The Capital Account, 66
Statistical Discrepancy, 68
Official Reserve Account, 69
The Balance-of-Payments Identity, 72
Balance-of-Payments Trends in Major Countries, 72
Europe’s Sovereign Debt Crisis of 2010, 12
Trade Liberalization and Economic Integration, 13
Privatization, 16
Global Financial Crisis of 2008–2009, 17
Multinational Corporations, 19
Summary, 21
m i n i c a s e : Nike and Sweatshop Labor, 23
a p p e n d i x 1 a : Gain from Trade: The Theory
of Comparative Advantage, 25
Costs of Monetary Union, 46
Prospects of the Euro: Some Critical Questions, 47
international finance in practice: Mundell
Wins Nobel Prize in Economics, 48
The Mexican Peso Crisis, 50
The Asian Currency Crisis, 51
Origins of the Asian Currency Crisis, 52
Lessons from the Asian Currency Crisis, 54
The Argentine Peso Crisis, 55
Fixed versus Flexible Exchange Rate Regimes, 56
Summary, 58
m i n i c a s e : Grexit or Not? 60
international finance in practice: The Dollar and the
Deficit, 74
Summary, 77
m i n i c a s e : Mexico’s Balance-of-Payments
Problem, 80
a p p e n d i x 3 a : The Relationship Between
Balance of Payments and National Income
Accounting, 81
xvii
xviii CONTENTS

CHAPTER 4 Governance of the Public Corporation: Law and Corporate Governance, 92

Key Issues, 83
Corporate Consequences of Law, 95
The Agency Problem, 84
Governance Ownership and Control Pattern, 95
Remedies for the Agency Problem, 86
Around the World, 82 Board of Directors, 87
Private Benefits of Control, 99
Capital Markets and Valuation, 99
Incentive Contracts, 87 Corporate Governance Reform, 100
international finance in practice: When Boards Objectives of Reform, 100
Are All in the Family, 88
Political Dynamics, 101
Concentrated Ownership, 88
The Sarbanes-Oxley Act, 101
Accounting Transparency, 90
The Cadbury Code of Best Practice, 102
Debt, 90
The Dodd-Frank Act, 103
Overseas Stock Listings, 90
Summary, 104
Market for Corporate Control, 91
m i n i c a s e : Parmalat: Europe’s Enron, 107

PART TWO The Foreign Exchange Market, Exchange Rate

Determination, and Currency Derivatives
CHAPTER 5 Function and Structure of the FX Market, 113 Spot Foreign Exchange Market
Microstructure, 127
The Market for international finance in practice: The Mouse Takes Over
the Floor, 114 The Forward Market, 129
Foreign
FX Market Participants, 114 Forward Rate Quotations, 129
Exchange, 112 Correspondent Banking Relationships, 116 Long and Short Forward Positions, 130
The Spot Market, 117 Non-Deliverable Forward Contracts, 130
Spot Rate Quotations, 117 Forward Cross-Exchange Rates, 130
international finance in practice: Where Money Talks Forward Premium, 132
Very Loudly, 118 Swap Transactions, 132
Cross-Exchange Rate Quotations, 122 Exchange-Traded Currency
Alternative Expressions for the Funds, 135
Cross-Exchange Rate, 123 Summary, 135
The Bid-Ask Spread, 123 m i n i c a s e : Shrewsbury Herbal
Spot FX Trading, 124 Products, Ltd., 139
The Cross-Rate Trading Desk, 125
Triangular Arbitrage, 127

CHAPTER 6 Interest Rate Parity, 140 Fisher Effects, 156

International Parity Covered Interest Arbitrage, 142 Forecasting Exchange Rates, 158

Relationships and Interest Rate Parity and Exchange Rate Efficient Market Approach, 159
Determination, 145
Forecasting Foreign Currency Carry Trade, 146
Fundamental Approach, 160
Technical Approach, 161
Exchange Rates, 140 Reasons for Deviations from Interest Performance of the Forecasters, 162
Rate Parity, 147
Summary, 166
Purchasing Power Parity, 149
m i n i c a s e : Turkish Lira and Purchasing
PPP Deviations and the Real Exchange Rate, 151 Power Parity, 171
Evidence on Purchasing Power Parity, 151 a p p e n d i x 6 a : Purchasing Power Parity and
international finance in practice: McCurrencies, 152 Exchange Rate Determination, 172
 C O N T E N T S xix

CHAPTER 7 Futures Contracts: Some Preliminaries, 174 American Option-Pricing Relationships, 185
Futures and Currency Futures Markets, 176 European Option-Pricing Relationships, 187

Options on Foreign international finance in practice: FX Market Volumes Binomial Option-Pricing Model, 189
Surge, 177
Exchange, 173 Basic Currency Futures Relationships, 178
European Option-Pricing Formula, 191
Empirical Tests of Currency Options, 192
Options Contracts: Some Preliminaries, 181 Summary, 193
Currency Options Markets, 181 m i n i c a s e : The Options Speculator, 195
Currency Futures Options, 182
Basic Option-Pricing Relationships at
Expiration, 182

PART THREE Foreign Exchange Exposure and Management

CHAPTER 8 Three Types of Exposure, 198 Hedging Recurrent Exposure with Swap
Contracts, 209
Management Forward Market Hedge, 200
Hedging through Invoice Currency, 210
of Transaction Money Market Hedge, 202
Hedging via Lead and Lag, 210
Exposure, 198 Options Market Hedge, 203
Exposure Netting, 211
Hedging Foreign Currency Payables, 205
Forward Contracts, 206 Should the Firm Hedge?, 211

Money Market Instruments, 206 What Risk Management Products Do

Firms Use?, 213
Currency Options Contracts, 207
Summary, 214
Cross-Hedging Minor Currency
Exposure, 208 m i n i c a s e : Airbus’ Dollar Exposure, 218

Hedging Contingent Exposure, 208 c a s e a p p l i c at i o n : Richard May’s Options, 218

CHAPTER 9 How to Measure Economic Exposure, 226 Diversification of the Market, 237
Management Operating Exposure: Definition, 230 R&D Efforts and Product Differentiation, 237

of Economic Illustration of Operating Exposure, 231 Financial Hedging, 238

Exposure, 225 Determinants of Operating Exposure, 233 c a s e a p p l i c at i o n : Exchange Risk Management

at Merck, 238
Managing Operating Exposure, 235
Selecting Low-Cost Production Summary, 240
Sites, 236 m i n i c a s e : Economic Exposure of Albion Computers
Flexible Sourcing Policy, 236 PLC, 242

CHAPTER 10 Translation Methods, 244 c a s e a p p l i c at i o n : Consolidation of

Accounts according to FASB 52: The Centralia
Management Current/Noncurrent Method, 244
Corporation, 250
of Translation Monetary/Nonmonetary Method, 245
Management of Translation Exposure, 254
Exposure, 244 Temporal Method, 245
Translation Exposure versus Transaction Exposure, 254
Current Rate Method, 245
Hedging Translation Exposure, 255
Financial Accounting Standards Board
Statement 8, 246 Balance Sheet Hedge, 255

Financial Accounting Standards Board Derivatives Hedge, 256

Statement 52, 246
The Mechanics of the FASB 52 Translation
Process, 249
Highly Inflationary Economies, 250
International Accounting Standards, 250
Translation Exposure versus Operating Exposure, 257
Empirical Analysis of the Change from
FASB 8 to FASB 52, 257
Summary, 258
m i n i c a s e : Sundance Sporting Goods, Inc., 259
xx CONTENTS

