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INTERNATIONAL FINANCE LECTURE NOTES

MM IPMI. INTERNATIONAL FINANCE LECTURE NOTES. Prof. Roy Sembel, Ph.D October 2009 – February 2010. Last week’s (January 16) AGENDA. Review of course outline, assignments, and last-week materials Book Review presentation, 25-30 minutes per group USD forecast results

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INTERNATIONAL FINANCE LECTURE NOTES

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  1. MM IPMI INTERNATIONAL FINANCE LECTURE NOTES Prof. Roy Sembel, Ph.D October 2009 – February 2010

  2. Last week’s (January 16) AGENDA Review of course outline, assignments, and last-week materials Book Review presentation, 25-30 minutes per group USD forecast results Simulation: temporary results

  3. Forecasting Rp/US$ Group Dates 11 12 13 14 15 comments 1 9250 9250 9250 9250 9250 TA 2 9260 9280 9315 9290 9280 TA 3 9276 9224 9241 9163 9206 TA • 9279 9275 9274 9276 9275 TA (MA-3) Average 9266 9257 9270 9245 9253 Random walk == Exch Rate on 10/1 Actual 9233 9157 9174 9165 9165

  4. Error of Forecast Group Dates 11 12 13 14 15 Total 1 2 3 Average Rd Wk

  5. January 23 AGENDA Course Review Simulation: temporary results Currency Risk Exposure: Transaction, Translation, Economic Exposure Managing Currency Risk with Derivatives Discussion: Barings, SocGen Case: Vogl

  6. STUDENT CENTERED APPROACH ‘Students’ Active learners: • Read reading materials • Discuss within group (articles, hot issues, investment simulation, solution for cases, book review, preparing presentation) • Participate actively in class discussion ‘Lecturer’  Facilitator: • Structure syllabus • Prepare reading materials, cases, simulation rules & template • Invite guest lecturers • Facilitate discussion, presentation 3-stage learning: • Individual learning • Group discussion • Class discussion Grading policy: • Individual efforts (class participation & quiz) 35% • Group efforts (case summary & group presentation) 40% • Final examination 25%

  7. COURSE OUTLINE Projects / Cases: • Event analysis: (Financial) Crises of the world • International Portfolio Investment Simulation • Book Review • Analysis of one Multi National Company (MNC) • Exchange rate forecasting Final Examination

  8. Project 1: Crises of the world • Oct 10  Choose one of the crises: Indonesia 1966, Indonesia 1997, Sub-prime mortgage 2007, Jerome Kerviel (Societe Generale 2007), DotCom Bubble 2000, The Great Depression 1929 • Nov 14  1-page description of the crises • Nov 28  Analysis of the causes of the crises • Dec 19  What happened after the crises • Jan 23  Lessons learned from the crises • Jan 30  Submit complete report • February 625-minute presentation of the crises

  9. Project 2: SimulationInternational Portfolio Investment • Nov 14  5-minute presentation of criteria, reasons, and fund allocation • Nov 28 – Jan 30  weekly performance report • February 6  5-minute presentation of final results and lessons learned

  10. Project 3: Book Review • Nov 14  Choose one book • Jan 9  Submit Report (10 pages, A4, times roman 12, line spacing1.5) • Jan 16  Book review presentation DONE! GOOD JOB!

  11. Project 4: Analysis of one Multi National Company (MNC) • Oct 10 Choose one MNC • Nov 14  Describe briefly the MNC • Nov 28  Analyze historical (weekly: last 52 weeks, yearly: last 5 years) performance of MNC’s stock • Dec 19  Analyze MNC’s funding and investment strategy • Jan 30  Analyze MNC’s financial risk management strategy • Feb 6  Submit complete report on MNC

  12. Project 5: Exchange Rate Forecasting • Nov 14, 2009 to January 9, 2010 Visit www.oanda.com, play around with Rp/$ data (average daily return, volatility, etc), download monthly data January 2007 – January 2010 • January 9, 2010  Forecast the Rp/$ (closing) exchange rates for 11/1, 12/1, 13/1, 14/1, 15/1. • January 16  Record your forecast error DONE! GOOD JOB!

