International Financial Management, 14th Edition
By Jeff Madura
Contents:
Preface, xvii
About the Author, xxiii
Part 1: The International Financial Environment 1
1: Multi national Financial Management: An Over vie w 3
1-1 Managing the MNC, 4
1-1a How Business Disciplines Are Used to Manage the MNC, 4
1-1b Agency Problems, 4
1-1c Management Structure of an MNC, 6
1-2 Why MNCs Pursue International Business, 8
1-2a Theory of Comparative Advantage, 8
1-2b Imperfect Markets Theory, 8
1-2c Product Cycle Theory, 9
1-3 Methods to Conduct International Business, 10
1-3a International Trade, 10
1-3b Licensing, 10
1-3c Franchising, 10
1-3d Joint Ventures, 10
1-3e Acquisitions of Existing Operations, 11
1-3f Establishment of New Foreign Subsidiaries, 11
1-3g Summary of Methods, 12
1-4 Valuation Model for an MNC, 13
1-4a Domestic Valuation Model, 13
1-4b Multinational Valuation Model, 14
1-4c Uncertainty Surrounding an MNC’s Cash Flows, 17
1-4d How Uncertainty Affects the MNC’s Cost of Capital, 20
1-5 Organization of the Text, 20
2: Inter nati onal Flow of Funds31
2-1 Balance of Payments, 31
2-1a Current Account, 31
2-1b Financial Account, 32
2-1c Capital Account, 33
2-2 Growth in International Trade, 34
2-2a Events That Increased Trade Volume, 34
2-2b Impact of Outsourcing on Trade, 36
2-2c Trade Volume among Countries, 37
2-2d Trend in U.S. Balance of Trade, 37
2-3 Factors Affecting International Trade Flows, 39
2-3a Cost of Labor, 40
2-3b Inflation, 40
2-3c National Income, 40
2-3d Credit Conditions, 41
2-3e Government Policies, 41
2-3f Exchange Rates, 46
2-4 International Capital Flows, 49
2-4a Factors Affecting Direct Foreign Investment, 49
2-4b Factors Affecting International Portfolio Investment, 50
2-4c Impact of International Capital Flows, 50
2-5 Agencies that Facilitate International Flows, 51
2-5a International Monetary Fund, 52
2-5b World Bank, 53
2-5c World Trade Organization, 53
2-5d International Finance Corporation, 54
2-5e International Development Association, 54
2-5f Bank for International Settlements, 54
2-5g OECD, 54
2-5h Regional Development Agencies, 54
3: Inter nati onal Financial Mar kets 61
3-1 Foreign Exchange Market, 61
3-1a History of Foreign Exchange, 62
3-1b Foreign Exchange Transactions, 63
3-1c Foreign Exchange Quotations, 68
3.1d Derivative Contracts in the Foreign Exchange Market, 72
3-2 International Money Market, 73
3-2a Dollar-Denominated Bank Accounts in Europe and Asia, 74
3-2b Money Market Interest Rates among Currencies, 74
3-2c Risk of International Money Market Securities, 75
3-3 International Credit Market, 76
3-3a Syndicated Loans in the Credit Market, 76
3-4 International Bond Market, 76
3-4a Eurobond Market, 77
3-4b Development of Other Bond Markets, 78
3-4c Risk of International Bonds, 78
3-5 International Stock Markets, 79
3-5a Issuance of Stock in Foreign Markets, 79
3-5b Issuance of Foreign Stock in the United States, 79
3-5c How Governance Varies among Stock Markets, 81
3-5d Integration of International Stock Markets and Credit Markets, 82
3-6 International Financial Market Crises, 82
3-6a Contagion Effects, 83
3-7 How Financial Markets Serve MNCs, 85
Appendix 3: Investing in International Financial Markets, 93
4: Exchange Rate Determi nati on 101
4-1 Measuring Exchange Rate Movements, 101
4-2 Exchange Rate Equilibrium, 102
4-2a Demand for a Currency, 103
4-2b Supply of a Currency for Sale, 104
4-2c Equilibrium Exchange Rate, 105
4-2d Change in the Equilibrium Exchange Rate, 106
4-3 Factors That Influence Exchange Rates, 108
4-3a Relative Inflation Rates, 108
4-3b Relative Interest Rates, 110