PART FOUR World Financial Markets and Institutions

CHAPTER 11 International Banking Services, 264 Forward Rate Agreements, 276
International The World’s Largest Banks, 265 Euronotes, 279

Banking and Money Reasons for International Banking, 266 Eurocommercial Paper, 279

Market, 264 Types of International Banking Offices, 266 Eurodollar Interest Rate Futures Contracts, 279
Correspondent Bank, 267 International Debt Crisis, 281
Representative Offices, 267 History, 281
Foreign Branches, 267 Debt-for-Equity Swaps, 282
Subsidiary and Affiliate Banks, 268 The Solution: Brady Bonds, 284
Edge Act Banks, 268 The Asian Crisis, 284
Offshore Banking Centers, 268 Global Financial Crisis, 285
International Banking Facilities, 269 The Credit Crunch, 285
Capital Adequacy Standards, 269 Impact of the Financial Crisis, 289
International Money Market, 272 Economic Stimulus, 291
Eurocurrency Market, 272 The Aftermath, 293
ICE LIBOR, 274 Summary, 294
Eurocredits, 274 m i n i c a s e : Detroit Motors’ Latin American
international finance in practice: The Rotten Heart Expansion, 299
of Finance, 276 a p p e n d i x 1 1 a : Eurocurrency Creation, 301

CHAPTER 12 The World’s Bond Markets: A Statistical Equity-Related Bonds, 309

Perspective, 304
International Bond Dual-Currency Bonds, 309
Foreign Bonds and Eurobonds, 305
Market, 304 Currency Distribution, Nationality, and
Bearer Bonds and Registered Bonds, 305 Type of Issuer, 310
National Security Regulations, 306 International Bond Market Credit Ratings, 311
Withholding Taxes, 306 international finance in practice: Heineken Refreshes
Security Regulations that Ease Bond Issuance, 306 Euromarket with Spectacular Unrated Bonds, 312

Global Bonds, 307 Eurobond Market Structure and Practices, 314

Types of Instruments, 307 Primary Market, 314

international finance in practice: SOX and Secondary Market, 314

Bonds, 308 Clearing Procedures, 316
Straight Fixed-Rate Issues, 308 International Bond Market Indexes, 318
Euro-Medium-Term Notes, 308 Summary, 320
Floating-Rate Notes, 309 m i n i c a s e : Sara Lee Corporation’s Eurobonds, 321

CHAPTER 13 A Statistical Perspective, 323 International Equity Market Benchmarks, 339

International Equity Market Capitalization, 323 iShares MSCI, 340

Markets, 323 Measure of Liquidity, 326 Factors Affecting International Equity

Market Structure, Trading Practices, and Costs, 326 Returns, 340

Market Consolidations and Mergers, 330 Macroeconomic Factors, 340

Trading in International Equities, 330 international finance in practice: Foreign Interest in

South Africa Takes Off, 342
Cross-Listing of Shares, 331
Exchange Rates, 342
Yankee Stock Offerings, 333
Industrial Structure, 342
American Depository Receipts, 334
Summary, 343
Global Registered Shares, 337
m i n i c a s e : San Pico’s New Stock Exchange, 345
Empirical Findings on Cross-Listing and ADRs, 338
 C O N T E N T S xxi

CHAPTER 14 Types of Swaps, 347 Equivalency of Currency Swap Debt Service

Obligations, 355
Interest Rate and international finance in practice: The World Bank’s First
Currency Swap, 348 Pricing the Basic Currency Swap, 356
Currency Swaps, 347
Size of the Swap Market, 348 A Basic Currency Swap Reconsidered, 357
The Swap Bank, 349 Variations of Basic Interest Rate and
Swap Market Quotations, 349 Currency Swaps, 358

international finance in practice: Double-Crossed 350 Risks of Interest Rate and Currency Swaps, 359

Interest Rate Swaps, 351 Is the Swap Market Efficient?, 359

Basic Interest Rate Swap, 351 Summary, 360

Pricing the Basic Interest Rate Swap, 353 m i n i c a s e : The Centralia Corporation’s Currency
Swap, 364
Currency Swaps, 354
Basic Currency Swap, 354

CHAPTER 15 International Correlation Structure and Risk International Diversification with

Diversification, 366 Hedge Funds, 385
International Portfolio
Optimal International Portfolio Selection, 368 Why Home Bias in Portfolio Holdings?, 386
Investment, 365
Effects of Changes in the Exchange Rate, 375 International Diversification with Small-Cap
International Bond Investment, 377 Stocks, 387

International Mutual Funds: A Performance Summary, 389

Evaluation, 378 m i n i c a s e : Solving for the Optimal International
International Diversification through Country Portfolio, 394
Funds, 380 a p p e n d i x 1 5 a : International Investment with
International Diversification with ADRs, 383 Exchange Risk Hedging, 397

International Diversification with Exchange-Traded a p p e n d i x 1 5 b : Solving for the Optimal

Funds, 384 Portfolio, 399

PART FIVE Financial Management of the Multinational Firm

CHAPTER 16 Global Trends in FDI, 405 Product Life Cycle, 412
Foreign Direct Why Do Firms Invest Overseas?, 408 Shareholder Diversification Services, 413

­Investment and Trade Barriers, 409 Cross-Border Mergers and

Acquisitions, 413
­Cross-Border Imperfect Labor Market, 409
Political Risk and FDI, 418
Intangible Assets, 410
Acquisitions, 404 Summary, 425
Vertical Integration, 411
international finance in practice: Linear Sequence in m i n i c a s e : Enron versus Bombay
Manufacturing: Singer & Company, 412 Politicians, 427

CHAPTER 17 Cost of Capital, 431 Pricing-to-Market Phenomenon, 446

International Capital Cost of Capital in Segmented versus Integrated c a s e a p p l i c at i o n : Nestlé, 447
Markets, 434
Structure and the Asset Pricing under Foreign Ownership
Does the Cost of Capital Differ among Restrictions, 448
Cost of Capital, 431 Countries?, 435 The Financial Structure of Subsidiaries, 451
c a s e a p p l i c at i o n : Novo Industri, 437 Summary, 452
Cross-Border Listings of Stocks, 439 a p p e n d i x 1 7 a : Pricing of Nontradable Assets:
Capital Asset Pricing under Cross-Listings, 444 Numerical Simulations, 457
The Effect of Foreign Equity Ownership
Restrictions, 446
xxii CONTENTS

CHAPTER 18 Review of Domestic Capital Budgeting, 459 Sensitivity Analysis, 470

International Capital The Adjusted Present Value Model, 460 Purchasing Power Parity Assumption, 470

Budgeting, 458 Capital Budgeting from the Parent Firm’s Real Options, 470
Perspective, 462 Summary, 472
Generality of the APV Model, 464 m i n i c a s e 1 : Dorchester, Ltd., 474
Estimating the Future Expected Exchange Rate, 465 m i n i c a s e 2 : Strik-it-Rich Gold Mining
c a s e a p p l i c at i o n : The Centralia Corporation, 465 Company, 475
Risk Adjustment in the Capital Budgeting
Analysis, 469

CHAPTER 19 The Management of International Cash Cash Management Systems in Practice, 485
Balances, 477
Multinational Cash Summary, 486
c a s e a p p l i c at i o n : Teltrex’s Cash Management
Management, 477 System, 477
m i n i c a s e 1 : Efficient Funds Flow at Eastern
Trading Company, 487
Bilateral Netting of Internal and External Net Cash m i n i c a s e 2 : Eastern Trading Company’s New
Flows, 482 MBA, 487
Reduction in Precautionary Cash Balances, 483

CHAPTER 20 A Typical Foreign Trade Transaction, 488 Countertrade, 493

International Trade Forfaiting, 491 Forms of Countertrade, 493

Finance, 488 Government Assistance in Exporting, 491 international finance in practice: Armed Forces Tops in
international finance in practice: First Islamic Forfaiting Countertrade List, 495
Fund Set Up, 492 Some Generalizations about Countertrade, 495
The Export-Import Bank and Affiliated Summary, 496
Organizations, 492 m i n i c a s e : American Machine Tools, Inc., 498

CHAPTER 21 The Objectives of Taxation, 499 international finance in practice: On or Off?

