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IBUS 302: International Finance
Topic 1–Introduction
Lawrence Schrenk, Instructor
Introduction IBUS 302: International Finance Lawrence P. Schrenk, Instructor Course Page http://auapps.american.edu/~schrenk/IBUS302/IBUS302.htm
Syllabus (Next Class)
Learning Objectives
1. Decide whether this is this the appropriate course for you.
2. Understand the importance of international finance.
3. Explain the features unique to international finance. ▪
Why Study International Finance? Your Career
“The number of CEOs with international experience rose in 2004 to 33 percent from 30 percent in 2003 and 21 percent in 2002. Among the top 100 CEOs, 41 percent have spent time abroad.” source
“The Global CEO: Overseas Experience is Becoming a Must on Top Executives' Resumes.” source
A Simple Example
Your firm plans to sell $1 million in products to a firm in England, the pound is currently valued at $2.00, and payment will be made in 3 months–so your buyer is expecting to pay £500,000 in 3 months.
Where is the exposure to foreign exchange risk? ▪ The risk is that the rate of exchange will change
between now and the date of payment. ▪
Who will Bear the Risk?
There are three possibilities:1. You bear it by accepting a payment of £500,000 in
3 months.
2. The buyer could bear it by agreeing to pay $1,000,000 in 3 months.
3. You could hedge the risk by entering a contract to receive $1,000,000 for £500,000 in 3 months. ▪
What are the implications of each choice? ▪
Overview
1. Similarities
2. Differences
3. Trends
Overview: Similarities
The basics principles of finance apply to international finance: ▪ The NPV and IRR Rules Stockholder Wealth Maximization The Benefits of Diversification Etc. ▪
The Differences
1. Political Risk
2. Increased Opportunity Set
3. Market Imperfections
4. Foreign Exchange Risk
1. Political Risk
Description: The possibility that sovereign governments makes unexpected changes in: The movement of goods, capital, and people
across their borders, The regulatory framework, Tax rates and codes, Etc.
Political Risk: Measures
1. Somalia 11. Guinea 20. Sri Lanka 2. Sudan 12. Bangladesh 21. Yemen 3. Zimbabwe 13. Burma 22. Niger 4. Chad 14. Haiti 23. Nepal 5. Iraq 15. North Korea 24. Burundi 6. Dem. Rep. of the 16. Uganda 25. Timor-Leste 7. Afghanistan 17. Ethiopia 26. Republic of the 8. Côte d'Ivoire 18. Lebanon 27. Kenya 9. Pakistan 19. Nigeria 28. Uzbekistan10. Central Africn
The Failed States Index:Most Vulnerable Countries 2008
Political Risk: Management
Difficulties ▪ Idiosyncratic Measurability Prediction Hedging ▪
2. Increased Opportunity Set
Description: Possibility of additional investments, markets, sources of capital, etc.
Possible Benefits Investments: Higher Return, More Diversification Markets: Greater Selling Potential Capital: Lower Cost of Capital Human Capital: More Resources
U.S. Can U.K. Ger Fra Swit Jap Aus Hong
Sing
U.S. 0.64 0.61 0.36 0.44 0.51 0.26 0.26 0.38 0.51Can 0.50 0.32 0.33 0.43 0.33 0.49 0.52 0.51U.K. 0.55 0.54 0.69 0.52 0.48 0.49 0.59Ger 0.78 0.64 0.36 0.20 0.31 0.44Fra 0.61 0.41 0.25 0.32 0.34Swit 0.50 0.25 0.31 0.46
Jap 0.25 0.34 0.47Aus 0.29 0.37Hong
0.65
International Correlation
– Meric, Ilhan and Gulser Meric. “Correlation Between the World's Stock Markets Before and After the 1987 Crash.” Journal of Investing 7.3 (Fall 1998): 67 f.