4-3c Relative Income Levels, 111
4-3d Government Controls, 112
4-3e Expectations, 112
4-3f Interaction of Factors, 113
4-3g Influence of Factors across Multiple Currency Markets, 115
4-3h Impact of Liquidity on Exchange Rate Adjustments, 115
4-4 Movements in Cross Exchange Rates, 116
4-5 Capitalizing on Expected Exchange Rate Movements, 118
4-5a Institutional Speculation Based on Expected Appreciation, 118
4-5b Institutional Speculation Based on Expected Depreciation, 119
4-5c Speculation by Individuals, 119
4-5d Carry Trades, 120
5: Curre ncy Deri vati ves 131
5-1 Forward Market, 131
5-1a How MNCs Use Forward Contracts, 131
5-1b Bank Quotations on Forward Rates, 132
5-1c Premium or Discount on the Forward Rate, 133
5-1d Movements in the Forward Rate over Time, 134
5-1e Offsetting a Forward Contract, 134
5-1f Using Forward Contracts for Swap Transactions, 135
5-1g Non-deliverable Forward Contracts, 135
5-2 Currency Futures Market, 136
5-2a Contract Specifications, 136
5-2b Trading Currency Futures, 137
5-2c Credit Risk of Currency Futures Contracts, 138
5-2d Comparing Currency Futures and Forward Contracts, 138
5-2e How MNCs Use Currency Futures, 139
5-2f Speculation with Currency Futures, 140
5-3 Currency Options Market, 142
5-3a Currency Options Exchanges, 142
5-3b Over-the-Counter Currency Options Market, 142
5-4 Currency Call Options, 142
5-4a Factors Affecting Currency Call Option Premiums, 143
5-4b How MNCs Use Currency Call Options, 144
5-4c Speculating with Currency Call Options, 145
5-5 Currency Put Options, 148
5-5a Factors Affecting Currency Put Option Premiums, 149
5-5b How MNCs Use Currency Put Options, 149
5-5c Speculating with Currency Put Options, 150
5-6 Other Forms of Currency Options, 152
5-6a Conditional Currency Options, 152
5-6b European Currency Options, 154
Appendix 5A: Currency Option Pricing, 165
Appendix 5B: Currency Option Combinations, 169
Part 1 Integrative Problem: The International Financial Environment, 183
Part 2: Exchange Rate Behavior 185
6: Gover nme nt Infl uence on Exchange Rates 187
6-1 Exchange Rate Systems, 187
6-1a Fixed Exchange Rate System, 187
6-1b Freely Floating Exchange Rate System, 189
6-1c Managed Float Exchange Rate System, 190
6-1d Pegged Exchange Rate System, 191
6-1e Dollarization, 197
6-1f Black Markets for Currencies, 197
6-2 A Single European Currency, 197
6-2a Monetary Policy in the Eurozone, 198
6-2b Impact on Firms in the Eurozone, 198
6-2c Impact on Financial Flows in the Eurozone, 199
6-2d Impact of a Eurozone Country Crisis on Other Eurozone Countries, 199
6-2e Impact of a Country Abandoning the Euro, 201
6-3 Direct Intervention, 202
6-3a Reasons for Direct Intervention, 202
6-3b The Direct Intervention Process, 203
6-3c Direct Intervention as a Policy Tool, 205
6-3d Speculating on Direct Intervention, 206
6-4 Indirect Intervention, 208
6-4a Government Control of Interest Rates, 208
6-4b Government Use of Foreign Exchange Controls, 209
Appendix 6: Government Intervention during the Asian Crisis, 217
7: Inter nati onal Arbitra ge and Interest Rate Parit y 227
7-1 Locational Arbitrage, 227
7-1a Gains from Locational Arbitrage, 228
7-1b Realignment Due to Locational Arbitrage, 228
7-2 Triangular Arbitrage, 229
7-2a Gains from Triangular Arbitrage, 230
7-2b Realignment Due to Triangular Arbitrage, 232
7-3 Covered Interest Arbitrage, 233
7-3a Covered Interest Arbitrage Process, 233
7-3b Realignment Due to Covered Interest Arbitrage, 234
7-3c Arbitrage Example When Accounting for Spreads, 236
7-3d Covered Interest Arbitrage by Non-U.S. Investors, 236
7-3e Comparing Different Types of Arbitrage, 237