It’s a Matter of Degree, 508
International Tax Tax Neutrality, 499
Transfer Pricing and Related Issues, 509
Environment and Tax Equity, 500
c a s e a p p l i c at i o n : Mintel Products Transfer Pricing
Transfer Pricing, 499 Types of Taxation, 500
Strategy, 509
Income Tax, 500
international finance in practice: Transfer Pricing: An
Withholding Tax, 502 Important International Tax Issue, 512
Value-Added Tax, 502 Miscellaneous Factors, 514
National Tax Environments, 504 international finance in practice: Wake Up and Smell the
Worldwide Taxation, 504 Coffee, 515
Territorial Taxation, 504 Advance Pricing Agreement, 516
Foreign Tax Credits, 505 Blocked Funds, 516
Organizational Structures, 505 Summary, 517
Branch and Subsidiary Income, 505 m i n i c a s e 1 : Sigma Corp.’s Location
Tax Havens, 506 Decision, 519
Controlled Foreign Corporation, 507 m i n i c a s e 2 : Eastern Trading Company’s Optimal
Transfer Pricing Strategy, 520
Tax Inversion, 507

Glossary, 521
Index, 528
 International
Financial
Management
Eighth Edition
 PART ONE
ONE

1 Globalization and the Multinational Firm

OUTLINE
OUTLINE

2 International Monetary System

3 Balance of Payments

4 Corporate Governance Around the World

2
Foundations of International
Financial Management

PART ONE lays the macroeconomic and institutional foundation for

all the topics to follow. A thorough understanding of this material is
essential for understanding the advanced topics covered in the
remaining sections.

CHAPTER 1 provides an introduction to International Financial

Management. The chapter discusses why it is important to study
international finance and distinguishes international finance from
domestic finance.

CHAPTER 2 introduces the various types of international monetary

systems under which the world economy can function and has functioned
at various times. The chapter traces the historical development of the
world’s international monetary systems from the early 1800s to the
present. Additionally, a detailed discussion of the European Monetary
Union is presented.

CHAPTER 3 presents balance-of-payment concepts and accounting.

The chapter shows that even a country must keep its “economic house
in order” or else it will experience current account deficits that will
undermine the value of its currency.

CHAPTER 4 provides an overview of corporate governance around the

world. Corporate governance structure varies greatly across countries,
reflecting diverse cultural, economic, political, and legal environments.

3
 CHAPTER

1 Globalization and the

CHAPTER OUTLINE

Multinational Firm
What’s Special about International Finance? AS THE TITLE International Financial Management indicates,
Foreign Exchange and Political Risks in this book we are concerned with financial management in
Market Imperfections an international setting. Financial management is mainly con-
Expanded Opportunity Set
cerned with how to optimally make various corporate financial
decisions, such as those pertaining to investment, financing,
Goals for International Financial Management dividend policy, and working capital management, with a view
Globalization of the World Economy: Major to achieving a set of given corporate objectives. In Anglo-
Trends and Developments American countries as well as in many advanced countries with
Emergence of Globalized Financial Markets well-developed capital markets, maximizing shareholder wealth
Emergence of the Euro as a Global Currency is generally considered the most important corporate objective.
Europe’s Sovereign Debt Crisis of 2010 Why do we need to study “international” financial man-
Trade Liberalization and Economic Integration agement? The answer to this question is straightforward: We
are now living in a highly globalized and integrated world
Privatization
economy. American consumers, for example, routinely purchase
Global Financial Crisis of 2008–2009 oil imported from Saudi Arabia and Nigeria, TV sets from
Multinational Corporations Korea, automobiles from Germany and Japan, garments from
Summary China, shoes from Indonesia, handbags from Italy, and wine
Key Words from France. Foreigners, in turn, purchase American-made air-
Questions craft, software, movies, jeans, smartphones, and other products.
Continued liberalization of international trade is certain to further
Internet Exercises
internationalize consumption patterns around the world.
Mini Case: Nike and Sweatshop Labor Like consumption, production of goods and services has
References and Suggested Readings become highly globalized. To a large extent, this has happened
Appendix 1A: Gain from Trade: The Theory of as a result of multinational corporations’ (MNCs) relent-
Comparative Advantage less efforts to source inputs and locate production anywhere
in the world where costs are lower and profits are higher. For
example, personal computers sold in the world market might have been assembled in
Malaysia with Taiwanese-made monitors, Korean-made keyboards, U.S.-made chips,
and preinstalled software packages that were jointly developed by U.S. and Indian
engineers. It has often become difficult to clearly associate a product with a single
country of origin.
Recently, financial markets have also become highly integrated. This development
allows investors to diversify their investment portfolios internationally. In 2016, for
instance, U.S. investors collectively invested $154 billion in foreign securities, such
as stocks and bonds, whereas foreigners invested $276 billion in U.S. securities.1 In
particular, Asian and Middle Eastern investors are investing heavily in U.S. and other
foreign financial markets in efforts to recycle their large trade surpluses. In addition,
many major corporations of the world, such as IBM, Toyota, and British Petroleum,
have their shares cross-listed on foreign stock exchanges, thereby rendering their shares
internationally tradable and gaining access to foreign capital as well. Consequently,
Toyota’s venture, say, in China can be financed partly by American investors who
purchase Toyota shares traded on the New York Stock Exchange.

