H U ZSOB Global Financial Markets and Institutions FIN101 Supplement: Introduction to Finance, Financial Markets, and Institutions Chapter 1 Dr. K. G. Viswanathan

H U ZSOB Viswanathan Ch. 12 Introduction to Exchange Rates Exchange Rate the conversion rate of one currency to another. Exchange rates between currencies are quoted in direct and indirect terms.

H U ZSOB Viswanathan Ch. 13 Introduction to Exchange Rates Direct Quote: indicates the units of home currencies that one unit of foreign currency buys at a specific point in time. [Home/(1)Foreign] Indirect Quote: indicates the units of foreign currency that one unit of home currency buys at a specific point in time. [Foreign/(1)Home]

H U ZSOB Viswanathan Ch. 14 Introduction to Exchange Rates Currency Appreciation and Depreciation: Currency prices move up (appreciate) and down (depreciate) against other currencies.

H U ZSOB Viswanathan Ch. 15 Converting Currencies For Direct Quotes: Given:DM1.60/$ DM200,000 USD Equivalent: = DM200,000/DM1.60 = US$125,000 Home CCY Foreign CCY (US$1)

H U ZSOB Viswanathan Ch. 16 Converting Currencies For Indirect Quotes: Given:US$0.6250/DM DM200,000 USD Equivalent: = DM200,000*US$ = US$125,000 Foreign CCY Home CCY (DM1)

H U ZSOB Viswanathan Ch. 17 Foreign Exchange Risk FX risk is the risk associated with the uncertainty of CF (Cash Flows) as a result of changes in exchange rates. Factors affecting exchange rates:  Macroeconomic Factors  Inflation  Interest Rates  Budget and Trade Deficits  Economic Growth  Money Supply  Political Factors  Government Stability  Market Regulations  Legal Environment These factors affect the supply and demand of currencies traded in FX markets, which in turn sets the price.

H U ZSOB Viswanathan Ch. 18 Foreign Exchange Risk Example: GE  Lufthansa (DM25 payable in 1 year) Current Exchange Rate: $0.625/DM$15.625Mil Dollar Depreciates after 1 Year FX Rate: $0.610/DM$15.250Mil Loss Due to change in FX Rate($375,000) Dollar Appreciates after 1 Year FX Rate: $0.650/DM$16.250Mil Gain Due to change in FX Rate$625,000 FX Risk can be managed by using derivatives.

H U ZSOB Viswanathan Ch. 19 FX Settlement Risk (Herstatt Risk) June 26, 1974 Bankhaus Herstatt lost its banking license, and was ordered into liquidation during the banking day. German interbank payments system closes at 3:30 local time, during which time the bank was paid in DM counterparty payments were made. Herstatt’s NY correspondent bank suspends all USD payments at 10:30am. As a result the settlement fails. Similar examples include: Drexel Burnham Lambert BCCI (Bank of Credit and Commerce International) Barings

H U ZSOB Viswanathan Ch. 110 FX Settlement Risk DM USD 5-6 hour lag A B D M 200,000 US$125,000

H U ZSOB Viswanathan Ch. 111 Impact of Globalization on Financial Markets & Institutions Financial Integration: degree to which capital can flow between financial markets. Intermediaries obtain and disburse funds around the globe.

H U ZSOB Viswanathan Ch. 112 International Bond Markets International Bond Markets are made up of two basic bond types:  Eurobonds  Foreign Bonds

H U ZSOB Viswanathan Ch. 113 Eurobonds “A eurobond is an underwritten bond offered through an international syndicate of investment bank in countries other than the country in whose currency the issue is denominated.” Example: US based firm issuing USD bonds in Europe and Asia.

H U ZSOB Viswanathan Ch. 114 Foreign Bonds “A foreign bond is an underwritten bond offered by a foreign issuer in a country, and denomination in the currency of that country.” Examples: Bulldogs – German firm issuing GBP bonds in the UK. Yankees – French firm issuing USD bonds in the US. Samurai Bonds – US firm issuing JPY bonds in Japan.

H U ZSOB Viswanathan Ch. 115 International Equity Markets Euroequity Markets: “Equity issues specifically designed for distribution among foreign markets, underwritten by a group of investment banks and purchased mainly by institutional investors.” Issuing Equities: Firms can raise additional capital by listing its issues on foreign exchanges.

H U ZSOB Viswanathan Ch. 116 Impact of Globalization on Investments Reasons to include foreign assets in a portfolio:  Diversification  Market Performance Ways to achieve international diversification:  Direct investment in stock traded on foreign exchanges  Investing in foreign securities traded on domestic exchanges  Investing in investment companies that invest in foreign securities. Changes in FX rates can dampen or amplify the impact of foreign investments.

H U ZSOB Viswanathan Ch. 117 Impact of Globalization on Corporate Finance Risks associated with international business activity:  Political Risk  Social Risk  Economic Risk Forms of international business activity:  Exporting and Importing  Operating subsidiaries in foreign markets  Selling in foreign markets  Financing from foreign sources