International Business Finance

Foreign Exchange Markets Participants:- –Banks and other financial institutions –Brokers – intermediaries/ confidential traders –Multinational Firms – require foreign currency –Central Banks – regulate exchange rates –Arbitrageurs – use market imperfections –Traders – foreign currency for accounts –Hedgers – off-setting contracts to remove risk –Speculators – accept risk to gain profit

Types of Market Spot Market – transactions settled in 2 days Forward Market –Transactions settled at some future date –Exchange Rates can be offered at a premium or at a discount if rate differentials apply Swap Market –Simultaneous purchase and sale of currency –Different Maturity dates –‘Spot for Forward’ most common type –‘Forward for Forward’ also popular

Forex Rate Determinants Changes in levels of national income Inflation Rates Real Interest Rate (inflation adjusted) Balance of Payments ‘Safe Havens’ in times of political risk ‘News’ – under the ‘Efficient Markets’ hypothesis asset prices embody all available information

Futures Markets Breakdown in Gold Exchange Standard Futures markets developed in 1972 IMM contracts interchangeable SIMEX Key Features of a Futures Contract:- –Standard Contract size –Standard Maturity Date –Margin Requirement –Maintenance Requirement –Settlement (<5% settled by delivery) –Commissions

Foreign Currency Options Flexibility is key to popularity –Right to buy or sell but no obligation –Insurancr against future currency losses ‘Call Option’ – right to buy foreign currency ‘Put Option” – right to sell foreign currency ‘Holder’ – purchaser of an option “Writer’ or ‘Grantee’ – seller of an option ‘Strike Price’ – exchange rate used ‘Premium’ – cost of the option on trading floor

Option Pricing and Valuation Black-Scholes option pricing model (1973) Cox-Rubinstein development (1979) Garman-Kohlhagen refinement (1983) Total Value (premium) has 2 components:- –Intrinsic Value Difference between spot value and strike price –Time Value Probability that spot rate will move further ‘in the money’ during its time to maturity

International Sources of Capital Capital can be obtained by Debt & Equity Weighted Average Cost of Capital-WACC Market Segmentation reduces market liquidity and impacts on Cost of Capital Influential factors:- –Asymmetry in Information –Transaction Costs –Exchange rate risks –Regulatory barriers

Strategies for Managing Exchange Rate Risk Exchange Risk –The probability that a company will be unable to adjust prices and costs to offset changes in the exchange rate Exchange Risk Avoidance –Elimination of risk by doing business locally Exchange Risk Adaptation –Use Hedging to provide protection against exchange rate fluctuations Currency Diversification –Spreading Financial Assets across many currencies

Eurocurrency Eurocurrency – Any Currency banked outside its country of origin Primarilly Eurodollar market – wholesale London Inter-Bank Offered Rate (LIBOR) Sources of Eurodollars:- –Companies with excess cash –European Banks with excess foreign currency – Foreign Government or business wants to hold dollars outside the USA –Reserves of countries with large trade surplus (OPEC)

International Bond Market Foreign Bond – sold outside borrower’s country, but denominated in issue country Eurobond – typically underwritten by syndicate of banks; sold in many countries May offer currency options Corporate Eurobonds popular for investors –Convertibility option (to common stock) –Market relatively unregulated –Very little red tape associated with bond issue –Transnational nature accesses wider range of available finance sources

Balance of Payments (BOP) IMF – Maintains BOP financial stability Standardized System and Presentation Double Entry System –Debits record imports, reductions in liability –Credits record exports, increase in liabilities Three broad categories –Current Account items –Capital Account items –Reserves

Current Account Merchandise: –Exports-Imports=Trade Balance Shipment and other transportation Travel Investment Income Other Official (Government purchases) Other Private (Royalties/ Fees) Unrequited transfers –Private –Official

Capital Account Direct Investment Portfolio Investment Other Long-Term, Official Other Long-Term, Private Other Short-Term, Official Other Short-Term, Private

Reserves Monetary Gold Special Drawing Rights IMF Reserve Position Foreign Exchange Assets Net errors and omissions