1
This information is from International Financial Statistics, 2016.

4

What’s Special about International Finance?
Foreign Exchange
and Political Risks
https:// www.cia.gov/library
/publications/the-world-factbook
Website of The World Factbook
published by the CIA provides
background information, such
as geography, government, and
economy, of countries around
the world.
Undoubtedly, we are now living in a world where all the major economic
functions—consumption, production, and investment—are highly globalized. It is thus
essential for financial managers to fully understand vital international dimensions of
financial management. This global shift is in marked contrast to a few decades ago,
when the authors of this book were learning finance. At that time, most professors
customarily (and safely, to some extent) ignored international aspects of finance. This
parochial attitude has become untenable since then.
Although we may be convinced of the importance of studying international finance,
we still have to ask ourselves, what’s special about international finance? Put another
way, how is international finance different from purely domestic finance (if such a
thing exists)? Three major dimensions set international finance apart from domestic
finance. They are:
1. Foreign exchange and political risks.
2. Market imperfections.
3. Expanded opportunity set.
As we will see, these major dimensions of international finance largely stem from the
fact that sovereign nations have the right and power to issue currencies, formulate their
own economic policies, impose taxes, and regulate movements of people, goods, and
capital across their borders. Before we move on, let us briefly describe each of the key
dimensions of international financial management.
Suppose Mexico is a major export market for your company and the Mexican peso depreci-
ates drastically against the U.S. dollar, as it did in December 1994. This means that your
company’s products can be priced out of the Mexican market, as the peso price of American
imports will rise following the peso’s fall. If such countries as Indonesia, Thailand, and
Korea are major export markets, your company would have faced the same difficult situ-
ation in the wake of the Asian currency crisis of 1997. In integrated financial markets,
individuals or households may also be seriously exposed to uncertain exchange rates. For
example, since the EU accession, many Hungarians have borrowed in terms of the euro or
Swiss franc to purchase houses. They were initially attracted by the easy availability and
low interest rates for foreign currency mortgage loans. However, as the Hungarian cur-
rency, forint, was falling against the euro and Swiss franc during the recent global financial
crisis, the burden of mortgage payments in terms of forint has increased sharply, forcing
many borrowers to default. The preceding examples suggest that when firms and indi-
viduals are engaged in cross-border transactions, they are potentially exposed to foreign
exchange risk that they would not normally encounter in purely domestic transactions.
Currently, the exchange rates among such major currencies as the U.S. dollar,
Japanese yen, British pound, and euro fluctuate continuously in an unpredictable
manner. This has been the case since the early 1970s, when fixed exchange rates were
abandoned. As can be seen from Exhibit 1.1, exchange rate volatility has exploded
since 1973. Exchange rate uncertainty will have a pervasive influence on all the major
economic functions, including consumption, production, and investment.
Another risk that firms and individuals may encounter in an international setting is
political risk. Political risk ranges from unexpected changes in tax rules to outright
expropriation of assets held by foreigners. Political risk arises from the fact that a
sovereign country can change the “rules of the game” and the affected parties may
not have effective recourse. In 1992, for example, the Enron Development Corpo-
ration, a subsidiary of a Houston-based energy company, signed a contract to build
India’s largest power plant. After Enron had spent nearly $300 million, the project
5
6 PART ONE
EXHIBIT 1.1
Monthly Percentage Change
in Japanese Yen-U.S. Dollar
Exchange Rate
Market Imperfections
FOUNDATIONS OF INTERNATIONAL FINANCIAL MANAGEMENT
15
10
Percentage change
5
–5
–10
–15
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Source: International Monetary Fund, International Financial Statistics, various issues.
was canceled in 1995 by nationalist politicians in the Maharashtra state who argued
India didn’t need the power plant. For another example, in April 2012 the Argentine
governent nationalized a majority stake in YPF, the country’s largest oil company, worth
approximately $10 billion, held by the Spanish parent company, Repsol, accusing the
latter for underproducing oil in Argentina. Broadly, the seizure of YPF is a part of the
campaign to bring strategic industries under government control. Both the Enron and
Repsol episodes illustrate the difficulty of enforcing contracts in foreign countries.2
Multinational firms and investors should be particularly aware of political risk when
they invest in those countries without a tradition of the rule of law. The meltdown of
Yukos, the largest Russian oil company, provides a compelling example. Following the
arrest of Mikhail Khodorkovsky, the majority owner and a critic of the government, on
fraud and tax evasion charges, the Russian authorities forced Yukos into bankruptcy. The
authorities sued the company for more than $20 billion in back taxes and auctioned off
its assets to cover the alleged tax arrears. This government action against Yukos, widely
viewed as politically motivated, inflicted serious damage on international shareholders
of Yukos, whose investment values were wiped out. It is important to understand that the
property rights of shareholders and investors are not universally respected.
Although the world economy is much more integrated today than was the case 10 or
20 years ago, a variety of barriers still hamper free movements of people, goods, ser-
vices, and capital across national boundaries. These barriers include legal restrictions,
excessive transaction and transportation costs, information asymmetry, and discrimi-
natory taxation. The world markets are thus highly imperfect. As we will discuss later
in this book, market imperfections, which represent various frictions and impedi-
ments preventing markets from functioning perfectly, play an important role in moti-
vating MNCs to locate production overseas. Honda, a Japanese automobile company,
for instance, decided to establish production facilities in Ohio, mainly to circumvent
trade barriers. One might even say that MNCs are a gift of market imperfections.
Imperfections in the world financial markets tend to restrict the extent to which inves-
tors can diversify their portfolios. An interesting example is provided by the Nestlé
Corporation, a well-known Swiss MNC. Nestlé used to issue two different classes of
common stock, bearer shares and registered shares, and foreigners were allowed to hold
2
Since then, Enron has renegotiated the deal with the Maharashtra state while the Spanish government retaliated
by restricting imports from Argentina.
Another random document with
no related content on Scribd:
"'I did! I did!' I exclaimed, with a fresh burst of tears. 'And now I
would give all the world to get home again!'"

"'Why don't you go, then?' was the natural question."

"'I have no money, and they watch me so closely that I have no

chance to run away. They treat me dreadfully. I have not had
anything to eat before, to-day.'"

"'What is your captain's name?' asked the stranger."

"I told him, and he shook his head."

"'You have got into a bad box, my lad. There is not a more desperate
set on the whole canal.'"

"'Hallo, George!' shouted my tormentor from the boat. 'What are you
about! Stop talking and mind your business!'"

"This admonition was accompanied with more threats and oaths

than I care to repeat."

"'I dare not say any more now,' said I; 'but if you wish to save my life,
write to Mr. George Stanton at H—, Massachusetts, and tell him that
his son George is on the canal-boat Diamond, and cannot get away.
Tell him I told you to say so; and oh! Do write at once, or it will be too
late to do any good.'"

"'I will do it before I sleep,' said my companion. 'You may depend

upon me. And one word more, my boy, before I leave you. You have
done very wrong, but do not despair. Remember the Prodigal Son.
Return to God, and He will return to you. He can hear you as well
from your horse's back as anywhere else, and He will, too, if you
truly seek Him.'"

"He jumped aboard his boat, which now came up, and I started up
my horses. When I was released at last, the captain called me, and
asked me what I had been talking about. I told him only that the man
had asked me if I was hungry, and, when I said yes, he had given
me some cakes and crackers."

"And you told him a fine parcel of lies about the way you were
treated, I dare say. I'll teach you to go gossiping along and letting
your horses get drowned, you young dog!'"

"He seized me by the collar as he spoke, and I verily thought my last

hour was come, but one of the men interfered."

"'Let the boy alone!' said he. 'Do you mean to kill him?' Haven't you
got enough on your hands already?'"

"'What is that to you?' asked the captain, fiercely."

"'It is so much to me that I won't stand by and see a child murdered.

Come now, captain, there is no use in bullying. I know enough to
hang you, and by— I'll do it, too, if you don't behave yourself better.
Get away, George, and go to bed.'"

"I was only too glad to obey, and crept to my miserable bed. My new
friend's words seemed to have thrown a little light on my dark path.
He had promised to write to my father, and I believed he would keep
his word; but that was not all. He had turned my thoughts to my
Father in heaven—a Father forgotten, sinned against, outraged, but
still my Father, pitying and caring for me through all. I repeated to
myself the parable of the Prodigal Son, which I had learned by heart
long ago. 'And while I was yet a great way oft; my Father saw me,
and had compassion on me.'"

