FINS3616 Lecture 1

Globaliza(on and the Mul(na(onal Corpora(on

Week 1 Chapter 1

Introduc(on

•  Globaliza(on – increasing connec(vity and integra(on of countries and corpora(ons and the people within them in terms of their economic, poli(cal, and social ac(vi(es

•  Mul(na(onal corpora(on – produces and sells goods or services in more than one na(on –  BRIC countries (Brazil, Russia, India and China) offer a lot of

opportuni(es for expansion •  Interna(onal scope creates opportuni(es but also challenges

–  Recent crisis

Globaliza(on and the Growth of Interna(onal Trade and Capital Flows

•  The growth of interna(onal trade –  Trade liberaliza(on so countries can specialize at produc(on of goods

for which they have a compara(ve advantage •  1960s only 20% of countries were open •  By 2000, over 70% of countries were open •  Free Trade agreements

–  GATT (1947) –  WTO (1986) –  Regional Trade agreements

»  European Union »  NAFTA »  ASEAN

–  Outsourcing – shiXing of non-‐strategic func(ons to specialist firms

Interna(onal Trade as a Percentage of GDP

Germany is the most open, Japan and the United States are the least


China’s number jumped significantly aXer trade reforms


Countries that border oceans tend to trade more Large countries tend to trade less than small

Globaliza(on of Financial Markets

–  Securi(za(on – repackaging of “pools” of loans or other receivables to create a new financial instrument

–  Pros and cons of development •  Pro – banks (and companies) could hedge against risk •  Cons – smart financiers exploit differences in country-‐specific regula(ons and complexity of instruments created opaqueness in the financial system

–  Global Financial Crisis – 2008 – 2010 »  Started in U.S. »  Longest and deepest in the postwar era »  Scale and depth of crisis raises deep issues about the func(oning of

the global financial system

Globaliza(on of Financial Markets

•  Incredible growth in the number of MNCs aXer WWII –  37,000 MNCs in 1990 –  82,053 in 2010

•  Globaliza(on of financial markets –  Trends in financial openness

•  1980s countries began to allow foreigners to invest in their markets •  Crea(on of new asset class – emerging markets

–  New financial landscape – deriva(ves •  Deriva(ve security – an investment whose payoff over (me is derived from the performance of underlying assets

–  Examples include futures, forwards, op(ons and swaps

How I learned to stop worrying and love the GFC

•  Securi(za(on and U.S. government’s quest to allow everyone to own a home fueled growth in subprime mortgages between 2000 and 2006 –  People bought houses they could not afford –  Banks securi(zed those loans and sold them to investors –  Once house prices started to fall, many defaulted on mortgages –  Banks holding assets backed by those mortgages suffered losses –  A bank in the UK faced a bank run in 2007 –  In March, 2008, JP Morgan Chase bought Bear Stearns due to its inability to

fund itself in the money markets –  Fannie Mae and Freddie Mac were taken over by the government

How I learned to stop worrying and love the GFC

–  In September, 2008 Lehman Brothers declared bankruptcy –  Money markets froze and a flight to quality ensued

•  Ramifica(ons of the crisis –  Many debates of who was responsible –  Correc(on of global imbalances?

•  U.S. trade deficit •  China trade surplus

–  Regulatory issues •  Central banks pumped money into banks •  Expansionary monetary and fiscal policies •  Policy implica(ons of “too big to fail”

Mul(na(onal Corpora(ons

•  A parent company in the firm’s origina(ng country and opera(ng subsidiaries, branches and affiliates abroad –  UN calls these “transna(onal corpora(ons”

•  How they enter foreign markets –  Expor(ng/Impor(ng –  Licensing – gives local firms right to manufacture their products in

exchange for a fee –  Franchising – the firm provides sales or service strategies in exchange

for fees –  Joint venture – two or more firms form a new legal en(ty, jointly

owned by all of the firms –  Greenfield – star(ng company from scratch

Mul(na(onal Corpora(ons

•  Goals of an MNC –  Maximize shareholder wealth

•  Australia, Canada, U.K. and U.S. •  Appropriate (me horizon is long

–  Maximize stakeholder wealth •  Europe and Asia •  Agency Theory – studies problems that arise from the separa(on of ownership and control

–  Corporate governance – legal/financial structure controlling rela(onship –  Corporate fraud

»  Enron »  Worldcom »  Tyco »  Parmalat

Methods of Overcoming Agency Problems Due to the Separa(on of Ownership and Control