  13. Final Examination • Group take-home examination [40% of total final examination score]: Complete report on Investment simulation, EVENT, MNC • Individual in-class examination [60% of total final examination score]: Questions on projects, hot issues, guest lecture, articles, etc.

  14. Assignment agenda January 23: Readings: ICF Ch 5, 10, 11, 12 Managing Derivatives Risks: Barings Several articles on Risk Management Project/Case: • Case: Vogl Co • EVENT: Lessons learned • Investment Simulation: weekly performance report

  15. Assignment agenda January 30: Readings: ICF Ch 16, 19, Appendix 3 p 87-97 Articles: Emerging Market Risk; Measuring Long Term Performance Project/Case: • EVENT: Submit complete report on the crises • MNC: Financial Risk Management in MNC • Investment Simulation: weekly performance report

  16. Assignment agenda February 6: Project/Case: • EVENT: Complete 25-minute presentation of the crises • Simulation: 5 minute presentation of International Portfolio Investment Simulation Results and Lessons learned • MNC: Complete report on MNC

  17. January 23 AGENDA Course Review Simulation: temporary results Currency Risk Exposure: Transaction, Translation, Economic Exposure Managing Currency Risk with Derivatives Discussion: Barings, SocGen Case: Vogl

  18. Investment Simulation Results Group Portfolio value Main contributor 19/12 9/1 16/1 23/1 1 105,4 106,3 106,6 105.1 Mexico, Indonesia 2 100,8 102,1 101,2 100.1 South Kor, Hong Kong 3 97,9 100,4 99,8 98.7 China, Indonesia 4 101,2 103,1 98,8 100.6 Indonesia, DJIA

  19. January 23 AGENDA Course Review Simulation: temporary results Currency Risk Exposure: Transaction, Translation, Economic Exposure Managing Currency Risk with Derivatives Discussion: Barings, SocGen Case: Vogl

  20. Currency risk exposure • Exchange rate exposure may affect financing costs • volatile cash flow from exchange rate changes increases risk • Transaction exposure • reflects the exposure of an MNC’s future cash transactions to exchange rate movements

  21. Currency risk exposure • Economic exposure • measures the direct and indirect risks to cash flows from exchange rate movements • Translation exposure • focuses on consolidated financial statements

  22. January 23 AGENDA Course Review Simulation: temporary results Currency Risk Exposure: Transaction, Translation, Economic Exposure Managing Currency Risk with Derivatives Discussion: Barings, SocGen Case: Vogl

  23. DERIVATIVE SECURITIES SECURITIES WHOSE VALUES DEPEND ON OTHER MORE ELEMENTARY ASSET. USES OF DERIVATIVE: SPECULATION ARBITRAGE HEDGING

  24. DERIVATIVES: BEAUTY OR BEAST ?

  25. FORWARDS CONTRACT BETWEEN TWO PARTIES TO BUY/SELL AN UNDERLYING ASSET WITH PRESPECIFIED AMOUNT, PRICE, AND DELIVERY TIME IN THE FUTURE. LONG VS SHORT

  26. FORWARDS EXAMPLES OF FORWARDS: PRE-HARVEST SALE (IJON) PRE-ARRANGED MARRIAGE (KAWIN SITI NURBAYA)

  27. FORWARDS LONG VS SHORT Payoff Long position Spot Price at maturity Delivery price Short position

  28. HEDGING A shoe manufacturer in Indonesia has just received an order to export several containers of shoes to Japan as soon as possible and will receive payment of 100 million yen six months from now. She estimates that the total cost (including insurance and transportation costs) of the exported shoes is Rp 8 billion rupiah. Yen may appreciate or depreciate against rupiah. Now, the spot price is Rp 100 / yen and six-month forward price is Rp 102 / yen What should she do ?

