International Finance

1. International Finance Yulia B. Ilina Asc. Prof. Department of Finance and Accounting

2. It would take a revolution to overthrow the greenback (handout) • How the replacement of the US dollar as a world reserve currency could affect international financial environment? Why it is said that other countries could benefit from it? • Why the USD could hardly be replaced?

3. Course content • Topic 1. Introduction. Goals of International Financial Management. Overview of International Financial Markets. International Parity Relationships and Exchange Rate Behavior. • Topic 2. Foreign Exchange Market and Arbitrage Activities. International Money Market. • Topic 3. International Banking. • Topic 4. International Capital Markets. • Topic 5. Corporate Governance around the World. • Topic 6. International Portfolio Investments • Topic 7. Futures and Options on Foreign Exchange. • Topic 8. Currency and Interest Rate Swaps. • Topic 9. Managing Currency Exposure with Derivatives.

4. Required textbooks • Eun C., Resnick B. G. International Financial Management. 4-th ed. McGraw-Hill, 2007 • Eiteman D.K., Stonehill A.I., Moffet M.H. Multinational Business Finance. 11-th ed. Pearson Education, Inc., 2007 Additional recommended textbook: Shapiro A. Multinational Financial Management. 8-th ed. Wiley, John & Sons, Inc., 2006.

5. Grading system

6. Current evaluation • In-class assignments: tests, group work assignments, Citibank case studies • Home assignments: exercises • In-class tests (30-40 min) are closed-book assignments that combine multiple-choice questions as well as open questions, based on cases discussed, and problems (numerical exercises). In case of missing (failure) the test, missing other in-class assignments they are not to be repeated or substituted by other types of activities. • The mid-term grading (required for Russian students – «аттестация» (rus.)) is made on accumulated basis. Student has to accumulate no less than 50% in total for all types of assignments by the grading period (date). • Home assignments should be submitted as scheduled. Assignments submitted later are not accepted.

7. Final evaluation (exam) • Final evaluation is exercised by written open-book exam (90 min). • Exam includes mini-tests, problems, open questions.

8. Topic 1 Introduction. Goals of International Financial Management. Overview of International Financial Markets. International Parity Relationships and Exchange Rate Behavior.

9. Key points • Goals for international financial management • The structure of international financial environment, overview of international financial system • Purchasing Power Parity and the Law of One Price • Real and nominal exchange rates • Fisher Effect • International Fisher Effect

10. What is a multinational corporation (MNC)? A multinational corporation (MNC) can be defined as a business firm incorporated in one country that has production and sales operations in several other countries. MNCs obtain financing from international financial markets.

11. Why multinational enterprise needs international financial environment? Searching lower cost financing alternatives (factors of production costs) Searching investment opportunities globally

12. Quarter's Top Funds Had a Global Flavor --- U.S. Did Well, but International Did Better (handout) Big slide, big rebound • What are reasons for International funds outperformance? Are any favorable factors underlying emerging markets current performance? • What could be the prospects of international investments performance?

13. Main difficulties managers face in the global financial marketplace Doing business in different currencies: exchange rate risk Different government regulations, tax laws, business practices, political environments

14. What is one of the most important financial aspects of international business? The impact of shifting exchange rates and what companies (individuals) can do to protect themselves against adverse exchange rate movements.

15. Exchange rate • The price of one country’s currency expressed in terms of another country’s currency

16. Exchange rate uncertainty is very important factor in international investments. Why? returns on foreign investments and revenues from international transactions are directly affected by currency movements, because they must be translated from foreign to domestic money 1 indirectly they are influenced by reaction of asset prices to exchange rate adjustments 2

17. Earnings: At the Mercy of a Mercurial Dollar (handout) • Comment the following: • “Investors in U.S. stocks were celebrating the weak U.S. dollar last year” • “While their domestic market was in recession, U.S. firms could report big sales figures from abroad”.

18. How is international financial management different from domestic financial management? • Foreign Exchange Risk • Political Risk • Market Imperfections • Expanded Opportunity Set

19. How is international financial management different from domestic financial management? Foreign Exchange Risk • The risk that foreign currency profits may evaporate in real terms due to unanticipated unfavorable exchange rate movements

20. How is international financial management different from domestic financial management? • Political Risk Sovereign governments have the right to regulate the movement of goods, capital, and people across their borders.

21. How is international financial management different from domestic financial management? • Market Imperfections • Legal restrictions on movement of goods, people, and money • Transactions costs • Shipping costs • Difference in taxation

22. Global imbalances (handout) • Why Asian governments try to prevent their currencies from strengthening? • Explain the following: The IMF's charter forbids members from "manipulating exchange rates . . . to gain an unfair competitive advantage over other members".

23. Why MNC is “a gift of market imperfections”? • Why Toyota placed its production in US? • In Russia?

24. The Example of Nestlé’s Market Imperfection • Nestlé used to issue two different classes of common stock: bearer shares and registered shares. • Foreigners were only allowed to buy bearer shares. • Swiss citizens could buy registered shares. • The bearer stock was more expensive. • On November 18, 1988, Nestlé lifted restrictions imposed on foreigners, allowing them to hold registered shares as well as bearer shares. What happened with share prices?