Biggest Non-‐Financial MNCs

Foreign Direct Investment: FDI

•  FDI – when a company from one country buys at least 10% of a company in another country –  Has grown 30-‐fold since 1980 to $18 trillion –  M&A play a huge role in this trend

FDI as a % of GDP

Other Important Interna(onal Players

•  Interna(onal banks •  Interna(onal ins(tu(ons

–  Interna(onal Monetary Funds (IMF) – member organiza(on whose goal is to ensure the stability of the interna(onal monetary and financial system through surveillance and technical assistance

–  The World Bank – member organiza(on whose goals are development, poverty allevia(on and advising

•  IBRD – middle-‐income countries •  IDA – poorest countries •  IFC – grow private sector of developing na(ons


•  Interna(onal ins(tu(ons (con(nued) –  Mul(lateral development banks – regional development banks

(including World Bank and regional banks in Africa, Asia and Europe) who provide financing and grants

–  World Trade organiza(on (WTO) – mediates trade disputes –  Organiza(on for Economic Coopera(on and Development (OECD) –

examines, devised and coordinates policies across 34 rela(vely wealthy na(ons to foster sustainable economic growth and employment, rising standards of living and financial stability

–  Bank for Interna(onal Senlements (BIS) – fosters interna(onal monetary and financial coopera(on – central banks’ central bank


•  Interna(onal ins(tu(ons (s(ll con(nued) –  European Union (EU) – Coopera(on among countries in this region

and (in most cases) adop(on of the same currency to promise interna(onal business and prevent war

•  Economic and monetary union (EMU)

–  Governments –  Individual investors –  Ins(tu(onal investors –  Sovereign wealth funds – government-‐run investment pools –  Hedge funds –  Private equity funds

Is Globaliza(on Worth It?

•  Global crisis leading to protec(onism –  Increasing tariffs and trade li(ga(on/technical barriers

•  Slowing trade liberaliza(on •  Trade openness and economic risk

–  Poten(ally raise need for welfare programs –  Ensure fairness


•  Countries who had opened their markets to foreigners subsequently fell into crisis

•  Benefits of openness –  Channels savings to most produc(ve uses –  Sharing of risk beyond what is possible domes(cally –  Domes(c recessions can be buffered through borrowing –  Cost of capital decreases

•  Costs of openness –  Some(mes capital is not used wisely –  Foreign capital can leave quickly causing financial vola(lity –  Difficulty in taxing profits – MNCs shiX to avoid –  Capital control effec(veness decreases

An(-‐Globalists

•  An(-‐globalist movement –  Iden(fies MNCs as “villains” of globaliza(on –  Cri(cize global financial ins(tu(ons such as the World Bank, IMF and

WTO –  They fear that MNC ac(vi(es will harm the environment –  They argue that globaliza(on is seen as a threat to employment in

their own country


•  Final thoughts on globaliza(on –  Can be valuable –  Some evidence that workers in developed countries have not

benefited •  Globaliza(on destroys some jobs and creates others

–  Some believe that government must intervene to bener spread the newly created wealth by helping those that have been displaced by globaliza(on

•  Retraining

Foreign Exchange Market

Chapter 2

The Structure of the Foreign Exchange Market

Most important cities: London New York Tokyo ForEx (or FX) operates 24 hrs/day Interbank market – 50% Corporations – 13.4% Other institutions – 48% Most trades are $1M or more! Largest financial market in the world -  $5.3 trillion a day (as of 2013)! -  Compared to only $50 billion on

NYSE (in 2010)

Rela(ve Share of the Forex Market Has Stayed Preny Constant

Types of Contracts Traded on the Forex Market

•  Spot •  Future transac(ons: swaps, forward contracts (Week 2: Ch. 3) •  Deriva(ves: futures and op(ons ( Week 12: Ch. 20) •  Conven(ons

–  Transac(ons completed within 2 business days •  Excep(on 1: U.S. and Mexico/Canada •  Excep(on 2: Holidays don’t count in U.S. dollar transac(ons •  Excep(on 3: Fridays are not business days in Middle East but Saturdays/Sundays are so – non-‐Middle Eastern currencies senle on Fridays and Middle Eastern currencies senle on Saturdays

Foreign Exchange Dealers

•  Foreign exchange dealers and brokers –  Who are they?