The clergyman stopped and cleared his throat.

"All the next day my head and limbs ached terribly, and I could hardly
sit up, but I was happier than I had been for many day. I confessed
my sins and sought earnestly for forgiveness, and it seemed to me
as if I found it, for a wonderful peace and quietness appeared to
descend on my heart. I believed that I was going to be very sick, and
I thought I should probably die. Oh! How earnestly I did pray that I
might be spared to see my dear father once more, if it were only for
long enough to beg his forgiveness for all my undutiful conduct."

"My forebodings proved true, so far as the sickness was concerned.

We were not far from Rochester, which was not then the busy little
city it has since become, but only a pretty, thriving village. By the
time we arrived at its outskirts, I was very ill indeed. I tried hard to sit
up and drive, but it was impossible, and just as we reached the
aqueduct, I fell from my horse and rolled into the water. A man who
saw me fall, instantly jumped in after me and brought me to shore."

"'Let him alone, you fool!' shouted the captain. 'He is only shamming.
He can help himself well enough.'"

"'Shamming!' said my preserver. 'He don't look much like it. There,
take him on board and use him well, for he seems to need it.'"

"'Oh, don't let him take me!' I pleaded, feebly clinging to his arm as
the captain approached. 'He will kill me, I know he will. He has
almost done so already. Let me die in peace.'"

"'What does all this mean?' said an elderly, well-dressed man,

approaching the spot, where quite a little crowd had gathered round
me. 'What is the matter, my little fellow? Don't be afraid, no one shall
hurt you. Tell me the whole story.'"

"'He has beaten and starved me,' I tried to explain. 'I know he means
to kill me! He said he would. Oh, do please send me home to my
father!'"

"My head again turned giddy as I spoke, and I should have fallen but
for the supporting arm of my new friend, who sat down on step and
took me on his knee."

"'Just look here, sir,' said he, turning down the collar of my shirt. 'Is
that the way to treat a little child like this?'"
"I dimly remember the looks and tones of pity and indignation as the
men gathered around me. I recollect the old gentleman's assuring
me that I should be taken care of, and then putting me into a wagon,
the motion of which distressed me exceedingly. After that, the time is
really a blank. I knew sometimes that I was in a comfortable bed and
kindly treated, and I have a dim remembrance of some ladies who
came often to see me; but I could not speak clearly or give any
distinct account of myself."

"But one night, after what seemed a very long and sound sleep, I
woke, and found that I was better. I lay perfectly still, not moving a
finger, but letting my eyes rove idly round the room. I looked at the
whitewashed walls and the uncarpeted floor, and I guessed that I
was in some almshouse or hospital. Presently my eyes fell upon a
lady who was sitting by the foot of the bed. I looked at her a long
time, as she sat reading by the light of the shaded lamp, and I
seemed to remember that it was not the first time I had seen her
near me. The tall figure and erect carriage seemed familiar, and
carried my thoughts back to home. So did the somewhat large but
noble and regular features, the clear, brown skin, and the abundant
dark hair, a little streaked with gray."

"'Mother!' said I, at last, 'Is that you?' It was the first time that I had
ever called her 'mother.' She did not start, but quietly laid down her
book and came to my side."

"'You feel better, do you not, my dear boy?' said she, laying her hand
on my forehead.

"Yes, mother, but very weak and faint.'"

"She gave me a little wine and then some nice broth, which seemed
to refresh me, but she would not allow me to talk."

"'Is my father here?' I asked, after lying still a little longer."

"'He is here. He has been watching by you for two or three nights,
and I persuaded him to lie down.'"
"I still felt very low and weak and it tired me to talk; so I lay still, and
looked at my mother with a kind of peaceful enjoyment of her
presence, till I fell asleep once more. The next morning I saw my
father, but I was not allowed to speak to him, for my strength was so
reduced that my recovery was considered a very doubtful matter. I
well remember the pain it gave me to see how old he had grown,
and how careworn and sad he looked. He assured me of his entire
forgiveness, and bade me give all my thoughts to getting well, that I
might go home once more."

"It was only by the best of nursing that I finally regained so much
strength as to allow of my being removed from the asylum whither I
had been carried by those who had rescued me from my tyrant, and
it was more than two months before I was considered well enough to
set out for home. During all this time my step-mother was unwearied
in her kindness and attention to me, and I began to wonder how I
could ever have disliked her. I do not think I should ever have done
so, had not my mind been prejudiced against her beforehand by
some of those unlucky people who are afflicted with an utter inability
to mind their own business. I found out, too, that it is possible for a
woman to understand Latin and Greek and yet be a good nurse, an
excellent housekeeper, and the kindest of mothers."

"I learned after a while how my parents had finally found me. When
Captain Stokes and Mr. Bangs came to read the advertisement at
the tavern, they were convinced that I was the child described, and
they were confirmed in their belief by my running away as I did.
Captain Stokes immediately wrote to my father, saying that a boy
answering in all respects to his description had joined the company
at P—, and had been with them some months, but had suddenly
disappeared, without leaving any trace of his whereabouts. He
believed, however, that I might have taken to the canal.
Advertisements were sent to all the towns upon the canal, and
persons employed to look out for me among the drivers; but no news
was obtained till my father received a letter from the man who had
accosted me on the night I have mentioned, saying that I was on the
canal-boat Diamond, and, the writer believed, very badly off. My
incoherent talk had made the people who took charge of me think
that I must be the child who had been so extensively advertised, and
they wrote to my father immediately, but with little hope of his arriving
in time to see me alive."

"Railroads, there were none in those days, and I made my journey

homeward in a packet-boat on the canal. I seemed to recognize
every stone and stump on the way, and I showed my mother the very
spot where the steersman of the other boat jumped off and spoke to
me. Many were the resolutions I made during that long journey, one
of which was that if I was once spared to get well, I would devote my
life to preaching that Gospel of repentance and salvation which had
been so effectually preached to me by the kind Christian boatman. I
kept my word; and the very first sermon that I ever preached was
upon the Parable of the Prodigal Son. However, I am anticipating my
story."

"I did not return to school that winter, but studied at home with my
mother; and I must say I found her a more able and interesting
teacher than my tutor at P—. Perhaps, however, my rapid progress
was owing in part to the fact that I had now a motive for all I did. Be
that as it might, when I returned to school in the spring, I was placed
two classes in advance of that in which I had been before. I worked
hard and gained great credit, and before the end of my stay I had
established as good a character as any boy in the school."

"The menagerie to which I had been attached, visited our village the
very next summer, and I went to see my old friends the lions and
carry them some bread and cake. My mates received me with great
kindness and congratulated me on my return home. Captain Stokes
told me that he had some idea at the time that my story was not true,
and had therefore kept his eye upon me, meaning, if his suspicions
were justified, to return me safely to my friends."

"He looked worn and sickly, and Mr. Bangs told me privately that he
was killing himself with drink. Bob and Polly knew me again directly,
even without the aid of the cakes I had brought them, and showed as
much pleasure at seeing me as a couple of dogs would have done.
Captain Stokes gave me a beautiful parrot as a parting present, and
I never saw him again. He died the next year, and the company was
broken up. Mr. Bangs went to New York and set up a riding school,
which he taught for many years, till he grew wealthy and retired from
business. I was told afterwards that he became a member of the
church in his old age, and lived and died a consistent Christian. I
was glad to hear it, for he certainly had a great deal of good about
him."

