Chapter 27 Principles PrinciplesofCorporateFinance Tenth Edition Managing International Risks Slides by Matthew Will Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Topics Covered Foreign Exchange Markets Some Basic Relationships Hedging Currency Risk Exchange Risk and International Investment Decisions Political Risk
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Foreign Exchange Markets Exchange Rate - Amount of one currency needed to purchase one unit of another. Spot Rate of Exchange - Exchange rate for an immediate transaction. Forward Exchange Rate - Exchange rate for a forward transaction.
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Exchange Rates Example What is the franc premium (annualized)? franc Premium = 2 x ( ) = 2.45% Dollar Discount = 2.45% Example What is the Yen discount (annualized)? Yen Discount = 2 x ( ) = 4.26% Dollar Premium = 4.26%
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin International Prices The Big Mac Index – The price of a Big Mac in different countries (Feb 1, 2007)
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Purchasing Power & Exchange Rates
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Exchange Rates Nominal versus Real Exchange Rates U.S. Dollar / UK (in log scale)
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Exchange Rates Nominal versus Real Exchange Rates U.S. Dollar / France (in log scale)
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Exchange Rates Nominal versus Real Exchange Rates U.S. Dollar / Italy (in log scale)
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Interest Rates and Inflation Countries with the highest interest rates generally have the highest inflation rates. In this diagram each of the 55 points represents a different country.
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Auto Industry Data 2003
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Exchange Rate Risk Example - Honda builds a new car in Japan for a cost + profit of 1,715,000 yen. At an exchange rate of Y:$1 the car sells for $14,209 in Indianapolis. If the dollar rises in value, against the yen, to an exchange rate of 134Y:$1, what will be the price of the car? 1,715,000 = $12, Conversely, if the yen is trading at a forward discount, Japan will experience a decrease in purchasing power.
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Exchange Rate Risk Example - Harley Davidson builds a motorcycle for a cost plus profit of $12,000. At an exchange rate of Y:$1, the motorcycle sells for 1,448,400 yen in Japan. If the dollar rises in value and the exchange rate is 134Y:$1, what will the motorcycle cost in Japan? $12,000 x 134 = 1,608,000 yen
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Capital Budgeting 1) Exchange to $ and analyze 2) Discount using foreign cash flows and interest rates, then exchange to $. 3) Choose a currency standard ($) and hedge all non dollar CF. Techniques
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin Political Risk