ASSIGNMENTS INTERNATIONAL FINANCE

Santiago Escobar Serna

Assignment 1

Assignment 2

SWM: strive to maximize the return to shareholders and minimize the risks. It assumes that
the stock market is efficient which means that the share price is always correct because it
captures all the expectations of return and risk as perceived by investors.

SCM: this theory also strives on maximizing long term returns to equity but they also take
into account other powerful stakeholders of a business. They protect important stakeholders
such as communities, the environment and employment. It assumes that
Corporate Governance:

Corporate governance refers to the system of rules, practices, and processes by which a
company is directed and controlled. it involves the interests of various stakeholders, such as
shareholders, management, customers, suppliers, financers, government, and the
community. The primary goal of corporate governance is to ensure that the companies
management acts in the best interest of its shareholders and other stakeholders

The market for corporate control:

The market for corporate control refers to the environment where the buying and selling of
controlling interests in corporations take place. This market involves activities such as
mergers, acquisitions, and takeovers, where one company acquires control of another. It is
based on the idea that if a company's current management is not performing well, external
investors or other corporations may acquire a controlling interest, leading to changes in
management or restructuring to improve performance.

Agency theory:

Agency theory is a branch of economic theory that explores the relationships and conflicts of
interest between principals (such as shareholders) and agents (such as managers) who act
on behalf of the principals. The theory aims to address the problems that arise when the
interests of the agent may not align with those of the principal, leading to issues of moral
hazard and adverse selection. Agency theory suggests mechanisms and strategies to
mitigate such conflicts and ensure that agents act in the best interests of the principals.

Primary operating goal of an MNE:

The primary operational goal of a Multinational Enterprise (MNE) is to maximize shareholder
wealth while effectively managing the complexities of operating in multiple countries.

Is international finance only relevant for multinational corporation:

No, international finance is not only relevant for multinational corporations. While MNCs
have a more direct and extensive involvement in international financial activities due to their
operations in multiple countries, international finance concepts are applicable to various
entities, including small and medium-sized enterprises (SMEs), investors, and financial
institutions

Additionally, governments and policymakers deal with international finance issues when
managing exchange rates, capital flows, and economic policies that affect the global
financial system.

Assignment 3
1) From 1991 till 2002, the Argentine peso was pegged to the US dollar on a one to one
basis. During 2001, the country faced an economic crisis which led to the end of the
convertivity plan. Even though the country did well at the beginning with the dollarization, the
Argentine economy was going through a downfall (due to internal and external factors) and
in the end, the government decided to end the dollarization.

2) Aid countries with balance of payments and exchange rate problems. It was established
to give temporary help to its member countries trying to defend their currencies against
cyclical, seasonal, or random occurrences. In addition, it also assists countries having
structural trade problems if they promise to take adequate steps to correct their problems.

3) The SDR is an international reserve asset created by the IMF to supplement existing
foreign exchange reserves. It serves as a unit of account for the IMF and other international
and regional organizations. It is also the base against which some countries peg the
exchange rate for their currencies.

4)Ecuador: Dollarization (replacement of the sucre for the US dollar)

● France: free floating (other)
● The US: free floating (other)
● Japan: free floating (inflation target)
● Colombia: floating (inflation target)

Assignment 4

● Law of one price: if identical products can be sold in two different markets, and no
restrictions exist between markets, the product's price should be the same in both
markets.
● Absolute purchasing power parity: the spot exchange rate is determined by the
relative prices of similar baskets of goods
● Relative purchasing power parity: it holds that PPP is not particularly helpful in
determining what the spot rate is today but the relative change in prices between two
countries over a period of time determines the change in the exchange rate over that
period. (inflation)
● Pass through: measure of the response of imported and exported product prices to
changes in exchange rates. There is complete (price increases by the same
percentage as the exchange rate) and partial pass through (price increases by less
percentage as the exchange rate)

Assignment 5

1. The fisher effect states that the nominal interest rates in each country are equal to
the required real rate of return plus compensation for expected inflation. Empirical
tests show that this effect usually exists for short term maturity government
 securities. The international fisher effect is the relationship between the percentage
change in the spot exchange rate over time and the differential between comparable
interest rates in different national capital markets. Empirical tests show some support
to this effect with some considerable short run deviations.

2. IRP provides the link between the foreign exchange markets and the international
money markets. It says that The difference in the national interest rates for securities
of similar risk and maturity should be equal to, but opposite in sign to, the forward
rate discount or premium for the foreign currency, except for transaction costs.

3. When a market is not in equilibrium there is a potential arbitrage profit. CIA is when
an arbitrager who recognizes this, will move to take advantage of the disequilibrium
by investing in a currency that offers higher returns. UIA, on the other hand, is when
investors borrow in countries with low interest rates and convert the profits into
currencies with higher interest rates.

4. When the forward rate is termed an unbiased predictor to the future spot rate, it
means that errors are normally distributed around the mean future spot rate.
Assignment 6

1) Transfer purchasing power between countries. International trade involves parties

who need to transfer purchasing power between countries that use different
currencies.

Obtain or provide credit for international trade transactions. The foreign exchange
market provides sources of credit.

Minimize exposure to foreign exchange risk. The market provides hedging facilities
that transfer risk between participants.

2) Bid: lower price in one currency at which a foreign exchange dealer is willing to
buy another currency from a client.

Ask: higher price in one currency at which a foreign exchange dealer is willing to sell
another currency to a client..

4) European terms: foreign currency/USD. American terms: USD/foreign

currencyA. USD/Mex peso. B. Yen/Yuan

5) When cross rates differ from the direct market rates between two currencies,
triangular arbitrage is possible. When the rates are unequal the market is in
disequilibrium and an opportunity to make riskless profits exists.