7-4 Interest Rate Parity (IRP), 238
7-4a Derivation of Interest Rate Parity, 238
7-4b Determining the Forward Premium, 239
7-4c Graphic Analysis of Interest Rate Parity, 241
7-4d Does Interest Rate Parity Hold?, 244
7-4e Considerations When Assessing Interest Rate Parity, 244
7-5 Variation in Forward Premiums, 245
7-5a Forward Premiums across Maturities, 245
7-5b Changes in Forward Premiums over Time, 246
8: Relati onships among Inflati on, Interest Rates ,
and Exchange Rates 259
8-1 Purchasing Power Parity (PPP), 259
8-1a Interpretations of Purchasing Power Parity, 259
8-1b Derivation of Purchasing Power Parity, 261
8-1c Using PPP to Estimate Exchange Rate Effects, 262
8-1d Graphic Analysis of Purchasing Power Parity, 263
8-1e Testing the Purchasing Power Parity Theory, 266
8-1f Why Deviations from PPP Exist, 267
8-2 International Fisher Effect, 268
8-2a Deriving a Country’s Expected Inflation Rate, 268
8-2b Estimating the Expected Exchange Rate Movement, 270
8-2c Implications of the International Fisher Effect, 270
8-2d Derivation of the International Fisher Effect, 272
8-2e Graphic Analysis of the International Fisher Effect, 275
8-2f Testing the International Fisher Effect, 276
8-2g Limitations of IFE Theory, 277
8-2h Comparison of IRP, PPP, and IFE Theories, 277
Part 2 Integrative Problem: Exchange Rate Behavior, 288
Midterm Self-Exam, 289
Part 3: Exchange Rate Risk Management 297
9: Fore casti ng Exchange Rates 299
9-1 Why Firms Forecast Exchange Rates, 299
9-2 Forecasting Techniques, 301
9-2a Technical Forecasting, 301
9-2b Fundamental Forecasting, 301
9-2c Market-Based Forecasting, 305
9-2d Mixed Forecasting, 307
9-3 Assessment of Forecast Performance, 309
9-3a Measurement of Forecast Error, 309
9-3b Forecast Errors among Time Horizons, 309
9-3c Forecast Errors among Currencies, 310
9-3d Comparing Forecast Errors among Forecast Techniques, 310
9-3e Graphic Evaluation of Forecast Bias, 311
9-3f Statistical Test of Forecast Bias, 313
9-3g Shifts in Forecast Bias over Time, 313
9-4 Accounting for Uncertainty Surrounding Forecasts, 313
9-4a Sensitivity Analysis Applied to Fundamental Forecasting, 314
9-4b Interval Forecasts, 314
10: Meas uri ng Exposure to Exchange Rate Fluctuati ons 325
10-1 Relevance of Exchange Rate Risk, 325
10-2 Transaction Exposure, 326
10-2a Estimating “Net” Cash Flows in Each Currency, 328
10-2b Transaction Exposure of an MNC’s Portfolio, 329
10-2c Transaction Exposure Based on Value at Risk, 331
10-3 Economic Exposure, 334
10-3a Exposure to Foreign Currency Depreciation, 335
10-3b Exposure to Foreign Currency Appreciation, 336
10-3c Measuring Economic Exposure, 336
10-4 Translation Exposure, 339
10-4a Determinants of Translation Exposure, 339
10-4b Exposure of an MNC’s Stock Price to Translation Effects, 341
11: Managing Tra nsacti on Exposure 355
11-1 Policies for Hedging Transaction Exposure, 355
11-1a Hedging Most of the Exposure, 355
11-1b Selective Hedging, 355
11-2 Hedging Exposure to Payables, 356
11-2a Forward or Futures Hedge on Payables, 356
11-2b Money Market Hedge on Payables, 357
11-2c Call Option Hedge on Payables, 358
11-2d Comparison of Techniques for Hedging Payables, 360
11-2e Evaluating Past Decisions on Hedging Payables, 363
11-3 Hedging Exposure to Receivables, 363
11-3a Forward or Futures Hedge on Receivables, 364
11-3b Money Market Hedge on Receivables, 364
11-3c Put Option Hedge on Receivables, 364
11-3d Comparison of Techniques for Hedging Receivables, 367
11-3e Evaluating Past Decisions on Hedging Receivables, 370
11-3f Summary of Hedging Techniques, 370
