Tài chính doanh nghiệp - Chapter 18: International aspects of financial management

International Aspects of Financial ManagementChapter 180Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerKey Concepts and SkillsUnderstand how exchange rates are quoted and what they meanKnow the difference between spot and forward ratesUnderstand purchasing power parity and interest rate parity and the implications for changes in exchange ratesUnderstand the types of exchange rate risk and how they can be managedUnderstand the impact of political risk on international business investing1Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerChapter OutlineTerminologyForeign Exchange Markets and Exchange RatesPurchasing Power ParityExchange Rates and Interest RatesExchange Rate RiskPolitical Risk2Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerDomestic Financial Management and International Financial ManagementConsiderations in International Financial ManagementHave to consider the effect of exchange rates when operating in more than one currencyHave to consider the political risk associated with actions of foreign governmentsMore financing opportunities when you consider the international capital markets and this may reduce the firm’s cost of capital3Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerInternational Finance TerminologyCross-rateEurobondEurocurrency (Eurodollars)Foreign bondsGiltsLondon Interbank Offer Rate (LIBOR)Swaps4Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerGlobal Capital MarketsThe number of exchanges in foreign countries continues to increase, as does the liquidity on those exchangesExchanges that allow for the flow of capital are extremely important to developing countriesAustralia and New Zealand have well developed capital markets in world termsInternational foreign markets are becoming more competitive and are often willing to try more innovative ways to do business5Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerExchange RatesThe price of one country’s currency in terms of anotherAll currencies are in some way quoted to U.S. dollarsMost countries are in terms of U.S. dollars except for countries like Australia and New ZealandConsider the following quote:Japan (Yen) 0.0112 89.19The first number 0.0112 is how many Australian dollars it takes to buy 1 YenThe second number 89.19 is how many Japanese Yen it takes to buy $1AUDThe two numbers are reciprocals of each other (1/89.19= 0.0112)6Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerExample: Exchange RatesSuppose you have $10,000. Given the rates below, how many U.S. Dollars can you buy?Exchange rate = 0.8213 U.S. dollar per Australian dollarBuy 10,000(0.8213) = $8,213 U.S. dollarsSuppose you are visiting London and you want to buy a souvenir that costs 1000 British pounds. How much does it cost if the exchange rate is AUD/GBP 0.4945?Exchange rate = 0.4945 pounds per dollarCost = 1000 / 0.4945 = $2,022.247Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerExample: Triangle ArbitrageWe observe the following quotes:29.10 Thai Baht (THB) per $1AUD2.882 Singapore $ (SGD) per $1AUD9.50 Thai Baht per $1SGDWhat is the cross rate?(29.10 THB/$1) / (2.882 SGD/$1) = 10.10 THB per SGDWe have $100 to invest; buy low, sell highBuy $100(29.10THB/$1) =2910THB, use THB to buy SGDBuy 2910THB /(9.5THB/SGD) = 306.32SGD, use SGD to buy AUD dollarsBuy 306.32SGD / (2.882SGD/$1) = $106.29Make $6.29 risk-free8Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerTransaction TerminologySpot trade – exchange currency immediatelySpot rate – the exchange rate for an immediate tradeForward trade – agree today to exchange currency at some future date and some specified price (also called a forward contract)Forward rate – the exchange rate specified in the forward contractIf the forward rate is higher than the spot rate, the foreign currency is selling at a premium (when quoted as $ equivalents)If the forward rate is lower than the spot rate, the foreign currency is selling at a discount9Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerAbsolute Purchasing Power ParityPrice of an item is the same regardless of the currency used to purchase itRequirements for absolute PPP to holdTransaction costs are zeroNo barriers to trade (no taxes, tariffs, etc)No difference in the commodity between locationsAbsolute PPP rarely holds in practice for many goods10Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerRelative Purchasing Power ParityProvides information about what causes changes in exchange ratesThe basic result is that exchange rates depend on relative inflation between countriesE(St ) = S0[1 + (hFC – hAUD)]tBecause absolute PPP doesn’t hold for many goods, we will focus on relative PPP from here on11Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerExample: PPPSuppose the Singapore spot exchange rate is 1.4680 Singapore dollars per Australian dollar. Australian inflation is expected to be 3% per year and Singapore inflation is expected to be 2%.Do you expect the Australian dollar to appreciate or depreciate relative to the Singapore dollar?Since inflation is higher in Australia, we would expect the AUD to depreciate relative to the Singapore dollar.What is the expected exchange in one year?E(S1) = 1.4680[1 + (.02 - .03)]1 = 1.453312Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerCovered Interest ArbitrageExamine the relationship between spot rates, forward rates and nominal rates between countriesAgain, the formulas will assume that the exchange rates are quoted in terms of foreign currency per Australian dollars (AUD)The Australian risk-free rate is assumed to be the short dated government bond rate13Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerExample: Covered Interest ArbitrageConsider the following information:S0 = 2 SGD/$ RAUD = 10%F1 = 1.8 SGD/$ RSGD = 5%What is the arbitrage opportunity?Borrow $100 at 10%Buy $100(2 SGD/$) = 200 SGD and invest at 5% for 1 yearIn 1 year, receive 200(1.05) = 210 SGD and convert back to dollars210 SGD/(1.8 SGD/$) = $116.67 and repay loanProfit = 116.67 – 100(1.1) = $6.67 risk free14Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerInterest Rate ParityBased on the previous example, there must be a forward rate that would prevent the arbitrage opportunityInterest rate parity defines what that forward rate should be15Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerShort-Run ExposureRisk from day-to-day fluctuations in exchange rates and the fact that companies have contracts to buy and sell goods in the short-run at fixed pricesManaging riskEnter into a forward agreement to guarantee the exchange rateUse foreign currency options to lock in exchange rates if they move against you but benefit from rates if they move in your favour16Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerLong-Run ExposureLong-run fluctuations come from unanticipated changes in relative economic conditionsCould be due to changes in labour markets or governmentsMore difficult to hedgeTry to match long-run inflows and outflows in the same currencyBorrowing in the foreign country may mitigate some of the problems17Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerTranslation ExposureIncome from foreign operations has to be translated back to dollars for accounting purposes, even if foreign currency is not actually converted back to dollarsIf gains and losses from this translation flowed through directly to the income statement, there would be significant volatility in EPSCurrent accounting regulations require that all cash flows be converted at the prevailing exchange rates with currency gains and losses accumulated in a special account within shareholders equity18Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerManaging Exchange Rate RiskLarge multinational firms may need to manage the exchange rate risk associated with several different currenciesThe firm needs to consider its net exposure to currency risk instead of just looking at each currency separatelyHedging individual currencies could be expensive and may actually increase exposure19Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerPolitical RiskChanges in value due to political actions in the foreign countryInvestment in countries that have unstable governments should require higher returnsThe extent of political risk depends on the nature of the businessThe more dependent the business is on other operations within the firm, the less valuable it is to othersNatural resource development can be very valuable to others, especially if much of the ground work in developing the resource has already been doneLocal financing can often reduce political risk20Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan TraylerQuick QuizWhat does an exchange rate tell us?What is triangle arbitrage?What are absolute purchasing power parity and relative purchasing power parity?What are covered interest arbitrage and interest rate parity?What are uncovered interest parity and the International Fisher Effect?What is the difference between short-run interest rate exposure and long-run interest rate exposure? How can you hedge each type?What is political risk and what types of business face the greatest risk?21Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Essentials of Corporate Finance by Ross, Trayler, Bird, Westerfield & JordanSlides prepared by Rowan Trayler