•  Commercial banks •  Investment banks •  Brokerage firms

–  Note: these are intermediaries – they don’t put own money at risk

–  Market makers – they make it easier for buyers and sellers to come together

–  Liquidity •  Ease with which one can sell an asset AT ITS FAIR VALUE •  Low transac(on costs

–  Other par(cipants in the forex market •  Central banks •  Mul(na(onal corpora(ons

eFX

•  Electronic foreign exchange trading (eFX) –  30% of all trading volume and 50% in spot markets

–  Straight Through Processing (STP) – forex trade takes place from placement of order to senlement in automated fashion

–  Best known and most ac(ve plaqorm: •  FXConnect •  Fxall •  Independent companies: HotSpot and Currenex

–  Originally designed for corporate clients or ins(tu(onal investors but got a boost from hedge funds and retail aggregators

Why is Forex a Compe((ve Market?

– No product differen(a(on – money is money – Has been a lot of players

•  Top 4 account for over 40% •  Top 20 over 90%

– S(ll exceedingly compe((ve with no signs of any clear leader in this market

The Top 20 Dealers in the Foreign Exchange Market

The Exchange Rate

•  Exchange rate – price of one currency in terms of another •  JPY102.328 = USD1 •  ¥102.328 = $1 •  ¥102.328/$1 or ¥102.328/$ (the number one is

implied) •  AUD = A$ ≠ $ = USD •  hnp://www.oanda.com/ •  hnp://www.xe.com/

Exchange Rate Quotes

•  Direct – quo(ng domes(c currency first (numerator) •  For American, “interes(ng” part is in $’s: $1.67 = £1; this is

called the American quote

•  Indirect – quo(ng foreign currency first •  For someone from Great Britain, “interes(ng” part is in £’s: $1 =

£0.599; oXen called European quote

•  Direct and indirect are inverse: Direct = 1/Indirect

Currencies and Currency Symbols

Rules to Remember

1.  Keep track of your currency units

–  The 16GB iPhone 5S is sold at a price of $199 in Apple's US website. If today’s exchange rate is A$0.90/$, what is the price of iPhone in Australian dollars (in the US)?

Rules to Remember

2.  Think of buying or selling the asset in the denominator

–  For real goods, this is easy: A can of Solo (the drink, not the Smuggler) can be quoted as A$2/can, we typically don’t quote Australian dollars in terms of Solos: 0.5 cans/A$

–  For currency, its harder since both are currencies: •  A$/$ : How many Australian Dollars will it cost to buy a US

dollar (or how many Aussie Dollars will I get if I sell a US Dollar)?

•  $/A$: How many US Dollars will it cost to buy an Australian Dollar?

Current Exchange Rates for Australia

Country Currency Direct Indirect

Great Britain GBP 1.85458 0.53921

United States

USD 1.11212 0.89918

Germany EUR 1.52837 0.65429

India INR 0.01797 55.6405

New Zealand NZD 9.92581 1.08014

Thailand THB 0.03417 29.2692

Malaysia MYR 0.33891 2.95068

Japan JPY 0.01086 92.0426

Canada CAD 1.00252 0.99749

Vehicle Currencies and Cross-‐Rates

•  Vehicle currency – a currency that is actively used in many international financial transactions around the world •  Used due to transaction costs of making markets in certain

currencies being too high

•  U.S. Dollar primary vehicle currency (89% of all transactions)

•  Cross-rates

•  Trading currency in the New York market where both currencies are not expressed in U.S. dollars •  Trend toward cross-rate transactions

What A Cross Rate Table Looks Like

Cross Exchange Example

•  An exchange rate between two countries, computed from the exchange rates between each of these countries and a third country

•  If you know the exchange rate between Australian dollar and US dollar, and also the exchange rate between Bri(sh pound and Australian dollar, what should be the exchange rate between US dollar and Bri(sh pound? –  Cross exchange rate

Cross Exchange Example •  Meng Fei needs to go to Sydney for another Australian filming of If You Are The One but doesn’t know how much it will cost to exchange some of his Chinese Yuan for Australian Dollars. The current spot exchange rate between ¥ and $ is ¥0.16323/$ and the spot rate between the $ and A$ is $0.89946/A$.

•  Calculate the ¥/A$ spot exchange rate. –  ¥/A$ = (¥/$)* $/A$ –  ¥/A$ = 0.16323*0.89946 –  ¥/A$ = ¥0.14682/A$

Equilibrium

•  Cross Exchange Rate Equilibrium:

€/£ = €/$ * $/£ or €/$ * $/£ * £/€ = 1

•  Triangular arbitrage

•  An arbitrage process involving three currencies

•  Keeps cross-‐rates in line with exchange rates quoted rela(ve to a third currency (such as the Australian Dollar or Chinese Yuan)

Triangular Arbitrage •  How Does it Work?