11-4 Limitations of Hedging, 371
11-4a Limitation of Hedging an Uncertain Payment, 371
11-4b Limitation of Repeated Short-Term Hedging, 371
11-5 Alternative Methods to Reduce Exchange Rate Risk, 373
11-5a Leading and Lagging, 373
11-5b Cross-Hedging, 374
11-5c Currency Diversification, 374
Appendix 11: Nontraditional Hedging Techniques, 388
12: Managing Economi c Exposure and Tra nslati on Exposure 393
12-1 Managing Economic Exposure, 393
12-1a Assessing Economic Exposure, 393
12-1b Restructuring to Reduce Economic Exposure, 394
12-1c Limitations of Restructuring Intended to Reduce Economic Exposure, 398
12-2 A Case Study on Hedging Economic Exposure, 398
12-2a Savor Co.’s Assessment of Economic Exposure, 398
12-2b Using a Financing Strategy to Hedge Economic Exposure, 400
12-3 Managing Exposure to Fixed Assets, 400
12-4 Managing Translation Exposure, 401
12-4a Hedging Translation Exposure with Forward Contracts, 401
12-4b Limitations of Hedging Translation Exposure, 402
Part 3 Integrative Problem: Exchange Risk Management, 411
Part 4: Long-Term Asset and Liability Management 413
13: Dire ct Forei gn Investme nt 415
13-1 Motives for Direct Foreign Investment, 415
13-1a Revenue-Related Motives, 415
13-1b Cost-Related Motives, 416
13-1c Comparing Benefits of DFI among Countries, 418
13-2 Benefits of International Diversification, 418
13-2a Diversification Analysis of International Projects, 420
13-3 Host Government Impact on DFI, 422
13-3a Incentives to Encourage DFI, 422
13-3b Barriers to DFI, 422
13-4 Assessing the Feasibility of Potential DFI, 424
13-4a A Case Study of Assessing Potential DFI, 424
13-4b Evaluating DFI Opportunities That Pass the First Screen, 426
14: Multi nati onal Capital Budgeti ng 435
14-1 Subsidiary versus Parent Perspective, 435
14-1a Tax Differentials, 435
14-1b Restrictions on Remitted Earnings, 436
14-1c Exchange Rate Movements, 436
14-1d Summary of Factors That Distinguish the Parent Perspective, 436
14-2 Input for Multinational Capital Budgeting, 437
14-3 Multinational Capital Budgeting Example, 439
14-3a Background, 439
14-3b Analysis, 440
14-4 Other Factors to Consider, 442
14-4a Exchange Rate Fluctuations, 442
14-4b Inflation, 445
14-4c Financing Arrangement, 446
14-4d Blocked Funds, 448
14-4e Uncertain Salvage Value, 450
14-4f Impact of Project on Prevailing Cash Flows, 451
14-4g Host Government Incentives, 451
14-4h Real Options, 452
14-5 Adjusting Project Assessment for Risk, 452
14-5a Risk-Adjusted Discount Rate, 452
14-5b Sensitivity Analysis, 453
14-5c Simulation, 456
Appendix 14: Incorporating International Tax Law in Multinational
Capital Budgeting, 468
15: Inter nati onal Corp orate Gover nance and Contr ol 475
15-1 International Corporate Governance, 475
15-1a Governance by Board Members, 475
15-1b Governance by Institutional Investors, 476
15-1c Governance by Shareholder Activists, 476
15-2 International Corporate Control, 477
15-2a Motives for International Acquisitions, 477
15-2b International Acquisition Process, 477
15-2c Barriers to International Corporate Control, 478
15-2d Model for Valuing a Foreign Target, 478
15-3 Factors Affecting Target Valuation, 480
15-3a Target-Specific Factors, 480
15-3b Country-Specific Factors, 481
15-4 A Case Study of Valuing a Foreign Target, 482
15-4a International Screening Process, 482
15-4b Estimating the Target’s Value, 483
15-4c Uncertainty Surrounding the Target’s Valuation, 484
15-4d Changes in Market Valuation of the Target over Time, 485
15-5 Disparity in Foreign Target Valuations, 486
15-5a Expected Cash Flows of the Foreign Target, 486
