Lecture 32

Review of International Finance

Topics
• International Financial Management

• International Flow of Funds and BoP

• International Financial Markets

• Foreign Exchange Rate and Types

• Government Intervention in Exchange Rates

Topics
•  Inflation, Exchange and Interest Rate

• Risk Management of Exchange Rates

• Managing Economic, Transaction & Translation
Exposure
• Direct Foreign Investment
MULTINATIONAL COMPANIES

• Goals of MNCs

• Agency Problems
• Centralized vs. Decentralized System
• Theories of International Business
Common methods to conduct international
business
– International trade,
– Licensing,
– Franchising,
– Joint ventures,
– Acquisitions of existing operations,
– Establishing new foreign subsidiaries

 Investment opportunities
 Financing opportunities
 Marginal Returns and Marginal Costs
• Capital Account (Flow of funds; one country to other)
– Direct Foreign Investment

– Portfolio Investment
– Capital Investment
• Trade volume is different
• Over all the World is developing
• Trade Agreements
– NAFTA, GATT, EU

• Trade Disagreements
– Tariffs, Quotas, Job loss
– Rules are different (Child labor, Bribe, etc)

– Outsourcing
• Economic Factors Affecting Trade
– Inflation

– Impact of National Income

– Government Restrictions

– Foreign Exchange Rates

• International Capital Flows

•Factors Affecting International Trade flows

•Factors affecting DFI

•Factors Affecting Portfolio Investment

•Agencies that Facilitate International Trade

 Motives to use International Market
• Economic Conditions
• Exchange Rate
• International Diversification

 Foreign exchange Market

 Gold Standard

 Fixed Exchange Rate

 Floating Exchange Rate

• Spot Market
• Bid/Ask Spread
• Direct & Indirect Quote
• Future Market
• Forward Market
• Attributes of Banks
• Options
– Put option
– Call Option
• Domestic Money Market
• Domestic & International Money Market
• Standardization of Banking Regulations
• Single European Act
– Basel Accord I
– Basel Accord II

• Syndicated Loans
• International Credit Market
– International Bond Markets
• International Stock Markets

– Transaction Costs

– Information Costs

– Exchange Rate Risk

• International Stock Diversification

• Exchange Rates
• Depreciation and Appreciation of Currency
• Exchange Rate Equilibrium
• Liquidity

• Factors that affect Exchange Rates

• Relative Interest Rate

• Relative Income Level

• Expectations

• Speculating on Anticipated Exchange Rates

• Exchange Rate System

– Fixed Exchange Rate

– Freely Floating
– Managed Float
– Pegged

• Currency Boards
– Investors Confidence
– Argentinean Economy and Currency Boards
• Dollarization (e.g. Ecuador)
• Single European currency
– Impact on Monetary & Fiscal Policy
– International trade

– International flows
– Impact on Exchange Rate Risk
– Government Intervention
• Reliance on Reserves
• Direct Intervention
– Sterilized

– Non Sterilized
• Indirect intervention
– Inflation, interest rates, income level, government
controls, expectations
• Arbitrage

• Locational Arbitrage
– Banks/Individuals

• Triangular Arbitrage

• Covered Interest Arbitrage

• Interest Rate Parity

• Transaction Costs

• Political Risk

• Differential Tax Laws

• MNCs need exchange rate forecasts for their
– Hedging Decisions,
– Short-term Financing Decisions,
– Short-term Investment Decisions,

– Capital Budgeting Decisions,

– Earnings Assessments
• Long-term financing decisions

• Forecasting Techniques

 Technical,
 Fundamental,
 Market-based
 Mixed.
• Forecasting Error
• Forecasting Services
• Forecasting Bias
• Diversification Argument
• Types of Exposure
– Transaction
– Economic
– Translation
– Source: Adopted from South-Western/ Thomson Learning 2006
 – Identify degree of transaction exposure.

– Decide whether to hedge this exposure.

– Choose a hedging technique if it decides to hedge part

or all of the exposure.

• Hedging Techniques
– Futures hedge,
– Forward hedge,
– Money market hedge, and
– Currency option hedge.
Management of Exposures

• Transaction
– Identify the degree
– Decision
– Hedging

• Economic
– Restructuring

• Translation
 Direct Foreign Investment

• Motives

– Revenues
– Costs

– Issues

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