PART B
Assignment 7

1. A foreign currency future Is a contract that calls for future delivery of a standard
amount of foreign exchange at a fixed time, place and price. On the other hand, a
foreign currency option is a contract that gives the buyer the

right, but not the obligation, to buy or sell a given amount pf foreign exchange at a
fixed price per unit for a specified time period. The future contract is used by
investors who speculate the movement of two different currencies (Mexican peso or
US dollar) while the option contract is used as a hedging tool for speculative
purposes.

2. The size of the futures are established, while in forwards are any desired value. The
maturity of futures are fixed (usually a year) while forwards are any maturity. Futures
are traded in an organized exchange while forwards are traded between individuals,
banks, firms. Futures have a single commission while forwards have no explicit
commission.

3. A put on a sterling gives the option to a holder to sell the currency at a fixed price
while the call on a sterling gives the holder the option to buy the currency at a fixed
price.

4. In Michael Moore's speculation, he anticipated an increase in the GBP against the

USD and thus bought one June futures contract at a price of 1.57 $/£. His bet proved
correct when the spot rate in June rose to 1.73 $/£, resulting in a profit of $8,000 at
maturity. This success was due to the GBP appreciating against the USD, yielding
gains from his futures contract.

5. Rollie Snyder speculated that the GBP would fall against the USD. He opted to buy a
put option with a strike price of 1.55 $/£ and a premium of 0.01 $/£. With a
break-even price of 1.54 $/£, Rollie made a net profit of $4,000 when the spot rate in
June was 1.63 $/£. Like Michael, Rollie's speculation was successful, as the GBP
depreciated against the USD, resulting in gains from his put option.

Assignment 8

1. Defining of terms
 1. Refers to changes in a firm's profitability, net cash flow, and market value
caused by changes in exchange rates.

2. Transaction exposure: impact of setting outstanding obligations entered into

before change in exchange rates but to be settled after change in exchange
rates. Translation exposure: changes in income and owners' equity in
consolidated financial statements caused by a change in exchange rates.
Operating exposure: change in expected future cash flows arising from an
unexpected change in exchange rates.

3. Reduce risk by the taking of a position that will rise or fall in value and offset a
fall or rise in the value of an existing position. It can protect from a loss but
also eliminates any gains. Hedging reduces the variability of expected cash
flows.

In favor of hedging:

❖ It improves the planning capability of the firm

❖ It reduces the probability that the firm's cash flows will fall to the point
of financial distress
❖ Management has better knowledge of the currency risk of the firm
❖ Management can take advantage of disequilibrium conditions in the
market

Transaction exposure
❖ Purchasing or selling goods on credit with prices stated in foreign
currency
❖ Borrowing funds with repayment in foreign currency
❖ Being a party to foreign exchange forward contracts
❖ Acquiring assets or liabilities in foreign currencies

Contractual exposure instruments

❖ Hedge in the money market
❖ Hedge in the forward market
❖ Hedge in the option market

Assignment 9
 1. Operating exposure: The operating exposure of any individual business or business
unit is the net of cash inflows and outflows by currency, and how that compares to
other companies competing in the same markets.
2. Economic exposure: is a type of foreign exchange exposure caused by the effect of
unexpected currency fluctuations on a company's future cash flows, foreign
investments, and earnings
3. Competitive exposure: the effects that currency fluctuations have on a company‫׳‬s
future revenues and costs, as a result of the overall effect of such macroeconomic
changes on the competitive position of the firm.
4.

Matching currency cash flows

- Risk-sharing agreements
- Back to back loans
- Currency swaps

3) To offset a continuous long exposure to a particular currency (e.g. Canadian dollar) the
U.S. firm can:
(A) Acquire debt denominated in that currency (matching).
(B) Seek out potential suppliers in Canada as a substitute for U.S. suppliers (natural hedge).
(C) Pay foreign suppliers with Canadian dollars (currency switching).

4) Risk-sharing is a contractual arrangement in which the buyer and seller agree to “share”
or split currency movement impacts on payments between them. If the two firms are
interested in a long-term relationship based on product quality and supplier reliability, and
not on the whims of the currency markets, a cooperative agreement to share the burden of
currency risk may be in order.

5) Back to back loans: two business firms in separate countries arrange to borrow each
other’s currency for a specific period of time. At an agreed terminal date they return the
borrowed currencies. The operation is conducted outside the foreign exchange markets,
although spot quotations may be used as the reference point for determining the amount of
funds to be swapped. Such a swap creates a covered hedge against exchange loss, since
each company, on its own books, borrows the same currency it repays

A cross-currency swap resembles a back-to-back loan except that it does not appear on a
firm’s balance sheet. In a currency swap, a firm and a swap dealer (or swap bank) agree to
exchange an equivalent amount of two different currencies for a specified period of time.
Currency swaps can be negotiated for a wide range of maturities up to 30 years in some
cases. The swap dealer or swap bank acts as a middleman in setting up the swap
agreement
Assignment 10

1. Translation exposure: is the potential for an increase or decrease in the

parent’s net worth and net income caused by a change in exchange rates
since the last translation.

2. change the unit of measure, from a foreign currency to the parent’s

reporting currency. Translation does not involve any exchange of one
currency for another.

3. Self-sustaining subsidiary operates independent of the parent company

whereas an integrated one operates as an extension of the parent.

4. Functional currency is the most important currency for a subsidiary’s

operations.

5. In the current rate method assets and liabilities are translated to the current
exchange rate while in the temporal method it is divided into

5.1. If we are talking about monetary, it is translated to the current exchange

rate. However, if they are not monetary, it is translated to the historical
exchange rate (both assets and liabilities)