1. International finance
Professor Ivar Bredesen
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2. Course contents The course is divided into four parts:
The International Financial Environment
Exchange Rate Behaviour
Exchange Rate Risk Management
Multinational Capital budgeting
Workload – 10 ECTS
course work and required assignments
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3. Required Reading or
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4. Organization of the Text http://www. cengage. co
Background on International Financial Markets (Chapters
2-5)
Exchange Rate Behavior (Chapters 6-8)
Long-Term Investment and Financing Decisions (Chapters 13-18)
Short-Term Investment and Financing Decisions (Chapters 19-21)
Exchange Rate Risk Management (Chapters 9-12)
Risk and Return of MNC
Value and Stock Price of MNC
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5. What will we be covering?
We will cover the following chapters:
1 -3: Mostly introductory chapters
4: Exchange rate determination
5: Currency derivatives
7: International arbitrage and interest rate parity
8: Inflation, interest rates and exchange rates
9: Forecasting exchange rates
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6. What will we be covering?
Important chapters, continued:
10: Measuring exposure to exchange rate fluctuations
11: Managing transaction exposure
12: Managing economic exposure and translation exposure
14: Multinational capital budgeting
Note that we will cover some chapters in more depth than the textbook. It is therefore important to read the lecture notes also.
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7. Financial Risk Management
The field of financial risk management normally contain the following:
Interest rate risk
Commodity price risk
Equity risk
Currency risk
This course will deal with currency risk
We need to know some finance to assess the instruments used to hedge currency risk and some economics to understand exchange rate behaviour
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8. Norsk Hydro (2004 annual report)
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9. The IMF’s Nominal Exchange Rate Index of the Dollar
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10. History of the International Monetary System
The Gold Standard,
Countries set par value for their currency in terms of gold
Norway joined the Swedish-Danish monetary union on October 16, New currency “krone” with value based on gold. Link to gold suspended on August Several changes after that
The “rules of the game” for the gold standard were simple
Example: US$ gold rate was $20.67/oz, the British pound was pegged at £4.2474/oz
US$/£ rate calculation is $20.67/£ = $4.8665/£
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11. History of the International Monetary System
The Inter-War years and WWII,
During WWI, currencies were allowed to fluctuate over wide ranges in terms of gold and each other, theoretically, supply and demand for imports/exports caused moderate changes in an exchange rate about an equilibrium value
Competitive devaluations and “beggar thy neighbour” policies
In 1934, the US devalued its currency to $35/oz from $20.67/oz prior to WWI
It became clear that the system needs “rules” and a “conductor”
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12. History of the International Monetary System http://www. youtube
Bretton Woods and the IMF, 1944
Allied powers met in Bretton Woods, NH and created a post-war international monetary system
The agreement established a US dollar based monetary system and created the IMF and World Bank
Under original provisions, all countries fixed their currencies in terms of gold but were not required to exchange their currencies
Only the US dollar remained convertible into gold (at $35/oz with Central banks, not individuals)
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13. Bretton Woods

14. Stability until 1971 USD/NOK 1945-1988

15. History of the International Monetary System
Fixed exchange rates,
Bretton Woods and IMF worked well post WWII, but diverging fiscal and monetary policies and external shocks caused the system’s demise
The US dollar remained the key to the web of exchange rates
Heavy capital outflows of dollars became required to meet investors’ and deficit needs and eventually this overhang of dollars held by foreigners created a lack of confidence in the US’ ability to meet its obligations
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16. History of the International Monetary System http://www. youtube
This lack of confidence forced President Nixon to suspend official purchases or sales of gold on Aug. 15, 1971
Exchange rates of most leading countries were allowed to float in relation to the US dollar
By the end of 1971, most of the major trading currencies had appreciated vis-à-vis the US dollar; i.e. the dollar depreciated
A year and a half later, the dollar came under attack again and lost 10% of its value
By early 1973 a fixed rate system no longer seemed feasible and the dollar, along with the other major currencies was allowed to float
By June 1973, the dollar had lost another 10% in value
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17. Huge problems today… Headlines For Tuesday, November 9, 2010
Tensions over currencies and trade gaps are simmering ahead of a summit of global leaders this week as America's move to flood its sluggish economy with $600 billion of cash triggers alarm in capitals from Berlin to Beijing….Export-reliant nations, many of them poor, fear the US Federal Reserve move will drive more cash into their markets in search of higher returns, driving their currencies even higher and hurting manufacturers that provide jobs and security for fast-growing populations. At the same time, China has maintained tight control over its currency, the yuan, adding to criticism it is kept artificially low and gives Chinese exporters an unfair export advantage….” [Associated Press/Factiva]
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18. New gold standard? Headlines For Tuesday, November 9, 2010
BBC adds that “…one solution – proposed by World Bank President Robert Zoellick – is to return to a modern version of the gold standard. Unlike the original gold standard… he does not advocate rigidly fixing the value of currencies against the price of gold.
Instead, Zoellick suggested that a future system of flexible exchange rates should reference gold – instead of the US dollar – as a common point of valuation. The implication of Zoellick's suggestion is that countries like China would rely much less on buying US dollars, and more on buying gold and other currencies to build up their reserves….” [BBC News]
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19. Trade imbalances Headlines For Tuesday, November 9, 2010
AFP writes that meanwhile, “…South Korea and the US have floated the idea of a numerical limit on trade surpluses or deficits, with the US proposing four percent of GDP. But the plan for a fixed target ran into strong opposition from China, Germany and other nations.