3. Market Imperfections
Description: Any condition that restricts the free flow of trade, capital, investment, profits, etc. Political: Corruption Legal/Regulatory: Discriminatory Taxes Social Culture: Attitudes to Inflation Business Culture: Alternate Goals
4. Foreign Exchange Risk
Description: The possibility that the value of an investment, cash flow, return might change due to changes in exchange rates for currencies.
Some Historical DataDollar/Pound Exchange Rate
1791-2007
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
1791
1804
1817
1830
1843
1856
1869
1882
1895
1908
1921
1934
1947
1960
1973
1986
1999
Date
Exc
han
ge
Rat
e
WW IIWW I
Great DepressionAmerican Civil War
Napoleonic Wars and
War of 1812
The Trends
1. Global Financial Markets
2. The Euro (€)
3. Liberalization and Integration
4. Privatization
1. Global Financial Markets
Description: Inter-country integrated capital and financial markets with minimal trade barriers. ▪
Financial Innovation Technology–Computers + Internet
Electronic Trading 24/7 Trading ▪
The ‘Big Bang’FTSE 1001985-1987
0
500
1000
1500
2000
2500
3000
1/2
/19
85
3/2
/19
85
5/2
/19
85
7/2
/19
85
9/2
/19
85
11
/2/1
98
5
1/2
/19
86
3/2
/19
86
5/2
/19
86
7/2
/19
86
9/2
/19
86
11
/2/1
98
6
1/2
/19
87
3/2
/19
87
5/2
/19
87
7/2
/19
87
9/2
/19
87
11
/2/1
98
7
The 'Big Bang'
2. The Euro (€)
Integration ▪ European Central Bank (ECB)
Unified Monetary Policy Macroeconomic Stability National Inflexibility
Currency Risk Transaction Costs ▪
The Eurozone
Austria Belgium Cyprus Finland France Germany Greece
Ireland Italy Luxembourg Malta The Netherlands Portugal Slovenia Spain
Benefits and Costs of the Euro
Benefits Reduce Transaction Costs Eliminate FX Uncertainty
Costs No National Monetary Policy No National FX Control Asymmetric Shocks
3. Liberalization and Integration
Increased Trade ▪ Reduced Tariffs Competitive Advantage (Appendix) Organizations
General Agreements on Tariffs and Trade (GATT) World Trade Organization (WTO) ▪
Exports
0
200,000
400,000
600,000
800,000
1,000,000
1,200,000
$ m
illi
on
s
Arg
entin
aB
razi
lC
anad
aC
hina
Cze
ch R
epub
licG
erm
any
Hun
gary
Kuw
ait
Mex
ico
Net
herla
nds
Rus
sian
Fed
erat
ion
Tha
iland
Uni
ted
Kin
gdom
Uni
ted
Sta
tes
Merchandise Exports
1995
2006
Exports
Change in Merchandise Exports1995-2006
0%
100%
200%
300%
400%
500%
600%
Argenti
na
Brazil
Canada
China
Czech
Rep
ublic
Germ
any
Hungar
y
Kuwait
Mex
ico
Nether
lands
Russian
Fed
erat
ion
Thaila
nd
United K
ingdom
United S
tate
s
World
% C
ha
ng
e
TariffsEU Average Applied Import Tariff Rates
0
2
4
6
8
10
12
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
Tar
iff
Rat
e
Ores and metals
Manufactured goods
Chemical products
Machinery, etc.
Other manufacturedgoods
4. Privatization
Description: The transfer of ownership and control of a corporation from the state to private agents. ▪ Various Degrees of Privatization Governmental Revenues Foreign Ownership Multiple Processes Corruption ▪
Privatization Trends
Dramatic rise in the number of privatizing countries, from 13 in 1988 to 43 in 1995. Latin America 49% (Average Value $68 million) East Asia 25% (Average Value $110 million) Europe and Central Asia 17% (Average Value
$11 million) Other 12%
–Mary M. Shirley. “Trends in Privatization.” Economic Reform Today 1 (1998): 8-10.
