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

2. 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

3. 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

4. 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 Slide 1 of 2

5. 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 Slide 2 of 2

6. 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 Slide 1 of 2

7. 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 Slide 2 of 2

8. 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 Slide 1 of 2

9. 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 Slide 2 of 2

10. 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

11. 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