Tài chính doanh nghiệp - Chapter 18: Internatinal aspects pf financial planning

18-1Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin18-2Key Concepts and SkillsUnderstand How exchange rates are quoted and what they meanThe difference between spot and forward ratesPurchasing power parity and interest rate parity and the implications for changes in exchange ratesThe types of exchange rate risk and how it can be managedThe impact of political risk on international business investing18-3Chapter Outline18.1 Terminology18.2 Foreign Exchange Markets and Exchange Rates18.3 Purchasing Power Parity18.4 Exchange Rates and Interest Rates18.5 Exchange Rate Risk18.6 Political Risk18-4International Finance TerminologyAmerican Depositary Receipt (ADR)Security issued in the U.S. representing shares of a foreign stockCan be traded in the U.S.Cross-rateImplicit exchange rate between two currencies when both are quoted in a third (usually dollars) currency.EurobondBond issued in multiple countries but denominated in the issuer’s home currency18-5International Finance TerminologyEurocurrency (Eurodollars)Money deposited in a financial center outside the country of the currency involved“Eurodollars” = dollar-denominated deposits in banks outside the U.S. banking systemForeign bondsSold by foreign borrowerDenominated in currency of the country of issueGiltsBritish and Irish government securities18-6International Finance TerminologyLondon Interbank Offer Rate (LIBOR)Rate international banks charge each other for loans of Eurodollars overnight in the London marketFrequently used as a benchmark rate for money market instrumentsSwapsInterest rate swap = two parties exchange a floating-rate payment for a fixed-rate paymentCurrency swap = agreement to deliver one currency in exchange for another18-7Global Capital MarketsNumber of exchanges in foreign countries continues to increase, as does the liquidity on those exchangesExchanges facilitate the flow of capital Extremely important to developing countriesDifferences:Market StructureRegulationTrading rulesUnited States = most developed capital markets in the world, but:Foreign markets becoming more competitive Often more willing to innovate 18-8Example: Work the WebThinking about going to Mexico for spring break or Japan for your summer vacation?How many pesos or yen can you get in exchange for $1,000?Click on the Web surfer to find out18-9FOREX TradingForeign Exchange Largest market in the world$1.9 trillion per day on averageTrading = 24/7 over-the-counterMost trading in USD, £, ¥, and €FOREX quotations:Direct = USD per foreign currencyIndirect = Units of foreign currency per USD18-10Foreign Exchange Quotes18-11Exchange RatesThe price of one country’s currency in terms of anotherMost currency quoted in terms of dollarsDirect Quotation = price of foreign currency expressed in U.S. dollars. (dollars per currency); Figure 18.1 “in US$”Indirect quotation = the amount of a foreign currency required to buy one U.S. dollar (currency per dollar); Figure 18.1 “per US$”Return to Quick Quiz18-12Direct Exchange Rate QuotationsDirect Quotation = price of FC in USD $1.3266 to buy 1 Euro: “Euro selling at $1.3266” $0.1221 to buy 1 Krona: “Krona selling at $.1221”U.S. $ to buy 1 UnitEuro1.3266Swedish Krona0.122118-13Indirect Exchange Rate QuotationsIndirect quotation = FC per USD 0.7538 Euros to buy 1 USD “USD at 0.7538 Euros” 8.19 Kronas to buy 1 USD “USD at 8.19 Kronas”Units of FC to buy 1 USDEuro0.7538Swedish Krona8.190018-14Direct & Indirect Exchange Rate QuotationsAn indirect quotation is the reciprocal of a direct quotationDirect Quotation = 1/Indirect QuotationEuros and British pounds normally quoted as direct quotations“The pound is selling at 1.4729 USD” All other currencies quoted as indirect18-15Example: Exchange RatesSuppose you have $10,000 . Based on the rates in Figure 18.1, how many Norwegian Krona can you buy?Exchange rate = 8.1900 Krona per U.S. dollarBuy 10,000(8.1900) = 81,900 KronaSuppose you are visiting London and you want to buy a souvenir that costs 1,000 British pounds. How much does it cost in U.S. dollars?Exchange rate = $1.4279 dollars per poundCost = 1,000 X 1.4279 = $1,427.9018-16Cross RatesThe exchange rate between any two currencies not involving U.S. dollarsUsually calculated from direct or indirect ratesBased on U.S. dollar exchange rates18-17Cross Rates: Euros and Kronas Euros Dollars  Dollar Krona Kronas Dollars  Dollar Euros××= 0.7538 x 0.1221= 0.0920 Euros/KronaCross Rate =Cross Rate == 8.19 x 1.3266= 10.8649 Kronas/Euro18-18ArbitrageA violation of the “Law of One Price”Arbitrage: A positive cash flowNo risk Triangle ArbitrageMoves through 3 exchange ratesReturn to Quick Quiz18-19Example: Triangle ArbitrageQuoted Rates: 10.00 Mexican Pesos (Ps) per $1 2.00 Swiss Francs (SF) per $1 4.00 Ps per SFImplied Cross-Rate (10.00 Ps/$1) / (2.00 SF/$1) = 5.00 Ps per SF18-20Example: Triangle ArbitrageUse $100 to buy Pesos 100*(10 Ps/$1) = 1000 Ps Use 1000 Pesos to buy SF 1000 Ps / (4 Ps/SF) = 250 SF Use 250 SF to buy USD 250 SF / (2 SF/$1) = $125$25 risk-free profit18-21Triangle Arbitrage18-22Currency Appreciation and DepreciationSuppose the exchange rate goes from 8.19 Kronas per USD to 12 Kronas per USD.A USD now buys more Kronas, so:The USD is appreciating (strengthening)The Krona is depreciating (weakening)18-23Transaction TerminologySpot rate (S)The exchange rate for an immediate tradeForward rate (F)The exchange rate specified today in a forward contract to exchange currency at some future date Normally reported as indirect quotations18-24The Forward Rate at a Premium to the Spot RateF > S  Foreign currency selling at a premiumExample: