International Finance

1、International Finance 725Dependence of US Economy on Foreign CountriesThe US economy, and economies all over the world are highly dependant on the price and supply of oil. Oil by it self is a strong force that interlinks economic health between countries. Furthermore crude production is a natural ex

2、ample of specialization that promotes international trade. Data Source Energy Information Administration Crude production in the USCrude Oil Production (thousands of barrels)050000100000150000200000250000300000350000Jan-20Jan-28Jan-36Jan-44Jan-52Jan-60Jan-68Jan-76Jan-84Jan-92Jan-00USA ProductionHow

3、dose the US fit into the global economyAre imports or exports responsible for the deficit?What makes international finance different?Taking finance to the international setting offers substantial gains with respect to diversification. However these gains come with the cost of additional risk. The th

4、ree main aspects that arise with international finance are:1. Foreign Exchange and policy Risk 2. Market imperfections 3. Expanded opportunity setForeign Exchange RiskThis risk refers to the relative price of domestic currency. A corporation operating in a foreign country may realize costs or revenu

5、e in foreign currency, in this case their bottom line will depend on the rate at which that currency can be converted. INTERNATIONAL BUSINESS;Daimler-Benz Posts $1.06 Billion Loss (1995)Daimler-Benz A.G. said today that it swung to a net loss of more than $1 billion in The first half, as the marks s

6、trength against the dollar caused the giant German industrial company to take a charge of $816 million. The company said it expected its loss for the second half to be smaller - but that it would have to take another big charge to reflect a reorganization of its aerospace unit. Foreign Exchange Risk

7、What happened with Daimler Benz: By holding contracts that stipulate payment in US dollars, Daimler was exposed to foreign exchange risk. The risk is that the Mark value of a dollars to be paid will fluctuate over the contract period. When the dollar dropped relative to the Mark, Daimler was paid th

8、e same number of dollars which where now worth fewer Marks. FX Risk is also a concern when investing in foreign securities: Any investor who invests outside of their domestic market must convert cash payments at some exchange rate. If the exchange rate is unknown this investor is betting not only on

9、 her foreign portfolio, but also on the exchange rate.Equity Portfolios and FX Risk Suppose an investor based in the US, and an investor based in Mexico both hold the S&P 500. Are both portfolios composed of the same risk? If not what is the difference between the two? Can you explain the differ

10、ence in the return on the S&P 500 in the US and in Mexico?Equity Portfolios and FX Risk The difference in the two portfolios is that the Mexican based investor is holding exchange rate risk, as well as, risk from the S&P 500. The difference in the two portfolios should be approximately equal

11、 to the exchange rate. This relation is shown in the graph above. Why is the average compensation for FX risk approximately equal to zero? Do you have to sustain exposure to FX risk?Political RiskPolitical Risk: referrers to the uncertainty associated with rules, regulations and policies governed by

12、 sovereign countries. A foreign government can change tax policy or ownership requirements at any time. Japan reviews emissions policyBy David Pilling and Jonathan Soble in Tokyo Published: February 21 2008 00:49 | Last updated: February 21 2008 00:49Japans trade and industry ministry will discuss i

13、mposing caps on greenhouse gas emissions as part of a review of measures to combat global warming after the Kyoto protocol expires in 2012.The review, to be completed by June, has led to speculation that the trade ministry (Meti) may be preparing to reverse its objection to a cap-and-trade system. U

14、ntil now it has backed big business insistence on a voluntary scheme. Chinese monetary policyPublished: February 27 2008 09:27 | Last updated: February 27 2008 09:27In theory, the stage is set for a round of aggressive monetary tightening in China.Certainly, the central bank which hiked policy lendi

15、ng rates by 135 basis points during its “prudent” policy stance last year has signalled as much by shifting to a “tightening” stance in December. And there is a cast-iron case for doing so. One-year lending rates are 7.5 per cent but inflation is rampant, with consumer prices increasing 7 per cent y