"Did you ever hear of the cruel captain again?" asked Agatha.

"Never. He may be living now, but it is not likely. The man who
befriended me is now alive, though a very old man, and is a member
of my congregation. He would accept of no reward for what he did
for me, and my father sent him as a present a fine gold watch and
chain, which he still wears."

CHAPTER V.
THE SCHOLAR'S STORY.

"I AM sure we are very much obliged to you, sir," said Herbert.
"Boys don't very often turn out well who run away from home,"
observed the squire. "You were very fortunate to escape as you did.
Many a lad who has run away and gone on the canal has either
been heard of no more, or, still worse, has grown-up into a ruffian
and drunkard."

"If I were going to run away, I would not go on the canal," observed
Harry. "I would go to sea."

"You might not fare very much better for that," returned the scholar,
"and you would be still more powerless to help yourself if you
chanced to fall into the hands of a brutal captain. Any resistance to
the will of the captain on board ship is a mutiny, and liable to be
punished with death. A seafaring life is hard enough, especially in
the beginning, if begun under the most favorable circumstances; and
the inevitable hardships of the position would not be lightened by an
accusing conscience."

"There is no great danger of Harry's running away," said May,

laughing. "Harry, do you remember when you and Tommy Baker set
out to go to Bengal to hunt tigers?"

Harry blushed and laughed at the same time.

"What was that?" asked Ned.

"Shall I tell, Harry?" asked May.

"O yes, I don't care," replied Harry. "I was only eight years old,
anyhow."

"When Harry was eight years old," May began, "he and Tommy
Baker, a little friend of his, was visiting at the house of a lady who
had a great many beautiful books, and among others one which had
in it a great many pictures and stories about tiger hunting. It had
beautiful colored plates, and the stories were very interesting. So we
always asked for the tiger book whenever we went to see the lady."
"What was her name?" asked Ned, who always wanted all the
particulars.

"Her name was Mrs. G—, but we always called her 'the lady.' All the
children did. Well, Harry and Tommy got the tiger book, and looked
at the pictures and read the stories, till they thought they would like
to go and hunt tigers too. So after supper, instead of coming straight
home, they set out to walk to Bengal. They had each for provisions
an apple and a nice frosted cake, which the lady had given them.
When it grew late and they did not come, mamma sent for them, but
the lady said they had set out some time before. Of course, every
one was alarmed, and papa and Uncle Henry went out to look for
them. Before long Uncle Henry found them a long way from home,
but trudging along back as fast as they could and looking very
crestfallen."

"'Why, boys, where have you been?' asked Uncle Henry."

"'Almost to the toll-gate,' answered Harry."

"'To the toll-gate! And what took you there?'"

"'We wanted to go to India and hunt tigers,' said Harry, beginning to

cry."

"'Well!' said Uncle Henry, laughing. 'What made you turn back?'"

"'Because there was a great big pig in the road,' sobbed Harry, 'and
we were afraid to go past him.'"

Harry joined heartily in the laugh which followed, to the surprise of

Edward, who never could see any fun in a joke against himself.

"Don't you hate to have such stories told about you?" he said to
Harry, in a low tone.

"O no! I don't care! I have often laughed at it myself. I mean to go to

India some time or other, for all that."
"Who else is going to tell a story?" asked Frank.

"I think it is this gentleman's turn next," said the squire, turning to the
scholar, who sat looking at Agatha in an absent-minded way, as if he
were thinking of something very far off. He started as the squire
spoke, and expressed his willingness to contribute his share to the
amusement of the evening.

"We have had two stories of early times-one in Michigan and one in
New York State," said he. "I will tell you a story of early times in
Vermont. It was related to me by the lady to whom the incident
occurred, but as I cannot pretend to repeat her words, I will put the
story in words of my own."

"THE LONELY THANKSGIVING."

"It would be hard to find any place where people dwell at all lonelier
than Bolt's Hill. You turn up the public road, broad and well-travelled,
which leads from Whitehall to Rockville, and go up, and up, and up,
till it seems as if you were going to the clouds. On one side of the
road is a perpendicular wall of rock, from twenty to sixty feet high,
covered with grim, black spruce-trees. On the other side, the land
descends rapidly to a deep ravine, at the bottom of which runs a
brawling stream, which in wet weather is increased to a roaring
torrent."

"There is not a house or a sign of habitation for several miles, but

after a while the precipice and the road turn away from the stream,
and the ravine widens out into a valley, at the bottom of which is a
little, bright green meadow. The traveller comes to an old mossy
apple-orchard, and then to an old red house. The house is low and
needs painting, and the roof, the stone walls which surround the yard
and garden, and all the little buildings about the door are covered
with green moss and whitish lichens, showing how long they have
been standing. The view in front of the house is bounded by a
narrow grove of spruce and other trees, and behind that rises again
the gray wall of rocks. Back of the house, pale green rocky pasture-
land runs down to the brook, with here and there a tree growing in
the scanty soil and rooting itself deep in the rifts of the rock."

"In summer, Bolt's Hill is a pleasant place enough. But the autumnal
and winter gales sweep over it with a sound which may be heard for
miles away, and which seems like the roar of the sea on a sandy
beach."

"But if Bolt's Hill be rather a dreary spot, the little girl who lived there
did not think so. It would be hard to find anywhere a more cheerful,
placid little maiden than Fanny Bolt, or one who enjoyed life any
more. Though she was the only child at home, she did not want for
playmates. She had the dog, the cat and kittens, the cosset lambs,
of which there were every summer one or two, and she was on
terms of intimacy with every horse, cow, and sheep about the place.
In summer, she went across lots to the district school, about three-
quarters of a mile away, and there she had plenty of friends, for all
the school children were fond of the bright, good-natured little girl."

"Fanny had not a great many books of her own. She possessed two
or three which had been her mother's. One called 'Examples for
Young Ladies,' and containing histories of various girls, good and
bad. The good girls invariably made happy marriages, and the bad
ones always caught cold and died, or were thrown out of carriages
and became cripples ever afterwards; the history always ending with
the epitaph of the young lady in question. Then she had a large
'Book of Trades,' with a great many pictures, in which she took great
delight. But her chief treasures were the 'Parents' Assistant' and four
big volumes of Mrs. Sherwood's works, which her sailor brother had
brought her from England the last time he came home. These tales
took her into a different world from her own—a world over which
Fanny pondered and dreamed as she rambled over the pastures or
sat with her sewing or knitting on the flat stone before the kitchen
door."

"Besides these peculiar treasures, Fanny, by the time she was

twelve years old, had read nearly all the books in the house. There
was quite a collection of voyages and travels in the corner cupboard,
which she knew almost by heart, and she had read a great deal of
English and American history. But the book she loved best of all was
the Bible—the great Bible with pictures, which lay on a stand in the
corner, and which she was allowed to look over and study as much
as she pleased, on the single condition that she should always have
clean hands when she touched it."

"Mrs. Bolt had family prayers every morning, and Fanny read her two
verses in turn with the rest, looking over her father as she sat by his
side. Then Fanny, ever since she could remember, had learned
every day first one, then two, then three verses in the New
Testament, which she repeated to her mother before she went to
bed; so that she was very familiar with the sacred text."