Spot rate = 0.7 £/$ Forward rate = 0.6 £/$The pound is expected to appreciate£ will buy more dollars in the future Forward rate for the pound is at a premium18-25The Forward Rate at a Discount to the Spot RateF < S  Foreign currency selling at a discountExample: Spot rate = 0.7 £/$ Forward rate = 0.8 £/$The pound is expected to depreciate£ will buy fewer dollars in the future Forward rate for the pound is at a discount18-26Spot/Forward RelationshipPrimary determinant of the spot/forward rate relationship = relationship between domestic and foreign interest rates.18-27Absolute Purchasing Power ParityPrice of an item is the same regardless of the currency used to purchase it or where it is selling: Requirements for Absolute PPP to holdNo transaction costsNo barriers to trade (no taxes, tariffs, etc.)No difference in the commodity between locationsAbsolute PPP rarely holds in practice Usually only for uniform, traded goodsP = Price of goodsS0 = Spot rateReturn to Quick Quiz18-28Relative Purchasing Power ParityQuantifies inflation-exchange rate relationshipProvides information about what causes changes in exchange ratesExchange rates depend on relative inflation between countries E(St ) = S0[1 + (hFC – hUS)]t S0 = Current spot exchange rate E(ST) = Expected exchange rate at time t hUS = Inflation rate in the U.S. hFC = Inflation rate in foreign country(18.3)Return to Quick Quiz18-29PPP ExampleGiven:Canadian$ spot rate (S0) = 1.2488 C$/USD Expected U.S. inflation (hUS) = 3% per year Expected Canadian inflation (hFC) = 2%Will the USD appreciate or depreciate relative to the Canadian dollar?What is the expected exchange rate in one year?18-30PPP ExampleWill the USD appreciate or depreciate relative to the Canadian dollar?Since inflation is higher in the US, we would expect the US dollar to depreciate relative to the Canadian dollarWhat is the expected exchange rate in one year? E(St ) = S0[1 + (hFC – hUS)]t E(S1) = 1.2488[1 + (.02 - .03)]1 = 1.236318-31Covered Interest ArbitrageCapitalizing on the interest rate differential between two countries while covering exchange rate risk with a forward contractReturn to Quick Quiz18-32Example: Covered Interest ArbitrageConsider the following informationS0 = 2 SF / $ RUS = 10%F1 = 1.9 SF / $ RS = 5%What is the arbitrage opportunity? Profit = 110.53 – 100(1.1) = $.53 risk freeIn 1 year:Receive 200(1.05) = 210 SF Convert 210 SF back to dollars210 SF / (1.9 SF / $) = $110.53Repay loan = 100(1.10) = $110Now:Borrow $100 at 10%Buy $100(2 SF/$) = 200 SF Invest 200 SF at 5% for 1 yearContract to exchange SF in 1 year at 1.90 SF/US$18-33Covered Interest Arbitrage18-34Interest Rate ParityInterest rate parity  investors should expect to earn the same return on similar-risk securities in all countries:Forward and spot rates are direct quotations.RUS = periodic interest rate in the home country (US)RFC = periodic interest rate in the foreign country (18.4)(18.5)Return to Quick Quiz18-35Exchange Rate RiskThe risk that the value of a cash flow in one currency translated from another currency will decline due to a change in exchange rates.A natural consequence of international operations in a world where relative currency values move up and down.18-36Short-Run ExposureRisk 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 pricesManaging riskEnter into a forward agreement to guarantee the exchange rateUse foreign currency options to lock in exchange rates if they move against you, but benefit from rates if they move in your favorReturn to Quick Quiz18-37Long-Run ExposureLong-run fluctuations from unanticipated changes in relative economic conditionsManaging risk More difficult to hedgeTry to match long-run inflows and outflows in the currencyBorrowing in the foreign country may mitigate some of the problemsReturn to Quick Quiz18-38Translation ExposureIncome from foreign operations translated back to U.S. dollars for accounting, even if foreign currency not actually converted:If gains/losses flowed through directly to the income statement  significant EPS volatilityAccounting regulations require:All cash flows be converted at the prevailing exchange ratesCurrency gains and losses accumulated in a special account within shareholders’ equity18-39Managing Exchange Rate RiskLarge multinational firms may need to manage the exchange rate risk associated with several different currenciesThe firm needs to consider its net exposure to currency risk instead of just looking at each currency separatelyHedging individual currencies could be expensive and may actually increase exposure18-40Political RiskChanges in value due to political actions in the foreign countryInvestment in countries that have unstable governments should require higher returnsExtent of political risk depends on the nature of the business:The more dependent the business is on other operations within the firm, the less valuable it is to othersNatural resource development can be very valuable to others, especially if much of the ground work has already been doneLocal financing can often reduce political riskReturn to Quick Quiz18-41Quick QuizWhat does an exchange rate tell us? (Slide 18.11)What is triangle arbitrage? (Slide 18.18)What is absolute purchasing power parity? (Slide 18.27)What is relative purchasing power parity? (Slide 18.28)What is covered interest arbitrage? (Slide 18.31)18-42Quick QuizWhat is interest rate parity? (Slide 18.34)What is the difference between short-run interest rate exposure and long-run interest rate exposure and how can you hedge each type? (Slide 18.36) (Slide 18.37)What is political risk and what types of business face the greatest risk? (Slide 18.40)Chapter 18END