15-5b Exchange Rate Effects on Remitted Earnings, 486
15-5c Required Return of Acquirer, 487
15-6 Other Corporate Control Decisions, 487
15-6a International Partial Acquisitions, 487
15-6b International Acquisitions of Privatized Businesses, 488
15-6c International Divestitures, 488
15-7 Corporate Control Decisions as Real Options, 490
15-7a Call Option on Real Assets, 490
15-7b Put Option on Real Assets, 491
16: Countr y Ris k Anal ysis 501
16-1 Country Risk Characteristics, 501
16-1a Political Risk Characteristics, 501
16-1b Financial Risk Characteristics, 504
16-2 Measuring Country Risk, 505
16-2a Techniques for Assessing Country Risk, 506
16-2b Deriving a Country Risk Rating, 507
16-2c Comparing Risk Ratings among Countries, 509
16-3 Incorporating Risk in Capital Budgeting, 510
16-3a Adjustment of the Discount Rate, 510
16-3b Adjustment of the Estimated Cash Flows, 510
16-3c Analysis of Existing Projects, 513
16-4 Preventing Host Government Takeovers, 514
16-4a Use a Short-Term Horizon, 514
16-4b Rely on Unique Supplies or Technology, 514
16-4c Hire Local Labor, 514
16-4d Borrow Local Funds, 514
16-4e Purchase Insurance, 515
16-4f Use Project Finance, 515
17: Multi nati onal Capital Str ucture and Cost of Capital 525
17-1 Components of Capital, 525
17-1a Retained Earnings, 525
17-1b Sources of Debt, 526
17-1c External Sources of Equity, 527
17-2 The MNC’s Capital Structure Decision, 528
17-2a Influence of Corporate Characteristics, 529
17-2b Influence of Host Country Characteristics, 529
17-2c Response to Changing Country Characteristics, 530
17-3 Subsidiary versus Parent Capital Structure Decisions, 531
17-3a Impact of Increased Subsidiary Debt Financing, 531
17-3b Impact of Reduced Subsidiary Debt Financing, 531
17-3c Limitations in Offsetting a Subsidiary’s Leverage, 532
17-4 Multinational Cost of Capital, 532
17-4a MNC’s Cost of Debt, 532
17-4b MNC’s Cost of Equity, 532
17-4c Estimating an MNC’s Cost of Capital, 533
17-4d Comparing Costs of Debt and Equity, 533
17-4e Cost of Capital for MNCs versus Domestic Firms, 534
17-4f Cost-of-Equity Comparison Using the CAPM, 536
17-5 Cost of Capital Across Countries, 537
17-5a Country Differences in the Cost of Debt, 538
17-5b Country Differences in the Cost of Equity, 540
18: Long-Term Debt Financing 551
18-1 Debt Denomination Decisions of Foreign Subsidiaries, 551
18-1a Foreign Subsidiary Borrows Its Local Currency, 551
18-1b Foreign Subsidiary Borrows Dollars, 553
18-2 Debt Denomination Analysis: A Case Study, 553
18-2a Analyzing Debt Denomination Alternatives, 554
18-3 Strategies to Hedge Foreign Financing, 555
18-3a Using Currency Swaps, 555
18-3b Using Parallel Loans, 556
18-4 Debt Maturity Decision, 559
18-4a Assessment of the Yield Curve, 559
18-4b Financing Costs of Loans with Different Maturities, 560
18-5 Fixed-Rate versus Floating-Rate Debt Decision, 561
18-5a Financing Costs of Fixed-Rate versus Floating-Rate Loans, 561
18-5b Hedging Interest Payments with Interest Rate Swaps, 562
Part 4 Integrative Problem: Long-Term Asset and Liability Management, 573
Part 5: Short-Term Asset and Liability Management 575
19: Financing Inter nati onal Tra de 577
19-1 Payment Methods for International Trade, 577
19-1a Prepayment, 577
19-1b Letters of Credit, 578
19-1c Drafts, 580
19-1d Consignment, 581
19-1e Open Account, 581
19-1f Impact of the Credit Crisis on Payment Methods, 581
19-2 Trade Finance Methods, 581
19-2a Accounts Receivable Financing, 582
19-2b Factoring, 582
19-2c Letters of Credit, 583
19-2d Banker’s Acceptances, 583
19-2e Medium-Term Capital Goods Financing (Forfaiting), 586
19-2f Countertrade, 586