16、ear-on-year in January. Money supply continues to surge. Banks made over $100bn of new loans in January, or more than one-fifth the amount targeted for the entire year.Political RiskChinas shoe industry under pressureBy Tom Mitchell in DongguanPublished: February 25 2008 22:06 | Last updated: Februa

17、ry 25 2008 22:06Rising costs have forced about 15 per cent of shoe manufacturers in a big south China industrial centre to shut down or relocate in the past year, according to the head of the Asia Footwear Association.Mexican Oil Industry NationalizationIn 1938 President Lzaro Crdenas nationalized t

18、he petroleum industry, giving the Mexican government a monopoly in the exploration, production, refining, and distribution of oil and natural gas, and in the manufacture and sale of basic petrochemicals. . In 1943 Mexico and the oil companies reached a final settlement under which the companies rece

19、ived US $24 million (a fraction of the book value of the expropriated facilities) as compensation. Nevertheless, the oil nationalization deprived Mexico of foreign capital and expertise for some twenty years. Exxon Mobil cut off from Venezuelas oil (CNN)CARACAS, Venezuela (AP) - Venezuelas state oil

20、 company said Tuesday that it has stopped selling crude to Exxon Mobil Corp. in response to the U.S. oil companys drive to use the courts to seize billions of dollars in Venezuelan assets. President Hugo Chavez has said Exxon Mobil is no longer welcome to do business in Venezuela.Exxon Mobil is lock

21、ed in a dispute over the nationalization of its oil ventures in Venezuela that has led President Hugo Chavez to threaten to cut off all Venezuelan oil supplies to the United States.Venezuela is currently the United States fourth largest oil supplier. Tuesdays announcement by state-run Petroleos de V

22、enezuela SA, or PDVSA, was limited to Exxon Mobil, which PDVSA accused of judicial-economic harassment for its efforts in U.S. and European courts.PDVSA said it has paralyzed sales of crude to Exxon Mobil and suspended commercial relations with the Irving, Texas-based company. The legal actions carr

23、ied out by the U.S. transnational are unnecessary . and hostile, PDVSA said in the statement. It said it will honor any existing contracts it has with Exxon Mobil for joint Market ImperfectionsMarket imperfections refer to the cross country frictions associated with international trade. Examples inc

24、lude tariffs, quotas, embargos, etc. To avoid these types of restriction many companies, such as Toyota and Honda, have built production facilities in major markets. For example, both companies now have production facilities in the United States.This type of move will avoid some trade frictions but

25、at a cost. What additional risk will these companies take on?Example of market imperfections: Sarbanes Oxley (SOx) this legislation was passed in 2002 as a result of several reporting scandals in the US, such as Enron and World com. SOx introduced several new reporting requirement, at substantial co

26、st to public companies traded in the us. As a result several foreign companies deregistered from US exchanges. Market Imperfections Nestle offered investors two types of share: November 18 1988 the restriction on registered shares was lifted Why are bearer shares priced higher than registered shares

27、?Bearer: Could be held by international investors Registered: Could be held by Swiss residents only Bearer shares allow investors the advantage of international diversification without being exposed to political risk, because Switzerland is known to have a very stable political environment.Nov 18 we

28、alth transfer form foreign to domestic investors, Big price jump for domestic investors, big price drop for foreign investors. Graph source: International Financial Management, Eun and Resnick 2007 4th edition Expanded Opportunity setCorporateGlobalization allows companies to allocate resources wher

29、e ever the cost of capital (labor, materials, etc) is lowestTrade agreements such as GATT, WTO,EU,NAFTA and more have worked to breakdown trade barriers that hindered cross boarder trade. By taking advantage of lower costs in different countries, as well as, a global market to sell goods multination

30、al corporations can increase profitsInvestmentFrom the investment prospective international diversification may allow investors to achieve similar returns with less risk.Stocks in other countries are not exposed to the same systematic factors as those in the domestic country therefore there should b

