1、McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/IrwinInternational Aspects of Financial ManagementChapter 18McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.1Key Concepts and SkillsnUnderstand how exchange rates are quoted and what
2、 they meannKnow the difference between spot and forward ratesnUnderstand purchasing power parity and interest rate parity and the implications for changes in exchange ratesnUnderstand the types of exchange rate risk and how it can be managednUnderstand the impact of political risk on international b
3、usiness investingMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.2Chapter OutlinenTerminologynForeign Exchange Markets and Exchange RatesnPurchasing Power ParitynExchange Rates and Interest RatesnExchange Rate RisknPolitical RiskMcGraw-Hill 2004 The McGraw-Hill
4、 Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.3Domestic Financial Management and International Financial ManagementnConsiderations in International Financial ManagementnHave to consider the effect of exchange rates when operating in more than one currencynHave to consider the political risk
5、 associated with actions of foreign governmentsnMore financing opportunities when you consider the international capital markets and this may reduce the firms cost of capitalMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.4International Finance TerminologynAmer
6、ican Depository Receipt(ADR)nCross-ratenEurobondnEurocurrency(Eurodollars)nForeign bondsnGiltsnLondon Interbank Offer Rate(LIBOR)nSwapsMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.5Global Capital MarketsnThe number of exchanges in foreign countries continues
7、 to increase,as does the liquidity on those exchangesnExchanges that allow for the flow of capital are extremely important to developing countriesnThe United States has one of the most developed capital markets in the world,but foreign markets are becoming more competitive and are often willing to t
8、ry more innovative ways to do businessMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.6Work the Web ExamplenThinking about going to Mexico for spring break or Japan for your summer vacation?nHow many pesos or yen can you get in exchange for$1000?nClick on the w
9、eb surfer to find outMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.7Exchange RatesnThe price of one countrys currency in terms of anothernMost currency is quoted in terms of dollarsnConsider the following quote:nFrance(Franc).14606.8479nThe first number(.1460
10、)is how many U.S.dollars it takes to buy 1 French FrancnThe second number(6.8479)is how many French Francs it takes to buy$1nThe two numbers are reciprocals of each other(1/6.8479=.1460)McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.8Example:Exchange RatesnSup
11、pose you have$10,000.Based on the rates in Figure 18.1,how many Italian Lira can you buy?nExchange rate=2021.37 Lira per U.S.dollarnBuy 10,000(2021.37)=20,213,700 LiranSuppose you are visiting London and you want to buy a souvenir that costs 1000 British pounds.How much does it cost in U.S.dollars?n
12、Exchange rate=.6669 pounds per dollarnCost=1000/.6669=$1499.48McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.9Example:Triangle ArbitragenWe observe the following quotesn10.00 FF per$1n2.00 DM per$1n4.00 FF per DMnWhat is the cross rate?n(10.00 FF/$1)/(2.00 DM/
13、$1)=5 FF per DMnWe have$100 to invest;buy low,sell highnBuy$100(10 FF/$1)=1000 FF,use FF to buy DMnBuy 1000FF/(4 FF/DM)=250 DM,use DM to buy dollarsnBuy 250 DM/(2 DM/$1)=$125nMake$25 risk-freeMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.10Transaction Termino
14、logynSpot trade exchange currency immediatelynSpot rate the exchange rate for an immediate tradenForward trade agree today to exchange currency at some future date and some specified price(also called a forward contract)nForward rate the exchange rate specified in the forward contractnIf the forward
15、 rate is higher than the spot rate,the foreign currency is selling at a premium(when quoted as$equivalents)nIf the forward rate is lower than the spot rate,the foreign currency is selling at a discountMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.11Absolute P
16、urchasing Power ParitynPrice of an item is the same regardless of the currency used to purchase itnRequirements for absolute PPP to holdnTransaction costs are zeronNo barriers to trade(no taxes,tariffs,etc.)nNo difference in the commodity between locationsnAbsolute PPP rarely holds in practice for m
17、any goodsMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.12Relative Purchasing Power ParitynProvides information about what causes changes in exchange ratesnThe basic result is that exchange rates depend on relative inflation between countriesnE(St)=S01+(hFC hU