19-3 Agencies that Facilitate International Trade, 587
19-3a Export-Import Bank of the United States, 587
19-3b Private Export Funding Corporation, 589
19-3c Overseas Private Investment Corporation, 589
20: Short -Term Financing 595
20-1 Sources of Foreign Financing, 595
20-1a Internal Short-Term Financing, 595
20-1b External Short-Term Financing, 596
20-2 Financing with a Foreign Currency, 596
20-2a Motive for Financing with a Foreign Currency, 597
20-2b Potential Cost Savings from Financing with a Foreign Currency, 597
20-2c Risk of Financing with a Foreign Currency, 598
20-2d Hedging the Foreign Currency Borrowed, 599
20-2e Reliance on the Forward Rate for Forecasting, 600
20-2f Use of Probability Distributions to Enhance the Financing Decision, 601
20-3 Financing with a Portfolio of Currencies, 602
21: Inter nati onal Cas h Manageme nt 611
21-1 Multinational Working Capital Management, 611
21-1a Subsidiary Expenses, 611
21-1b Subsidiary Revenue, 612
21-1c Subsidiary Dividend Payments, 612
21-1d Subsidiary Liquidity Management, 612
21-2 Centralized Cash Management, 612
21-2a Accommodating Cash Shortages, 613
21-3 Optimizing Cash Flows, 614
21-3a Accelerating Cash Inflows, 614
21-3b Minimizing Currency Conversion Costs, 614
21-3c Managing Blocked Funds, 616
21-3d Managing Intersubsidiary Cash Transfers, 617
21-4 Investing Excess Cash, 617
21-4a Benefits of Investing in a Foreign Currency, 617
21-4b Risk of Investing in a Foreign Currency, 618
21-4c Hedging the Investment in a Foreign Currency, 619
21-4d Break-Even Point from Investing in a Foreign Currency, 620
21-4e Using a Probability Distribution to Enhance the Investment Decision, 621
21-4f Investing in a Portfolio of Currencies, 622
21-4g Dynamic Hedging, 624
Part 5 Integrative Problem: Short-Term Asset and Liability Management, 631
Final Self-Exam, 633
Appendix A: Answers to Self-Test Questions, 643
Appendix B: Supplemental Cases, 656
Appendix C: Using Excel to Conduct Analysis, 676
Appendix D: International Investing Project, 684
Appendix E: Discussion in the Boardroom, 687
Appendix F: Use of Bitcoin to Conduct International Transactions, 695
Glossary, 698
Index, 705
About the Author, xxiii
Part 1: The International Financial Environment 1
1: Multi national Financial Management: An Over vie w 3
1-1 Managing the MNC, 4
1-1a How Business Disciplines Are Used to Manage the MNC, 4
1-1b Agency Problems, 4
1-1c Management Structure of an MNC, 6
1-2 Why MNCs Pursue International Business, 8
1-2a Theory of Comparative Advantage, 8
1-2b Imperfect Markets Theory, 8
1-2c Product Cycle Theory, 9
1-3 Methods to Conduct International Business, 10
1-3a International Trade, 10
1-3b Licensing, 10
1-3c Franchising, 10
1-3d Joint Ventures, 10
1-3e Acquisitions of Existing Operations, 11
1-3f Establishment of New Foreign Subsidiaries, 11
1-3g Summary of Methods, 12
1-4 Valuation Model for an MNC, 13
1-4a Domestic Valuation Model, 13
1-4b Multinational Valuation Model, 14
1-4c Uncertainty Surrounding an MNC’s Cash Flows, 17
1-4d How Uncertainty Affects the MNC’s Cost of Capital, 20
1-5 Organization of the Text, 20
2: Inter nati onal Flow of Funds31
2-1 Balance of Payments, 31
2-1a Current Account, 31
2-1b Financial Account, 32
2-1c Capital Account, 33
2-2 Growth in International Trade, 34
2-2a Events That Increased Trade Volume, 34
2-2b Impact of Outsourcing on Trade, 36
2-2c Trade Volume among Countries, 37
2-2d Trend in U.S. Balance of Trade, 37
2-3 Factors Affecting International Trade Flows, 39
2-3a Cost of Labor, 40
2-3b Inflation, 40
2-3c National Income, 40
2-3d Credit Conditions, 41