  29. HEDGING SITUATION: Long yen position (will receive yen) RISK: Yen depreciate against rupiah SOLUTION: Concentrate on shoe business Hedge the currency risk: take short yen position (sell yen forward) to cover the long yen position

  30. FORWARDS HEDGING YEN RECEIVABLES Payoff Long yen position in shoe business Rp / yen in six months Rp 102 /yen Short yen position in derivative market Net result: Currency fluctuation will not affect profit The Rp 2.2 billion profit is locked in from the shoe business, i.e., Rp 10.2 billion (or yen 100 million x Rp 102/yen) - Rp 8 billion

  31. FORWARDS VS FUTURES FORWARDS: TAILOR MADE BETWEEN TWO PARTIES FUTURES: STANDARDIZED, TRADED ON ORGANIZED EXCHANGE

  32. OPTIONS CONTRACT THAT GIVES ITS HOLDER A RIGHT TO BUY (CALL) OR SELL (PUT) A CERTAIN AMOUNT OF A CERTAIN UNDERLYING ASSET WITH A CERTAIN PREDETERMINED PRICE (STRIKE/EXERCISE PRICE) AT A CERTAIN TIME IN THE FUTURE AMERICAN VS EUROPEAN OPTIONS PRICE (PREMIUM) OF OPTIONS VS PRICE OF UNDERLYING ASSET

  33. CALL VS PUT PUT OPTIONS Right to SELL • S • At a price X • At time T CALL OPTIONS Right to BUY • S • At a price X • At time T

  34. How does it work? CALL CALL OPTIONS Right to BUY • S • At a price X • At time T NOW MATURITY Seller Short SELL S Writer Rp Premium S Rp X Buyer BUY S Long Taker Expired • Right to BUY • S • At price X • At time T Hak digunakan Hak tidak digunakan

  35. How does it work? PUT PUT OPTIONS Right to SELL • S • At a price X • At time T NOW MATURITY Seller Short BUY S Writer Rp Premium S Rp X Buyer SELL S Long Taker • Right to SELL • S • At price X • At time T Hak digunakan Hak tidak digunakan Expired

  36. INTRINSIC VS TIME VALUE • INTRINSIC VALUE: • MAX (0, | S – X | ) • TIME VALUE: • PREMIUM ABOVE INTRINSIC VALUE

  37. OPTIONS PAY-OFF Pay-off Long Call Options Profit Long Call Options C BEP = X + C Price of asset at maturity of options -C X=30 Strike price Profit Short Call Options Pay-off Short Call Options

  38. PAY-OFF Pay-off Long Put Options Profit Long Put Options BEP P -P X=30 Strike Price Pay-off Short Put Options Profit Short Put Options OPTIONS Price of asset at maturity of options

  39. CASE STUDY PT Bank Bangkrut plans to expand its operation to the US and offer to buy a US bank at US$ 10 million. The US bank needs 3 months to consider the offer. Bank Bangkrut gives the US Bank 3 months to decide. 1. WHAT FINANCIAL RISKS ARE FACED BY BB ? 2. WHAT SHOULD IT DO TO HEDGE THE RISK ?

  40. CASE STUDY RISK EXPOSURE: HEDGING Payoff Rp/$ 10,000

  41. January 23 AGENDA Course Review Simulation: temporary results Currency Risk Exposure: Transaction, Translation, Economic Exposure Managing Currency Risk with Derivatives Discussion: Barings, SocGen, Local Disputes Case: Vogl

  42. CASE: BARINGS • What caused Barings’ debacle? • Explain the risks of Leeson’s transactions! • What lessons we learned from Barings?

  43. January 23 AGENDA Course Review Simulation: temporary results Currency Risk Exposure: Transaction, Translation, Economic Exposure Managing Currency Risk with Derivatives Discussion: Barings Case: Vogl

  44. VOGL • Currency exposure? • Tools: Forwards? Options? Why?

  45. THANK YOU VERY MUCH FOR YOUR ATTENTION

  46. Assignment agenda January 30: Readings: ICF Ch 16, 19, Appendix 3 p 87-97 Articles: Emerging Market Risk; Measuring Long Term Performance Project/Case: • EVENT: Submit complete report on the crises • MNC: Financial Risk Management in MNC • Investment Simulation: weekly performance report

  47. LEARNING LOG

  48. PREMIUM OPTIONS FACTOR EFFECT ON CALL PUT - + S s + + X - + T + + D - + + - r

  49. OPTION VALUATION BINOMIAL MODEL BLACK-SCHOLES C = N(d1) S - N(d2) X e(-Rf * T) d1 = [ log(S/X) + Rf * T + s2 * T/2] / [s * T0.5] d2 = d1 - s * T0.5 SIMULATION

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