18、S)tnBecause absolute PPP doesnt hold for many goods,we will focus on relative PPP from here on outMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.13Example:PPPnSuppose the Canadian spot exchange rate is 1.4680 Canadian dollars per U.S.dollar.U.S.inflation is ex
19、pected to be 3%per year and Canadian inflation is expected to be 2%.nDo you expect the U.S.dollar to appreciate or depreciate relative to the Canadian dollar?nSince inflation is higher in the US,we would expect the US dollar to depreciate relative to the Canadian dollar.nWhat is the expected exchang
20、e in one year?nE(S1)=1.46801+(.02-.03)1=1.4533McGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.14Covered Interest ArbitragenExamine the relationship between spot rates,forward rates and nominal rates between countriesnAgain,the formulas will assume that the exch
21、ange rates are quoted in terms of foreign currency per U.S.dollarnThe U.S.risk-free rate is assumed to be the T-bill rateMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.15Example:Covered Interest ArbitragenConsider the following informationnS0=2 DM/$RUS=10%nF1=
22、1.8 DM/$RG=5%nWhat is the arbitrage opportunity?nBorrow$100 at 10%nBuy$100(2 DM/$)=200 DM and invest at 5%for 1 yearnIn 1 year,receive 200(1.05)=210 DM and convert back to dollarsn210 DM/(1.8 DM/$)=$116.67 and repay loannProfit=116.67 100(1.1)=$6.67 risk freeMcGraw-Hill 2004 The McGraw-Hill Companie
23、s,Inc.All rights reserved.McGraw-Hill/Irwin18.16Interest Rate ParitynBased on the previous example,there must be a forward rate that would prevent the arbitrage opportunity.nInterest rate parity defines what that forward rate should be)(1 :Approx.)1()1(:Exact0101USFCUSFCRRSFRRSFMcGraw-Hill 2004 The
24、McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.17Short-Run ExposurenRisk from day-to-day fluctuations in exchange rates and the fact that companies have contracts to buy and sell goods in the short-run at fixed pricesnManaging risknEnter into a forward agreement to guarantee the e
25、xchange ratenUse foreign currency options to lock in exchange rates if they move against you but benefit from rates if they move in your favorMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.18Long-Run ExposurenLong-run fluctuations come from unanticipated chang
26、es in relative economic conditionsnCould be due to changes in labor markets or governmentsnMore difficult to hedgenTry to match long-run inflows and outflows in the currencynBorrowing in the foreign country may mitigate some of the problemsMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights re
27、served.McGraw-Hill/Irwin18.19Translation ExposurenIncome from foreign operations has to be translated back to U.S.dollars for accounting purposes,even if foreign currency is not actually converted back to dollarsnIf gains and losses from this translation flowed through directly to the income stateme
28、nt,there would be significant volatility in EPSnCurrent accounting regulations require that all cash flows be converted at the prevailing exchange rates with currency gains and losses accumulated in a special account within shareholders equityMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights
29、 reserved.McGraw-Hill/Irwin18.20Managing Exchange Rate RisknLarge multinational firms may need to manage the exchange rate risk associated with several different currenciesnThe firm needs to consider its net exposure to currency risk instead of just looking at each currency separatelynHedging indivi
30、dual currencies could be expensive and may actually increase exposureMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.21Political RisknChanges in value due to political actions in the foreign countrynInvestment in countries that have unstable governments should
31、require higher returnsnThe extent of political risk depends on the nature of the businessnThe more dependent the business is on other operations within the firm,the less valuable it is to othersnNatural resource development can be very valuable to others,especially if much of the ground work in deve
32、loping the resource has already been donenLocal financing can often reduce political riskMcGraw-Hill 2004 The McGraw-Hill Companies,Inc.All rights reserved.McGraw-Hill/Irwin18.22Quick QuiznWhat does an exchange rate tell us?nWhat is triangle arbitrage?nWhat are absolute purchasing power parity and r
33、elative purchasing power parity?nWhat are covered interest arbitrage and interest rate parity?nWhat are uncovered interest parity and the International Fisher Effect?nWhat are the two methods for international capital budgeting?nWhat is the difference between short-run interest rate exposure and long-run interest rate exposure?How can you hedge each type?nWhat is political risk and what types of business face the greatest risk?