31、e less correlation in the systematic components of returns across countriesEvolution of Globalization1920 1930 1939 1944 1967 1973 1974 1985-861920s countries begin imposing restrictions on trade, predatory depreciationIncrease tariffs. In large part due to WW IHit hard by WW I and unable to pay rep

32、utations Germany prints massive amount of money causing rampant inflation 1922 1936 1947 1971 1978The Great Depression hits the global economy countries struggle to balance budget Tripartite Agreement France the UK and US attempt to avoid competitive depreciation of currency WW IIIMF and World Bank

33、Article of Agreement are signed in Bretton Woods New Hampshire General Agreement on Tariffs and Trade (GATT) is establishedIMF approve plans to create SRD Special Draw Rights, a new international reserve assetGeneralized floating begins among major currenciesCommittee of Twenty meet to reform intern

34、ational monetary system Guidelines to manage floating exchange rates are adopted 2nd Amendments to the IMF articles allow members to choose their own exchange rate agreement US Declare it will no longer buy and sell gold to settle international transactions Bretton woods system abandonedIMF increase

35、s access to loan, and develops Bailout plans for developing countriesEvolution of Globalization1975 1985 1999 US Eliminates Fixed Brokerage Fees 1980 1986Japan Deregulates their foreign exchange market Tokyo Stock Exchange admits a limited number of foreign brokerage firms as members The “Big Bang”,

36、 LSE 1.Eliminates fixed brokerage fees2.In Europe commercial banks allowed to act as Investment banks. London affiliate banks are eligible for listing3.Volume on LSE jumps US Repeals the Glass-Steagall act separating commercial and investment BankingOther countries such as Chile, Mexico, Korea and o

37、thers begin to deregulate exchangesTrade liberalizationSeveral treaties and agreements have been established to promote international trade. Some major innovations include.General Agreement on Tariffs and Trade (1947): still in existence today has 110 members its aim is to lower tariffs and trade ba

38、rriers and is managed by the WTOWorld Trade Organization (WTO): Began in 1995, it replace or augmented the GATT agreement. The major task of the WTO is to facilitate international tradeEuropean Union (EU): Established in 1993 now has 27 member countries its purpose is to ensure economic unification

39、of a European region by guaranteeing freedom of movement of people, goods, services and capital among member countries. North American Free Trade Agreement (NAFTA): initiated in 1994 between Canada, Mexico, and US, NFTA phases out all tariffs and import quotas over a 15 year period. International Mo

40、netary Policy1. Bimetallism 2. Classical Gold Standard3. Inter war period4. Brentton Woods System 5. Flexible Exchange RatesBimetallism (prior to 1875)Bimetallism refers to the use of noble metals Gold and Silver as currency. Prior to 1875 this was the predominant monetary system in major countriesT

41、he United Kingdom maintained gold and silver coinage until 1816 when the silver coin as dropped and they moved to the gold standard France maintained the bimetal system from the French revolution to the 1878The United States operated under bimetal form 1972 to 1873 when it stopped producing the silv

42、er dollar.Exchange Rates Under the Bimetal System: exchange rates where determined by the metal content of the currencies being exchanged. Gold and silver had a universal price, and currencies were exchanged at the value of the metal being exchanged. This worked well if the currency being exchanged

43、was of the same metal but different countries maintained different metal systems.Bimetallism (prior to 1875)Example:Then the exchange of British pounds for German Marks was made though French francs, which made French francs the dominant international currency.Country Currency GermanySilver UKGold F

44、rance Bimetal (silver & gold)British PoundsGold French FrancsGold & Silver German MarksSilver Gershams Law: This law dictated the currency used to trade.During the gold rush era gold flooded the market and the intrinsic value of gold fell relative to silver. However the exchange rate in Fran