"Fanny did not often go to Sunday-school. Her parents were 'Church

people,' and there was no Episcopal church nearer than that at
Rockville, twelve miles away. On the first Sunday of every month, Mr.
and Mrs. Bolt drove over to Rockville to church, and these were
Fanny's great holidays. Then she met her special friends, the rector's
two little daughters. Then she went to Sunday-school, and in
consideration of her living so far away, the teacher allowed her to
take home two or three books at a time. One day, one of the other
little girls in the class objected to this indulgence."

"'We can only have one book at a time, and she has three. I don't
think it is fair.'"

"'Fanny can only come once in a month,' replied the teacher; 'and
when she comes she has learned the lessons for the whole month.
She never misses a lesson, and it is only fair that she should have
the same privileges as you who are more favored.'"
"Fanny had not always been an only child. She had once had two
brothers. The elder had gone to sea before Fanny was born. He had
come home two or three times since she could remember, and had
always brought her and her mother beautiful presents; but he had
not been home now for five years. The ship in which he sailed had
been lost, and though some of the sailors were saved, David Bolt
was not among them. Every one but Fanny believed that he was
drowned; but Fanny could not think so. She never talked about
David now, because it seemed to grieve her mother, but she thought
of him a great deal, and always prayed for him when she said her
prayers."

"The other brother, John, had been injured by the fall of a tree he
was cutting down, and after lingering some months, he too died, and
was buried near the little church in Rockville. Fanny always went to
see his grave when she went to church. She loved to think of John,
too, and remember the talks she used to have with him as he lay on
his bed in the little room opening out of the kitchen. But she felt very
differently about John from what she did about David. John was safe
in heaven, never to suffer any more. Fanny was sure of that."

"But poor David might be cast ashore on some desert island, or a

slave among the savage Arabs, like the Captain Riley whose
narrative was among the books in the corner cupboard; and most
earnestly did the little girl pray that God would care for him and bring
him safely home again."

"One November—the one in which our story begins—the winter had

set in early, and very cold and stormy. There had been snowstorms
already, and the sleighing was good, though the road between Bolt's
Hill and Rockville was somewhat drifted. Fanny did not go to school
now. She learned her lessons at home, and recited them to her
father in the evening. She could not run about the fields any more,
but she did not want either for work or amusement. She had her
lessons to learn and her daily task of spinning to do, for Fanny had
already learned to spin both on the great and little wheel. Then for
amusement, she had the footstool she was working in worsted for a
present to Mr. Henderson, the rector of the church at Rockville: she
had her swing in the garret, her dolls and playhouse, and her books,
which she loved the more the oftener she read them over."

"The day before Thanksgiving—that is to say, on the twenty-seventh

day of November, Mrs. Bolt said to Fanny at the breakfast table:"

"'Now, Fanny, you are to be housekeeper to-day. Your father and

myself are going to Rockville to do some business, and we want you
to stay at home, keep up the fire, and have a comfortable house and
a good supper for us when we come home.'"

"Fanny looked a little grave and disappointed when she heard that
her parents were going to Rockville without her, but her face soon
cleared up again. And she began to please herself with thinking of all
the work she should do, and the nice supper she would have for her
mother at night; for Fanny was already quite a good cook."

"'You will not be lonely,' continued Mrs. Bolt. 'Your father stopped at
Mrs. Morrell's last evening, and invited Miss Gibson to come up and
spend two or three weeks with us, and she is coming this morning.'"

"Fanny clapped her hands with joy. Miss Gibson was the lady who
had taught the district school for the last two summers. She was very
young, only eighteen; and though she well knew how to command
obedience in school, out of school she was the best playfellow in the
world. She knew heaps of stories and more plays than were ever
heard of in the Bolt Hill district before, and all the children loved her.
Miss Gibson was an orphan, and had no home of her own, but she
was a welcome guest at every house in the district. Fanny loved her
dearly, and nothing could please her more than the news that she
was to have her darling Miss Gibson to herself for a whole day."

"'It looks like snow,' said Captain Bolt, as he came in after bringing
the horse round to the door; 'but then it has looked so for two or
three days. Mind and keep up good fires, Fanny. There is plenty of
dry wood and pine-knots in the shed. I shall be home in time to
milk.'"
"'Oh, father, let me milk!' said Fanny. 'I can do it just as well as not.'"

"'Very well, do as you please. And if anything should happen—mind,

I don't see how anything can—but if anything should happen to
prevent our coming home to-night, don't you be scared, but put your
trust in God and go to bed in peace.'"

"'But, father, what could happen?' asked Fanny."

"Nothing that I know of, child, but it is way of mine to look at all sorts
of possibilities. Come now, mother, if you are ready.'"

"Fanny stood at the door of the farm-house with her skirt thrown over
her head, and watched the sleigh down the hill, till a turn in the road
hid it from her eyes. Then, she turned the other way to see if Miss
Gibson was coming, though it was rather early to expect her. Mr.
Morrell lived five miles away by the road, but by the path, ''cross lots,'
along which Fanny used to go to school and by which Miss Gibson
would come, it was only about a mile. This path was almost always
kept open in winter, for it was much the nearest way to the little
village called Rockville Four Corners."

"As I said, it was early for Fanny to expect her friend, but Miss
Gibson had said she should come as early as she could get away.
Fanny gazed for some time across the pasture but saw nothing, and
finally she went in, made up a bright fire, and occupied herself in
washing up the breakfast dishes and putting the kitchen in nice
order. She had done all this, got out her spinning wheel, and learned
her Scripture verses, and still Miss Gibson did not make her
appearance."

"'There is no use in this,' said Fanny, decidedly. 'The more I look for
her the more she won't come. "A watched pot never boils," as father
says. I will just set about my spinning and not go to the door again till
she comes.'"

"As Fanny turned to go into the house, a few snow-flakes came

drifting downwards through the air."
"'There!' said Fanny. 'It is going to snow, after all. I hope father and
mother will not get caught in the storm.'"

"Fanny drew her wheel—her own pretty wheel, made expressly for
her and given her on her last birthday—into its usual place, and
applied herself sedulously to her task, stepping busily backwards
and forwards and singing to herself. She was spinning some
uncommonly fine stocking yarn, and she took great pride in making a
smooth, even thread."

"'I will not even look out of the window,' said she to herself, 'till I have
spun all these rolls.'"

"This was a very good plan of Fanny's. Nothing makes the time pass
more quickly than setting oneself a certain task, and sticking to it
steadily till it is finished. Fanny went on with her spinning, and soon
became interested in her work, which she tried to do as well as she
possibly could. As she took up the last roll, a fierce gust of wind
shook the window so strongly that she turned, without thinking, and
looked out. The air was full of snow-flakes whirling in all directions,
as they were driven by the wind. Fanny went to the window. She
could not even see the barn."

"'It is only a squall,' thought Fanny. 'It will be over presently. I only
hope Miss Gibson has not got caught in it. I do wonder why she does
not come. She told father she would be here directly after
breakfast.'"

"Fanny was destined to wonder a great many times before the day
closed, for Miss Gibson did not come at all, because she did not
even set out. The truth of the matter was this. When Miss Gibson
rose in the morning, she found she had a bad sore throat. She had
taken cold in some way, and her throat was very much swollen and
so sore that she could hardly swallow her breakfast."