G20 finance ministers last month set no specific targets but pledged to work to reduce excessive current account imbalances and maintain them at ‘sustainable’ levels. Persistently large imbalances, assessed against ‘indicative guidelines’ to be agreed later, would warrant an assessment by the International Monetary Fund….” [Agence France Presse/Factiva]
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20. Foreign Exchange Markets
The FOREX market provides the physical and institutional structure through which
The money of one country is exchanged for that of another country
The rate of exchange between currencies is determined
Foreign exchange transactions are physically completed
The FOREX market is extremely competitive and highly efficient
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21. Transactions in the Interbank Market
Transactions within this market can be executed on a spot, forward, or swap basis
A spot transaction requires almost immediate delivery of foreign exchange
A forward transaction requires delivery of foreign exchange at some future date
A swap transaction is the simultaneous exchange of one foreign currency for another
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22. Outright Forward Transactions
This transaction requires delivery at a future value date of a specified amount of one currency for another
The exchange rate is agreed upon at the time of the transaction, but payment and delivery are delayed
Forward rates are contracts quoted for value dates of one, two, three, six, nine and twelve months
Terminology typically used is buying or selling forward
A contract to deliver dollars for euros in six months is both buying euros forward for dollars and selling dollars forward for euros
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23. Swap Transactions
A swap transaction in the interbank market is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates
Both purchase and sale are conducted with the same counterpart
A common type of swap is a spot against forward
The dealer buys a currency in the spot market and simultaneously sells the same amount back to the same bank in the forward market
Since this transaction occurs at the same time and with the same counterpart, the dealer incurs no exchange rate exposure
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24. Size of the FOREX Market http://www.bis.org/publ/rpfxf10t.pdf
The Bank for International Settlements (BIS) estimates that daily global net turnover in traditional FOREX market activity to be US$4.0 trillion in April 2010, up from 3.2 trillion in 2007
Spot transactions at $1,490 billion/day, up 48 %
Outright forward transactions at $475 billion/day
Swap transactions at $1,765 billion/day
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25. Global Foreign Exchange Market Turnover, April 2010 (daily averages, billions of U.S. dollars)
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26. Turnover by instrument
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27. Turnover by currency
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29. Top trading centers
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30. Norway April 2010 (million USD) total, USD, Euro, Yen, GBP, Swiss Francs
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31. Foreign Exchange Rates & Quotations
Direct and Indirect Quotes
A direct quote is a home currency price of a unit of a foreign currency
NOK 5/$ is a direct quote in Norway
An indirect quote measures how much foreign currency you can buy for one unit of your own
NOK 0.2/$ is an indirect quote in the Norway,
NOK 0.2/$ is a direct quote in the US and an indirect quote in Norway
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32. Foreign Exchange Rates & Quotations
Interbank quotes are given as a bid and ask
The bid is the price at which a dealer will buy another currency and the ask or offer is the price at which a dealer will sell another currency
This is the bid/ask spread. bid/ask % spread = ask rate – bid rate
ask rate
Example: ¥ ¥118.37/$ is the bid/ask for Japanese yen
Bid/Ask spread = ( – )/ = %
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33. Foreign Exchange Rates & Quotations
Forward Quotations can be expressed in several ways
We will generally use the actual forward exchange rate – called an outright quote
Forward quotes are also quoted in terms of points i.e. how much they differ from the spot rate. A point is the last digit of a quotation, with convention dictating the number of digits to the right of the decimal
The difference between spot rates and forward rates can also be expressed as a % per-annum deviation from the spot rate (premium or discount)
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34. Foreign Exchange Rates & Quotations
Expressing Forward Quotations on a Points Basis
The yen is quoted only to two decimal points
A forward quotation is not a foreign exchange rate, rather the difference between the spot and forward rates
Example:
Bid Ask
Outright spot: ¥ ¥118.37
Outright forward: ¥ ¥116.97
Plus points (3 months)
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35. Foreign Exchange Rates & Quotations
Forward Quotations in Percentage Terms
For direct quotes (i.e. quote expressed in home currency terms), the formula is
If > 0, the foreign currency is said to be trading with a premium, if < 0 the foreign currency is trading with a discount
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36. Euro spot and forward Jan 10 - 2011 http://markets. ft
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37. Foreign Exchange Rates & Quotations
Cross Rates
Many currencies pairs are inactively traded, so their exchange rate is determined through their relationship to a widely traded third currency
Example: A Mexican importer needs Japanese yen to pay for purchases in Tokyo. Both the Mexican peso (MXP) and Japanese yen (¥) are quoted in US dollars
Assume the following quotes:
Japanese yen ¥110.73/$
Mexican peso MXP /$
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38. Foreign Exchange Rates & Quotations
Cross Rates
The Mexican importer can buy one US dollar for Mexican pesos and with that dollar buy ¥110.73; the cross rate would be
9.6745/MXP
MXP /$
110.73/$
dollar
pesos/US
Mexican
yen/US
Japanese =
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39. Currency Futures and Options Market
A currency futures contract specifies a standard volume of a particular currency to be exchanged on a specific settlement date. Unlike forward contracts however, futures contracts are sold on exchanges.
Currency options contracts give the right to buy or sell a specific currency at a specific price within a specific period of time. They are sold on exchanges too.
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