International Finance: Theo

ry & Practice
 Wan Lu
Beijing Technology And Business Unive
rsity
Wechat ID: wanjinloo
Scheduling
1. Time:
2 P.M. Mon. Week 12~week 20
2. Assessment:
Attendence 30%
Term paper 70%
* A topic covering contents of lessons
* 2,500-3,500 words
* Minimal 5 sources(references)
Preview
Part 1. Theory (week12-14)
1. What is international finance
2. Why international finance matters
3. Exchange rate
4. International financial markets
5. International financial institutions
6. International monetary regime
7. International financial governance (regul
ations)
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Part 2. Practice (week15-20)

1. China's traditional financial system in gl
obal context
2. Disruptor in chinese and global financial
system - internet finance (Fintech)
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Part1. Theory
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1. What is international finance
a. Financial practice across borders
b. No difference from financial system in a c
losed economy in the nature
* Investing and raising money
* Transfer monetary capital from unproducti
ve use to productive use
c. More complexities and uncertainties
* Diversity and difference in reality
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2. Why international finance matters.

a. Our life: more conveniences

* Currency exchange
* Money transfer
* Online shopping
* Cross border investment
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b. Our business: more choices

* Global capital market for financing and In
vesting: V.C.s, global bond markets,global st
ock markets and global commodity markets
* Global M & A: M.N.C.s and the rise of Ch
inese companies
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c. Our economy: more opportunities
* Global capital & wealth reallocation and r
ebalancing
* China's story: economic & financial openi
ng, way to modernization and prosperity
* New challenges: international financial or
der reform and reshaping
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3. Exchange rate
a. Def: conversion rate or relative price betw
een different currencies
b.Importantce:
* Determinant of currency exchange
* Currency exchange and currency market a
re important for international business and i
nternational finance
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* e.g.
For biz: payment & settlement in global trad
e and Exchange rate risk exposure
For finance: investing & financing in global
financial markets and exchange rate risk
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c. Determination
* Purchasing power parity(PPP)
Fair(equilibrium) exhange rate between two
currencies is determined by the equality and
parity of their purchasing powers.
e.g. U.S.$1= C.N. ￥ 7 means what $1 can b
uy is the same to that of ￥ 7
What if not? Arbitrage opportunity
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i.e. If $1 can buy more than ￥ 7 can, say,
￥ 8 then consumers will exhange $1 with
￥ 7 to buy more. correspondingly,more de
mands for dollar revalue it until $1= ￥ 8 by
which the purchasing powers of two currenc
ies are the same.
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Limits of PPP theory:
Focused on trade and business, not finance
with much larger trading volume of currenci
es(accounted for more than 90% of global c
urrency trading)
Based on perfect substitute hypothesis for c
onsumers in which they just care about pric
e, not the fact in reality where many other fa
ctors should be considered.
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* Interest rate parity(IP)
Fair(equilibrium) exhange rate between two
currencies is determined by interst rates(rate
s of return) they bear
A simple mathematical expression:

..... .................. (1)

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(2)

(1 + r) = (1 + r * )(1 + ΔSe) = 1 + r * + ΔSe

+ r * ΔSe (3)
r * ΔS is small enough to be negligible and r
ounded off
So the expression can be simplfied as:
ΔSe = r − r * (4)
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Significance:
Shift from trade to finance
90% of currency exchange takes place in gl
obal financial markets
Short-term exchange rate determination com
pared to long-term determination of PPP
Conclusion: combination of PPP& IP is a po
werful analytical toolkit
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4. International financial markets
a. Currency market (forex market)
* Market where different currencies are exc
hanged and traded
* An OTC market without a physical central
location where accounts of different currenc
ies are traded between banks worldwide
* Largest financial market in the world with
1.5-5 trillion dollars traded everyday
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* Including spot trading and forward trading
such as futures contracts and swaps
* one of the most volatile and riskiest financ
ial markets in the world
* Diverse Investors including individuals, fi
rms, financial institutions and governments
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b. International bond market
* Market where different bonds from the wo
rld are traded
* Much more types of bonds than stocks suc
h as commercial papers, corporate bonds, go
vernment bonds,convertible bonds and ABS
* Crossborder bonds known as foreign bond
s and eurobonds
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eg.
foreign bonds: Yankee bond, samurai bond,
bulldog bond and panda bond
eurobond(offshore bond): issued by a Chine
se company, denominated in USD and trade
d in London
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* Issuers: big corporates, big banks and gov
ernments
* Investors: Individuals, mutual funds, bank
s, insurance companies, pension funds and g
overnments
* Size:
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* More flexible and cheaper way of
financing than stock
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c. International stock market
* market where companies from all over world i
ssue different types of stocks to finance their bus
inesses and discover their values
* Best platform to raise long-term capital world
wide for the long-term development of compani
es
* most important financial market in the world a
s the barometer of global economy
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* Some examples (meeting the standard of internat
ional stock market)
NYSE:
The largest stock market with a total Capitalizatio
n up to $20 tn and more than 3,000 listed compani
es of which about 400 are foreign ones
Dow Jones Industrial Average 30(DJIA) Is the mo
st quoted and referred index in the world to interpr
et global finance and economy
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Nasdaq:
the first and largest OTC stock market in the wor
ld wired by telecommunications and computer n
etworks with a capitalization of more than $5 tn
and around 6,000 listed companies
Market maker mechanism to provide liquidity an
d stablize the market
A booster and incubator for global tech compani
es without profitability requirement
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London Stock Exchange: $3.8tn, 2,880
Most international stock market in the world wit
h more than 50% foreign companies
Most diverse types of securities
A favored market by global institutional inversto
rs
Composed of 4 independent markets such as AI
M
FTSE index is another clsoely watched global m
arket index
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Hongkong Stock Exchange:
One of the top 3 stock markets in the world with
a total capitalization of $3.9tn and around 2,500 l
isted companies
Market with the best corporate governance struct
ure and rule of law
Gateway of Chinese companies to global capital
where mainland chinese companies take more th
an 73% of market capitalization and more than 5
0% of total number of companies
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5. International financial institutions
a. Banking (covering more than 50 countries)
* Top 10 global banks by assets 2019