2-3e Government Policies, 41
2-3f Exchange Rates, 46
2-4 International Capital Flows, 49
2-4a Factors Affecting Direct Foreign Investment, 49
2-4b Factors Affecting International Portfolio Investment, 50
2-4c Impact of International Capital Flows, 50
2-5 Agencies that Facilitate International Flows, 51
2-5a International Monetary Fund, 52
2-5b World Bank, 53
2-5c World Trade Organization, 53
2-5d International Finance Corporation, 54
2-5e International Development Association, 54
2-5f Bank for International Settlements, 54
2-5g OECD, 54
2-5h Regional Development Agencies, 54
3: Inter nati onal Financial Mar kets 61
3-1 Foreign Exchange Market, 61
3-1a History of Foreign Exchange, 62
3-1b Foreign Exchange Transactions, 63
3-1c Foreign Exchange Quotations, 68
3.1d Derivative Contracts in the Foreign Exchange Market, 72
3-2 International Money Market, 73
3-2a Dollar-Denominated Bank Accounts in Europe and Asia, 74
3-2b Money Market Interest Rates among Currencies, 74
3-2c Risk of International Money Market Securities, 75
3-3 International Credit Market, 76
3-3a Syndicated Loans in the Credit Market, 76
3-4 International Bond Market, 76
3-4a Eurobond Market, 77
3-4b Development of Other Bond Markets, 78
3-4c Risk of International Bonds, 78
3-5 International Stock Markets, 79
3-5a Issuance of Stock in Foreign Markets, 79
3-5b Issuance of Foreign Stock in the United States, 79
3-5c How Governance Varies among Stock Markets, 81
3-5d Integration of International Stock Markets and Credit Markets, 82
3-6 International Financial Market Crises, 82
3-6a Contagion Effects, 83
3-7 How Financial Markets Serve MNCs, 85
Appendix 3: Investing in International Financial Markets, 93
4: Exchange Rate Determi nati on 101
4-1 Measuring Exchange Rate Movements, 101
4-2 Exchange Rate Equilibrium, 102
4-2a Demand for a Currency, 103
4-2b Supply of a Currency for Sale, 104
4-2c Equilibrium Exchange Rate, 105
4-2d Change in the Equilibrium Exchange Rate, 106
4-3 Factors That Influence Exchange Rates, 108
4-3a Relative Inflation Rates, 108
4-3b Relative Interest Rates, 110
4-3c Relative Income Levels, 111
4-3d Government Controls, 112
4-3e Expectations, 112
4-3f Interaction of Factors, 113
4-3g Influence of Factors across Multiple Currency Markets, 115
4-3h Impact of Liquidity on Exchange Rate Adjustments, 115
4-4 Movements in Cross Exchange Rates, 116
4-5 Capitalizing on Expected Exchange Rate Movements, 118
4-5a Institutional Speculation Based on Expected Appreciation, 118
4-5b Institutional Speculation Based on Expected Depreciation, 119
4-5c Speculation by Individuals, 119
4-5d Carry Trades, 120
5: Curre ncy Deri vati ves 131
5-1 Forward Market, 131
5-1a How MNCs Use Forward Contracts, 131
5-1b Bank Quotations on Forward Rates, 132
5-1c Premium or Discount on the Forward Rate, 133
5-1d Movements in the Forward Rate over Time, 134
5-1e Offsetting a Forward Contract, 134
5-1f Using Forward Contracts for Swap Transactions, 135
5-1g Non-deliverable Forward Contracts, 135
5-2 Currency Futures Market, 136
5-2a Contract Specifications, 136
5-2b Trading Currency Futures, 137
5-2c Credit Risk of Currency Futures Contracts, 138
5-2d Comparing Currency Futures and Forward Contracts, 138
5-2e How MNCs Use Currency Futures, 139
5-2f Speculation with Currency Futures, 140
5-3 Currency Options Market, 142
5-3a Currency Options Exchanges, 142
5-3b Over-the-Counter Currency Options Market, 142
5-4 Currency Call Options, 142
5-4a Factors Affecting Currency Call Option Premiums, 143
5-4b How MNCs Use Currency Call Options, 144
5-4c Speculating with Currency Call Options, 145