"'You will never be able to go up to Bolt's Hill this morning,' said Mrs.
Morrell."
"'I don't like to disappoint Fanny,' said Miss Gibson, 'especially as
she is to be alone to-day. Perhaps I will feel better when I have had
my breakfast.'"

"'We shall see,' returned Mrs. Morrell, shaking her head. 'I am much
mistaken if you get out of the house this day, or to-morrow either.'"

"It turned out that Mrs. Morrell was right. Miss Gibson's cold grew
worse very fast, and before breakfast was over she was obliged to
lie down on the sofa."

"'It is too bad that you should be disappointed, and Fanny too,' said
good-natured Mrs. Morrell. 'I'll tell you what I'll do, Eunice.' (Miss
Gibson's name was Eunice.) 'I will send Jake up to Bolt's Hill with the
sled to bring Fanny down here to spend the day. She will enjoy that,
and so shall I; for there is not a nicer girl than Fanny in the whole
district.'"

"Jake set out on his errand with no good will. He was Mr. Morrell's
nephew, and 'bound' to him; that is, he was to live in his uncle's
house and work for him till he was grown-up; at which time he was to
have a suit of clothes, a horse, and some other matters to start him
in the world. Mr. Morrell had one son, who was in college studying to
be a minister. Jake chose to feel himself very much injured that he
could not go to college, too, though, as his aunt said, it was hard to
tell what he would have done there, since he was the dunce of the
village school, was always at the bottom of the spelling and parsing
classes, and had never yet succeeded in learning the multiplication
table. The only thing to which Jake really applied himself, and in
which he showed any ingenuity, was in shirking work; and it seemed
us if he sometimes took more pains to avoid work than would have
been necessary to do it. In short, Jake was thoroughly and entirely
lazy, and being so, he was almost, as a matter of course, thoroughly
selfish and very much given to lying."

"Jake had finished his chores before breakfast, for a wonder, and he
felt very virtuous in consequence, and very much disposed to spend
the rest of the day in lounging in the chimney-corner. It was therefore
with no good will that he found himself required to go up to Bolt's Hill
and drag Fanny down to his aunt's."

"'I don't believe she will come,' said he, sulkily, 'and, besides, I don't
see why I am to be bothered with her. However, I suppose I can go.'"

"I suppose you can, and pretty quick, too!' returned Mrs. Morrell,
sharply."

"Jake knew by experience that to quarrel with his aunt was no way to
secure his dearly beloved ease, and that he must at least pretend to
obey her. But he had no sort of notion of going clear up to Bolt's Hill.
He took his sled and went out, indeed, but only as far as the grocery
at the corner by the blacksmiths shop, where he lounged away a
couple of hours enjoying the society of two or three village loafers.
Then he returned home."

"'Where is Fanny?' asked his aunt, meeting him at the door."

"Oh, I met Captain Bolt just up at the corner, and he had Fanny with
him. They were coming round this way to tell Miss Gibson that she
need not come up, because they were all going to Rockville for the
day.'"

"'So you see, Eunice, it was well you did not go up there,' said Mrs.
Morrell. 'It is queer too—not a bit like the Bolts.'"

"'Something new might have happened, you know,' said Miss

Gibson. In her heart, she felt hurt that her friends should have
treated her so unceremoniously—inviting her for a visit, and then
going away from home on the very day she was expected. But she
had abundance of that charity which thinketh no evil. She presently
made up her mind that something unforeseen must have happened
which made it necessary for Fanny to go with her parents to
Rockville, and wisely resolved to think no more of the matter till she
saw her friends again. That Jake had made up the whole story was
an idea which never entered her mind."
"Meantime Fanny, in the old red house on the hill, found the time
pass rather slowly. The storm did not abate as she expected; on the
contrary, the snow seemed to fall faster mid faster all the time, and
the wind, catching it up, spun it in whirls and eddies round the house,
and then piled it up in great drifts under the windows and along the
fences. There was no use in looking out of the window, for nothing
was to be seen. Long before noon, Fanny had given up all idea of
Miss Gibson's arriving that day. It was clear she could not come out
in such a storm. Fanny could not help crying a little over her
disappointment; but she soon wiped her eyes."

"'There is no use in crying,' said she to herself, briskly and cheerfully.

'I must just make the best of it, that's all. I mean to work at my
cushion till it is time for dinner, and then make myself some batter
slap-jacks. Mother said I might get anything I liked, and I mean to
have slap-jacks and maple molasses.'"

"Fanny got out her work-basket, sorted her worsteds—crewels she

called them, and went industriously to work. She was embroidering a
pretty pattern, and she soon fell to singing cheerfully over her work.
By-and-by old Bose, the dog, came to the door and scratched to
come in. As Fanny opened the door, the wind pulled it out of her
hand and slammed it back against the wall, while what seemed a
whole snow-drift came whirling in at the door."

"'Whew!' exclaimed Fanny. 'This rather beats all I ever saw, even on
Bolt's Hill! Come in, Bose, you good old dog! You shall have your
dinner with me. I declare!' said Fanny, struck with a sudden thought,
'I mean to have a dinner party.'"

"No sooner said than done. Fanny ran upstairs to the garret, and
presently came down carefully carrying a large basket, and followed
by a very large and beautiful yellowish-white cat, with long hair and a
long, bushy tail. She set the basket down in a warm corner by the
fire. It contained a bunch of yellowish-white fur, which presently
began to move and showed itself to be composed of three plump
kittens, about four weeks old, which stretched themselves, crept out
of the basket, and began playing about the floor. The old cat was
evidently greatly pleased, and showed her satisfaction in cat fashion
by purring, making pretty little coaxing noises, rubbing her head, and
finally mounting in Fanny's lap and sitting on her shoulder. She was
a foreigner, a Japanese, and had been brought home by David Bolt
on his last visit as a present to his little sister. She was only a kitten
then, but she was now growing old. She was still lively and playful
and an excellent mouser. None of her kittens were ever killed. All the
children in the village were glad to have them, and two or three of
them had been carried as far as Rockville and Whitehall. When she
had no kittens, the cat generally slept on Fanny's bed."

"Fanny made her slap-jacks and cooked some ham for her own
dinner. Old Bose sat by her side, wagging his tail, and now and then
giving a short bark. Puss sat up in a chair by the table, and behaved
as well as possible, purring loudly, and now and then speaking to her
kittens which capered about the room. Fanny said grace as her
father did, and eat her dinner, now and then giving her companions a
morsel. Then she washed up all her dishes, swept the hearth, and
sat down to read."

"Meantime the storm kept on increasing in force, if that were

possible, and the short November day drew towards a close. When
Fanny finished her story and looked out, she found it was growing
dark."

"'I must go out and milk, if I am to do it at all,' said she; 'though I don't
exactly see how I am to get to the barn. However, I can try, and if I
cannot make it out I can come back.'"

"She wrapped herself in her shawl, tying it round her that it might not
be in her way, put on her hood, and pulled on a pair of old woollen
stockings over her shoes. Thus equipped, she set out for the barn."

"She found the task rather easier than she expected. The wind had
blown away the snow so as to form a sort of path for a part of the
way; and though there was a drift before the barn-door, she made
her way through it the first time without much trouble, aided by Bose,
who flounced backwards and forwards through the snow and helped