1 $3.42 tn
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2 $2.83 tn

3 $2.74 tn

4. $2.59 tn
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5 $2.47 tn

6 $2.41 tn

7 $2.35 tn
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8 $2.11tn

9 $2.1 tn

10 $2.1 tn
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* Top 10 most valuable global banks 2018
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* Top 10 with most valuable brands 2019
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b. Top 10 global insurance companies
* Health
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* Non-health
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c. Investment banking & brokerage
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6. International monetary regime
a. Def: institutional arrangement of currency for
settlement and reserve in global trade and financ
e
b. Background of Bretton woods system:
Based on in Bretton Woods agreement reached i
n 1944, Bretton Woods of New Hampshire betw
een allied nations to set up postwar new internati
onal financial order
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c. Nutshell of Bretton Woods system:

* Repealed gold standard
* Pegged to U.S. Dollar(fixed exchange rates)
* Gold exchange standard(US$1=1/35 of an o
unce of gold)
* setup of IMF and World Bank
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d. Post-Bretton Woods era:
* Collapse of Bretton Woods in 1971
* Floating exchange rate
* Financial innovations
* Legacy of Bretton Woods
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e. New light:
* Moral hazard and decline of USD
* Super sovereign currency
* Rise of cryptocurrency and blockchain(DL
T) and their challenge to traditional monetary
system
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7. International financial governance (regulati
ons)
a. IMF and World bank
* IMF: emergency loans to member countries
to stablize their currencies (against devaluatio
n) and finance (against bank run)
* World bank: interest free or low rate long-t
erm loans to fund development projects in un
derdeveloped nations
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b. Splintered financial regulations and financial gl
obalization
c. global financial governance and regional financ
ial cooperation
* G20: founded in 1999 and updated in 2009, 90
% global GDP and 4 billion people, new mechani
sm for governance
* AIIB: founded in beijing, 2015. by 2019, 100 m
ember countries and $100bn capital to fund infras
tructure development in Asia and worldwide
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d. New wave: regtech
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Supplement 1: BIS
BIS: bank for international settlements
a. Oldest international financial cooperative o
rganization between central banks founded in
1930 in Basel
b. Not an outcome from WW2 like IMF& Wo
rld Bank but WW1 so not a part of U.N.
c. 60 member central banks and monetary aut
horities with China's joining in 1996
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d. Businesses and services including gold res
erving, depositing, loaning, settling and notes
trading for central banks worldwide
e. Basel agreement on capital adequacy
f. new hub center in Hong Kong in 2019
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Supplement 2: DCEP
a. DCEP: Digital Currency Electronic Payme
nt specifically used for Chinese CBDC(centra
l bank digital currency) and issued by Peopl
e's Bank Of China
b. tested from April 17, 2020 in four places in
cluding Xiong An, Su Zhou, Shen Zhen and
Cheng Du (also scenarios of 2022 Beijing Wi
nter Olympics in the near future)
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c. Smart Timing: New momentum after pand
emic, leapfrogging in sovereign digtal curren
cy and offsetting the impact of Libra white pa
per 2.0(released in April16)
d. Possibly first CBDC in the world
e. targeted not at retail DIGICCY but internat
ional trade, finance and settlement
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e. Powered by blockchain technology and less depe
ndence on bank accounts, money transfer and settle
ments to bypass the incumbent international financi
al and settlement system like swift and chips system
correspondingly
f. digitization of M0(cash) instead of M1(bank cards
and mobile payment) to support offline payment an
d better financial inclusion and democratization(unb
anked and underbanked)
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g. Better data tracking, mining and analytics
for money, finance and economy to smooth t
he operation of general economy
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Specifics for term paper:
a. any topics covering contents in classes wit
h more specific ones favored
b. 2,500~3,500 words in english
c. Minimally 5 sources with at least 2 acade
mic ones(papers, journals, monographs and t
extbooks)
d. Deadline: Tuesday, week 20
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e. Outline recommended
Part 1 Introduction
Part 2 Finding problems
Part 3 Analyzing problems
Part 4 Solving problems
Part 5 Conclusion
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Part2. Practice
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1. China's traditional financial system in global co
ntext
a. The importance of financial reform and opening
for Chinese economy
* The accomplishments of Chinese economy: ope
ning and reform from 1978 to the second largest e
conomy today with powerful trade, markets, comp
anies and technologies, also known as world powe
rhouse and growth engine
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* Inconsistency and imbalance between chin
ese economy and finance: RMB as a weak i
nternational currency not matched with econ