45、ce remained constant at 15.5:1 silver to gold francs. Since the price of gold was still set people elected to pay debts in the over valued currency (gold) and silver fell out of circulation. This effectively put France on the gold standard. Bimetallism (prior to 1875)1. If the exchange rate between

46、gold and silver was fixed2. Either gold or silver could be used to settle debts 3. The more abundant metal would be used to transact and the scare metal will fall out of circulationClassical Gold StandardThe gold standard as introduced 1821 in England when notes issued by the Bank of England became

47、fully redeemable for goldFrance, unofficially on the gold standard since 1850, officially adopted the gold standard in 1878Germany converted in 1875 after receiving a large endowment from France The united states converted in 1879 Russia and Japan followed in 1897The gold standard remained the domin

48、ant international system until 1914 when WW I strained the system beyond its capacityClassical Gold StandardExchange Rates under the Gold Standard: the gold standard is convenient in that there exists an international reference asset (gold) which all currencies can be evaluated against. Therefore ex

49、change rates could be determined by the respective currencies gold content.How is miss pricing resolved using the gold standard? Example: suppose that instead of 2 pound per ounce the British pound is trading at 1.8 pounds per ounce. Example: Suppose the British pound is pegged to gold at 6 pounds p

50、er ounce, and French francs are pegged to gold at 12 pounds per ounce. Then what is the French franc to pound exchange rate?In this case the pound is cheap relative to francs so investors will buy pound with francs but not francs with poundsClassical Gold Standard Auto correction under the gold stan

51、dard:1. Buying pressure will increase on the pound 2. Buying pressure will decrease on the franc 3. The excess demand for the pound will cause the price of the pound to increase relative to the franc and the miss pricing will be corrected.Classical Gold Standard Trade imbalance under the Gold standa

52、rd: The gold standard also has a build in auto correction for trade imbalances. Germany FranceGoods 1000 pounds of gold Goods 750 pounds of gold Flow of Goods250 pounds of gold Flow of gold / currency Supply of gold increases increase supply causes a loss in value, and prices increase Supply of gold

53、 decreases decreased supply causes an increase in value, and prices decrease Classical Gold Standard Trade imbalance under gold standard: Disadvantages of the Gold standardAs a result of the increase in prices in Germany, German exports become more expensive to French citizen and France stops buying

54、 German goods. Less demand for German goods causes the trade imbalance to close.1. The supply of gold is limited and countries are required to maintain a pegged ratio, which means a countrys money supply is limited and regulated by the trade imbalance self correction. The restriction of a countries

55、money supply can seriously impair economic growth. 2. The gold standard works well if all countries adhere to the rules however, nothing binds countries to follow the gold standard, and therefore, it can be abandoned at any time as it was in WW IInter War PeriodDuring the period between WW I and WW

56、II There was no organized international monetary policy.Several countries had accrued substantial debt, with no international regulation of monetary policy, they engaged in predatory depreciation, which caused unprecedented inflation.Predatory depreciation: a country can increase its money, supply w

57、hich will cause the price of its currency to decrease. Goods manufactured in this country then become less expensive on the world market, which attracts foreign investment.Germany depreciated the Mark excessively form 1920-1923Eventually countries returned to the gold standard. This gold standard di

58、d not last long as countries no longer abided by the rules Most countries kept gold reserves, which limited the benefits of this system 1929 the world experienced an almost universal loss in confidence of domestic currencies.Massive bank runs ended the gold standard in the 1930s USA 1919, help the U

59、S become the dominant international currency UK 1925 Switzerland France Scandinavia 1928Images of post war GermanyBretton Woods SystemIn 1944, 44 major countries met at Bretton Woods New Hampshire to discuss international monetary policyThe Bretton Woods accord established:Under the Bretton System:1

60、. The International Monetary Fund (IMF)2. The International Bank of Reconstruction, also known as the World Bank1.Each country established a par rate in relation to the US dollar. 2.The US dollar was then pegged to gold at $35 per ounce3.Each country was responsible for maintaining their par exchange rate with the do