25. 12,000 10,000 Bearer share 8,000 6,000 4,000 Registered share 2,000 0 11 20 31 9 18 24 Nestlé’s Foreign Ownership Restrictions (October-November, 1988) SF

26. The Example of Nestlé’s Market Imperfection • Following this, the price spread between the two types of shares narrowed dramatically. • Foreigners holding Nestlé bearer shares were exposed to political risk in a country that is widely viewed as a haven from such risk. • The Nestlé episode illustrates both the importance of considering market imperfections and the peril of political risk.

27. How is it related to international finance? The World Bank group is set to launch a $5.5bn initiative to raise funds to buy distressed assets from banks in emerging and developing markets in a bid to clean up their balance sheets and free up credit flows. The move came as the International Monetary Fund warned yesterday that rising losses on loans were likely to strain bank balance sheets in emerging Europe "for years to come", saying non-performing loan ratios could peak as high as double their current level.

28. How is it related to international finance? • Last fall, Berkshire invested billions in General Electric Co. and Goldman Sachs to help those venerable companies raise capital. Berkshire invested $3 billion in preferred GE shares and $5 billion in preferred Goldman shares, and both companies agreed to pay Berkshire a 10 percent dividend.

29. How is it related to international finance? • Cameco Corp. said late Friday its fourth-quarter earnings fell by nearly half as the world's largest uranium producer recorded unrealized losses on financial instruments.

30. Goals for International Financial Management • What goal should the effective global manager be working toward? Maximization of shareholder wealth? or Other Goals?

31. Problem. How is it related to international finance? A working group of French chief executive officers was set up by the Confederation of French Industry (CNPF) and the French Association of Private Companies (AFEP) to study the French corporate governance structure. The group reported the following, among other things “The board of directors should not simply aim at maximizing share values as in the U.K. and the U.S. Rather, its goal should be to serve the company, whose interests should be clearly distinguished from those of its shareholders, employees, creditors, suppliers and clients but still equated with their general common interest, which is to safeguard the prosperity and continuity of the company”. Evaluate the above recommendation of the working group.

32. Solution The recommendations of the French working group clearly show that shareholder wealth maximization is not a universally accepted goal of corporate management, especially outside the United States and possibly a few other Anglo-Saxon countries including the United Kingdom and Canada. To some extent, this may reflect the fact that share ownership is not wide spread in most other countries. In France, about 15% of households own shares.

33. Maximize Shareholder Wealth • Long accepted as a goal in the Anglo-Saxon countries, but complications arise. Who are and where are the shareholders? In what currency should we maximize their wealth?

34. Other Goals • In other countries shareholders are viewed as merely one among many “stakeholders” of the firm including: • Employees • Suppliers • Customers • In Japan, managers have typically sought to maximize the value of the keiretsu—a family of firms to which the individual firms belong

35. Peter Drucker suggestions • to be successful, multinational corporations must work to exploit global markets; • exchange rates are inevitably unstable, and attempting to predict them is foolish; • not hedging against exchange rate fluctuations is equivalent to speculating; and • corporate losses can’t be blamed on market volatility.

36. Emergence of Globalized Financial Markets • Deregulation of Financial Markets coupled with • Advances in Technology have greatly reduced information and transactions costs, which has led to: • Financial Innovations, such as • Currency futures and options • Currency swaps • Multi-currency bonds • Multi-currency loans • Cross-border stock listings • International mutual funds etc.

37. Global Capital Markets • The United States has one of the most developed capital markets in the world, but foreign markets are becoming more competitive, and they are often willing to try more innovative ways to do business

39. International Financial System • Money • Markets • Institutions

40. International Money

41. International Financial Markets

43. World finance: Liquid fuel (home reading for the class 2) • What are most profitable financial market sectors today? • What is pessimistic about the current situation?

44. World finance: Liquid fuel

45. International Parity Relationships and Exchange Rate Behavior

46. Key Points • Purchasing Power Parity and the Law of One Price • Real and nominal exchange rates • Fisher Effect • International Fisher Effect • Foreign exchange quotations • Forward rates, forward premiums and discounts • Interest Rate Parity: covered interest arbitrage, uncovered interest rate parity • The relationship between the forward rate and the future spot rate. Forward rate as an unbiased predictor. An integrative look at the International Parity conditions.

47. International Parity Conditions The economic theories that link exchange rates, price levels and interest rates together are called international parity conditions (relations)

48. International Parity Conditions Why is it necessary for companies and investors to have an understanding of IPCs? It is important to understand forces driving exchange rate changes, as changes affect investment and financing opportunities

49. International Parity Conditions When the market can be said to be in equilibrium? When no profitable arbitrage opportunities exist

50. What is the law of one price? If identical products or services can be sold in two different markets, the product’s price should be the same in both markets (if frictions or costs of moving the products or services between markets do not exist)