International Finance Chapter 17 International Finance © 2000 South-Western College Publishing

INTERNATIONAL FINANCE In the last thirty years business has become increasingly international - global Volume of both imports and exports has increased U.S. is now a net importer The nature of international business has changed Import - Export has shifted to Multi-National Companies (MNCs) Run complete companies in other countries Direct Investment in facilities and equipment Portfolio Investments in foreign stocks and bonds are common TM 17-1

EXCHANGE RATES AFFECT PRICES AND QUANTITIES They change the domestic price paid for foreign goods They therefore impact: 1. The general cost of living 2. Domestic employment CHANGING EXCHANGE RATES AND EXCHANGE RATE RISK A firm can make or lose money on an international transaction due to rate movements outside of the business deal itself SPOT AND FORWARD RATES The Terminology of Exchange Rate Movements A currency gets stronger or rises when it becomes more valuable in terms of dollars The converse is to get weaker or fall against the dollar. Hedging With Forward Exchange Rates Forward contracts lock in exchange rates in advance removing exchange rate risk from transactions TM 17-3

SUPPLY AND DEMAND - THE SOURCE OF EXCHANGE RATE MOVEMENT The Supply and Demand for Foreign Exchange Depends on the demand in each country for the exports of the other Dollars (per franc) $.25 Supply Exch Rate (dir) Demand $.20 Francs (a) Supply & Demand for Francs in Terms of Dollars ($ weaker as it moves up on vertical axis) - Foreign Exchange, Figure 17-2 TM 17-4 Slide 1 of 2

WHY EXCHANGE RATES MOVE Preferences in Consumption Government Policy Francs (per dollar) F5.0 Supply Exch Rate (indir) Demand F4.0 Dollars (b) Supply & Demand for Dollars in Terms of Francs ($ stronger as it moves up on vertical axis) - Foreign Exchange, Figure 17-2 WHY EXCHANGE RATES MOVE Preferences in Consumption Government Policy Economic Conditions Speculation Direct Government Intervention TM 17-4 Slide 2 of 2

GOVERNMENT INTERVENTION Exchange rates affect the domestic economy through the cost of imported goods and the employment from production for export Therefore the Government Has an Incentive to Influence Exchange Rates It does so by buying and selling its own currency in foreign exchange market TM 17-5 Slide 1 of 2

THE INTERNATIONAL MONETARY SYSTEM Now on a floating exchange rate system From WWII until early 70s on a fixed exchange rate system Administered by the International Monetary Fund (IMF) Convertibility Not all currencies are traded in foreign exchange markets Difficult to expatriate profits from direct investment THE BALANCE OF TRADE Deficit vs surplus Deficit induced by foreign government policy - Japan Negative Effects of a Deficit Weak dollar Economic control TM 17-5 Slide 2 of 2

INTERNATIONAL CAPITAL MARKETS The Unique Status of the American Dollar An "international currency" Superpower militarily and economically International businesses are willing to take dollars in trade Contracts are often denominated in dollars even when parties are not American THE EURODOLLAR MARKET A Eurodollar is an American dollar deposited in a bank outside the United States Banks create the Eurodollar Market by lending Eurodollars to international companies and foreign governments TM 17-6 Slide 1 of 2

THE INTERNATIONAL BOND MARKET A bond sold outside of the home country of the borrower Foreign Bond A bond denominated in the currency of the country in which it is sold, but issued by a foreign borrower Eurobond A bond denominated a currency other than that of the country in which it is sold Less disclosure - lower flotation costs Issued in bearer form - owner not identified No tax withheld on interest Attractive to investors interested in privacy and/or avoiding their own countries' taxes TM 17-6 Slide 2 of 2

POLITICAL RISK Expropriation is generally the worst case scenario The probability that the value of an investment will be reduced by political actions Actions are usually by the host government, but the idea includes terrorism Expropriation is generally the worst case scenario Less drastic actions include: Raising taxes Limiting expatriated profit Requiring that inputs be purchased locally Limiting prices Part ownership by natives Political risk is small in Western Europe, Japan, Taiwan, and Australia It can be substantial in the former Eastern Bloc and the third world nations of Africa, Asia, and South America TM 17-7

TRANSLATION GAIN/LOSS/RISK Gain or loss on translating balance sheet of subsidiary in a foreign country (Direct investment) Not real unless the assets are actually sold No tax effect TM 17-8