1. International Finance
Ivar Bredesen Associate Professor
South-Western/Thomson Learning © 2003

2. Course contents The course is divided into three parts:
The International Financial Environment
Exchange Rate Behaviour
Exchange Rate Risk Management
Workload – 10 ECTS
8 course work
2 assignments

3. Required Reading
Jeff Madura and Roland Fox: International Financial Management, 1st ed.
Excellent intermediate level textbook in international finance
Textbooks home page

4. Required Reading

5. Part I The International Financial Environment
Multinational Corporation (MNC)
Foreign Exchange Markets
Dividend
Remittance
& Financing
Exporting
& Importing
Investing
& Financing
Product Markets
Subsidiaries
International
Financial
Markets

6. 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

7. Norsk Hydro (2004 annual report)

8. Norsk Hydro 2004

9. The effects of exchange-rate changes
Shifts in ‘forex’ (FOReign EXchange), can impact on various aspects of a firm’s activities
Income to be received from abroad
The amount actually paid for imports at some future date
The valuation of foreign assets and liabilities
The long-term viability of foreign operations
The acceptability, or otherwise, of an overseas investment project

10. What’s Special about “International” Finance?
Foreign Exchange Risk
The risk that foreign currency profits may evaporate in home currency terms due to unanticipated unfavorable exchange rate movements.
Suppose $1 = ¥100 and you buy 10 shares of Toyota for ¥100,000 (i.e. $100 per share = ¥10,000 per share).
One year later the investment is worth ten percent more in yen: ¥110,000
But, if the yen has depreciated to $1 = ¥120, your investment has actually lost money in dollar terms.
Your $1,000 investment is only worth $916.67

11. Exchange-rate movements, US$ to £, November 1989–November 2004

12. Exchange-rate movements, £ to euro, November 1998 to November 2004

13. Exchange-rate movements, US$ to euro, November 1999 to November 2004 (weekly)

14. What’s Special about “International” Finance?
Political Risk
Sovereign governments have the right to regulate the movement of goods, capital, and people across their borders. These laws sometimes change in unexpected ways.
Statoil has invested 43.3 billion NOK in countries like Venezuela, Angola, Algerie, Iran, Aserbajdsjan

15. The Example of Nestlé’s Market Imperfection
Nestlé used to issue two different classes of common stock bearer shares and registered shares.
Foreigners were only allowed to buy bearer shares.
Swiss citizens could buy registered shares.
The bearer stock was more expensive.
On November 18, 1988, Nestlé lifted restrictions imposed on foreigners, allowing them to hold registered shares as well as bearer shares.

16. Nestlé’s Foreign Ownership Restrictions
12,000
10,000
8,000
6,000
4,000
2,000 11 20 31 9 18 24
Bearer share SF
Registered share

17. The Example of Nestlé’s Market Imperfection
Following this, the price spread between the two types of shares narrowed dramatically.
This implies that there was a major transfer of wealth from foreign shareholders to Swiss shareholders.
Foreigners holding Nestlé bearer shares were exposed to political risk in a country that is widely viewed as a haven from such risk.
The Nestlé episode illustrates both the importance of considering market imperfections and the peril of political risk.

18. Emergence of Globalized Financial Markets
Deregulation of Financial Markets
coupled with
Advances in Technology have greatly reduced information and transactions costs, which has led to:
Financial Innovations, such as
Currency futures and options
Multi-currency bonds
Cross-border stock listings
International mutual funds

19. Multinational Corporations
The textbook focuses on the operation of a multinational company, meaning a firm that has incorporated on one country and has production and sales operations in other countries.
Many small and medium sized companies also have international operations, and the discussion in the textbook is relevant not just for multinationals

20. Valuation Model for an MNC
Domestic Model
E (CF$,t ) = expected cash flows to be received at the end of period t
n = the number of periods into the future in which cash flows are received
k = the required rate of return by investors

21. Valuation Model for an MNC
Valuing International Cash Flows
E (CFj,t ) = expected cash flows denominated in currency j to be received by the U.S. parent at the end of period t
E (ERj,t ) = expected exchange rate at which currency j can be converted to dollars at the end of period t
k = the weighted average cost of capital of the U.S. parent company

22. Valuation Model for an MNC
Impact of New International Opportunities
on an MNC’s Value
Exchange Rate Risk
Political Risk
Exposure to
Foreign Economies

23. How Chapters Relate to Valuation
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