omy and trade, no pricing power in global m
arket, second largest stock market but not an
international one (mainland), big but not str
ong banking sector, not a(or one of) rulemak
er(s) in major international financial govern
ance
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* Flaws in China's finance and its reform and ope
ning:
Externally, a limitedly convertible RMB for whic
h current account is open while capital account is
controlled, limited access to both chinese capital
market and overseas capital market, limited acces
s to banking sector in China and limited FDI in so
me keysectors, all of which have become major b
arriers for deepening of economic opening
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Internally, a typical bank-leading financial syste
m in which banks place more than 70% of socia
l financing, most of which are costly and exclus
ive financing, 60% of bank assets are owned by
state banks which are subject to inefficient own
ership and motivation structures(e.g. risk averse
d and state firm preferred), authorization system
in stock markets and hardship of MSME financi
ng
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b. Stock market in China
* Fundamentals of stock market
Def: market for raising and exchanging equity c
apitals
Functionalities: raising long-term capitals, value
discovery, risk sharing and providing liquidity
categorization: primary market vs. secondary m
arket and exchange market vs. OTC market
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* Path of stock market reform and opening i
n China:
12.1990 Shanghai Stock Exchange SSE
04.1991 Shenzhen Stock Exchange SZSE
1992 China's Securities Regulatory Comm
ission
1993 Class B share, H share
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07. 1999 Securities Law
07. 2003 QFII
05. 2004 SZSE SME Board
04. 2005 Non-Tradable Share reform
06. 2007 QDII
10. 2009 ChiNext
02. 2013 Shorting Mechanism
12. 2013 Neeq Market (New Third Board)
11. 2014 Shanghai-Hong Kong Connect
12. 2016 Shenzhen-Hong Kong Connect
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06. 2018 CDR
06. 2019 STAR market
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* Multi-tier stock market
Shanghai Stock Exchange (SSE):
Founded on Nov. 26, 1990 as the first stock market in
P.R.C
total market cap up to $4.5 tn as the fourth largest sto
ck market after NYSE, Nasdaq and Tokyo stock exch
ange
Total number of listed companies around 1,500 by 20
19
Blue chip market with around 680 S.O.E.
Shanghai composite index and SSE180
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*
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Shenzhen Stock Exchange(SZSE):
Founded on Apr.16, 1991 as the second stock mar
ket in P.R.C
Located in a dynamic rising city-Shen Zhen
Total market cap up to $2.5 tn as the eighth largest
stock market in the world
Total number of listed companies around 2,300 by
2019
Stage mainly for small and mid-size private comp
anies with only about 490 S.O.Es
SZSE Component Index 500
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S
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Chinext:
Founded on Oct. 23, 2009 as the first market boar
d to finance tech companies
Not an independent market but a new board in S
ZSE like AIM in LSE
Total market cap about ￥ 6tn by 2019, 10X rise
in 10 years
Total number of listed companies more than 780
by 2019
High PE ratio peaked at more than 100X in 2015,
about 50X by the end of 2019
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New third board(Neeq)
Launched on Jan.16, 2013 with a transition from Z
hong Guan Cun ownership transfer system
Total market cap around ￥ 3.3 tn by 2019
Total number of listed companies close to 9,000 by
2019
A watershed in stock market reform as the first Chi
nese independent OTC market subject to registrati
on system, with no profitability requirement and m
ore flexible corporate governance
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Sci & Tech Innovation Board(STAR Board):
Launched on Jun.13, 2019 as the latest market b
oard
Not an independent market but a new board in S
SE
Total market cap close to ￥ 1.4tn while total n
umber of listed companies up to 100 by the end
of this April
different targeting with Chinext(culture&educat
ion) and Neeq (incubator) as driving force for n
ew tech
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* Some Issues In Stock Market
Stock Issuance: dominance of Approval System
Stock Trading: More Than 60% Of Money
From Individual Investors and manipulation
Corporate Governance: Insider Control, pyramidin
g and interst transfer
Limited market opening
separation between banking and stock
market
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c. Banking in China
* Largest financial institutions in China with tota
l assets of ￥ 290tn in 2019
* Total social financing in 2019 up to ￥ 25.58 t
n among which bank loans contributed 66%
( ￥ 16.88 tn)
* More than 4,000 different types of banks and a
pproximately 180,000 outlets nationwide
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* Structuring banking sector in China
Central bank
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policy banks
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State bancorps
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Joint stock banks
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City commercial banks
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Privately owned banks
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Rural commercial banks
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* Some issues in banking sector

limited access to capital markets
Financial exclusivity: economy of scale ,pricing
power and ownership structure
risk exposure: credit risk & liquidity risk