–  If €/$ * $/£ * £/€ < 1 then either €/$, $/£, or £/€ must rise. The currency in denominator is too low rela(ve to the currency in the numerator

•  Buy each currency in the denominator with currency in numerator

–  If €/$ * $/£ * £/€ > 1 then either €/$, $/£, or £/€ must fall. The currency in denominator is too high rela(ve to the currency in the numerator

•  Sell each currency in the denominator with the currency in the numerator

Triangular Arbitrage Example •  Current Exchange Rates:

–  RUR 5/$ –  ¥20.2/RUR –  $0.01/¥

•  RUR/$ * ¥/RUR * $/¥ = 1.01 > 1 –  Sell $1 for 5 rubles –  Sell 5 rubles for 101 yen –  Sell 101 yen for $1.01

•  Profit = $1.01 -‐ $1 = 1 cent –  or 1% of the ini(al amount

Bid-‐Ask Spreads and Bank Profits

•  Bid-‐ask spreads •  Bid – rate at which banks will

buy the base currency

•  Ask – rate at which banks will sell base currency

•  What banks make on FX transac(ons

•  100 * (Ask-‐bid)/ask

Magnitude of bid-‐ask spreads

•  Interbank market –  Within 5 pips (fourth decimal point in a currency quote) –  0.05% -‐ 0.07% for major currencies –  Lower for extremely liquid currencies like U.S. dollar (i.e., 0.03% for $/€ exchange rate quote)

–  Higher for less liquid currencies •  Physical exchange

–  3% or more •  Banks have to have inventory, which means it is not interest bearing •  Banks must transact with brokers

–  Use credit cards to exchange when in another country – this is the best possible rate for you!

•  Differs across the day

Bid-‐Ask Spread Example Meng Fei owes his coworker/friend Le Jia some money. Le Jia asks Meng Fei to buy him some Ugg Boots while they are in Australia. In order to hedge his purchase, Meng Fei purchases Australian dollars with Yuan.

Right aXer he makes the currency purchase, Le Jia tells him he doesn’t want Ugg Boots anymore because he just found out that no male above the age of 10 should ever be caught wearing Ugg Boots…ever!

Bid-‐Ask Spread Example •  Following the mix-‐up, Meng Fei goes back online to sell the Australian Dollars back for Yuan.

•  He no(ces that the % bid-‐ask spread is 4 pips (Turns out the manager of the bank is a really big fan of If You Are The One) –  The ask rate is ¥0.1470/A$, the bid rate is ¥0.1466/A$ and the percentage spread is:

–  [(¥0.1470/A$) – (¥0.1466/A$ )]/(¥0.1466/A$ ) = 0.2729% •  Ming Fei bought A$250 at ¥0.1470/A$, the cost would have been: A$250 * (¥0.1470/A$) = ¥36.75

•  Selling back: A$250 * (¥0.1466/A$ ) = ¥36.65, or a loss of ¥0.10 on the two transac(ons: 0. 2729% of ¥36.75

Communica(on Systems

•  Society of Worldwide Interbank Financial Telecommunica(ons (SWIFT) – links more than 7500 banks in 200 countries

•  Clearing House Interbank Payments System (CHIPS) – clearing house in U.S. for dollars

•  Fedwire – links computers of more than 7500 ins(tu(ons that have deposits with the U.S. Federal Reserve

•  Trans-‐European Automated Real-‐(me Gross Senlement Express Transfer (TARGET) – Euro counterpart to Fedwire

Cross-‐currency senlement (Herstan) risk

•  The risk that a financial ins(tu(on may not deliver the currency on one side of a completed transac(on

•  How this risk is addressed –  Bank of Interna(onal Senlements (BIS) encourages the voluntary restric(on of transac(on amounts to limit this form of risk

–  Simultaneity of both transac(ons – Con(nuous Linked Senlement acts as a global clearing house

–  Ne�ng arrangements

Ne�ng Arrangements

Ne�ng Arrangements (cont.)

Describing Changes in Exchange Rates

•  Appreciate/depreciate – the value of a currency increases/decreases in terms of another

•  Devalue/Revalue – the value of a currency is changed by the domes(c government

•  Rate: (new – old)/old –  Is referring to the currency in the denominator of the exchange

rate (for $/£ -‐ we’re talking about £) –  Rate will not necessarily be the same if you calculate the rate for

the £ and the rate for the $ due to perspec(ve (i.e., the denominators are different)

Homework

•  Chapter 1, Ques(ons 1, 5, 6, 11 •  Chapter 2, Ques(ons 3, 10 •  Chapter 2, Problems 1-‐6

•  Read Chapters 3 & 5

Documents

FINS3616 Lecture 1