5-5 Currency Put Options, 148
5-5a Factors Affecting Currency Put Option Premiums, 149
5-5b How MNCs Use Currency Put Options, 149
5-5c Speculating with Currency Put Options, 150
5-6 Other Forms of Currency Options, 152
5-6a Conditional Currency Options, 152
5-6b European Currency Options, 154
Appendix 5A: Currency Option Pricing, 165
Appendix 5B: Currency Option Combinations, 169
Part 1 Integrative Problem: The International Financial Environment, 183
Part 2: Exchange Rate Behavior 185
6: Gover nme nt Infl uence on Exchange Rates 187
6-1 Exchange Rate Systems, 187
6-1a Fixed Exchange Rate System, 187
6-1b Freely Floating Exchange Rate System, 189
6-1c Managed Float Exchange Rate System, 190
6-1d Pegged Exchange Rate System, 191
6-1e Dollarization, 197
6-1f Black Markets for Currencies, 197
6-2 A Single European Currency, 197
6-2a Monetary Policy in the Eurozone, 198
6-2b Impact on Firms in the Eurozone, 198
6-2c Impact on Financial Flows in the Eurozone, 199
6-2d Impact of a Eurozone Country Crisis on Other Eurozone Countries, 199
6-2e Impact of a Country Abandoning the Euro, 201
6-3 Direct Intervention, 202
6-3a Reasons for Direct Intervention, 202
6-3b The Direct Intervention Process, 203
6-3c Direct Intervention as a Policy Tool, 205
6-3d Speculating on Direct Intervention, 206
6-4 Indirect Intervention, 208
6-4a Government Control of Interest Rates, 208
6-4b Government Use of Foreign Exchange Controls, 209
Appendix 6: Government Intervention during the Asian Crisis, 217
7: Inter nati onal Arbitra ge and Interest Rate Parit y 227
7-1 Locational Arbitrage, 227
7-1a Gains from Locational Arbitrage, 228
7-1b Realignment Due to Locational Arbitrage, 228
7-2 Triangular Arbitrage, 229
7-2a Gains from Triangular Arbitrage, 230
7-2b Realignment Due to Triangular Arbitrage, 232
7-3 Covered Interest Arbitrage, 233
7-3a Covered Interest Arbitrage Process, 233
7-3b Realignment Due to Covered Interest Arbitrage, 234
7-3c Arbitrage Example When Accounting for Spreads, 236
7-3d Covered Interest Arbitrage by Non-U.S. Investors, 236
7-3e Comparing Different Types of Arbitrage, 237
7-4 Interest Rate Parity (IRP), 238
7-4a Derivation of Interest Rate Parity, 238
7-4b Determining the Forward Premium, 239
7-4c Graphic Analysis of Interest Rate Parity, 241
7-4d Does Interest Rate Parity Hold?, 244
7-4e Considerations When Assessing Interest Rate Parity, 244
7-5 Variation in Forward Premiums, 245
7-5a Forward Premiums across Maturities, 245
7-5b Changes in Forward Premiums over Time, 246
8: Relati onships among Inflati on, Interest Rates ,
and Exchange Rates 259
8-1 Purchasing Power Parity (PPP), 259
8-1a Interpretations of Purchasing Power Parity, 259
8-1b Derivation of Purchasing Power Parity, 261
8-1c Using PPP to Estimate Exchange Rate Effects, 262
8-1d Graphic Analysis of Purchasing Power Parity, 263
8-1e Testing the Purchasing Power Parity Theory, 266
8-1f Why Deviations from PPP Exist, 267
8-2 International Fisher Effect, 268
8-2a Deriving a Country’s Expected Inflation Rate, 268
8-2b Estimating the Expected Exchange Rate Movement, 270
8-2c Implications of the International Fisher Effect, 270
8-2d Derivation of the International Fisher Effect, 272
8-2e Graphic Analysis of the International Fisher Effect, 275
8-2f Testing the International Fisher Effect, 276
8-2g Limitations of IFE Theory, 277
8-2h Comparison of IRP, PPP, and IFE Theories, 277
Part 2 Integrative Problem: Exchange Rate Behavior, 288
Midterm Self-Exam, 289
Part 3: Exchange Rate Risk Management 297
9: Fore casti ng Exchange Rates 299
9-1 Why Firms Forecast Exchange Rates, 299
9-2 Forecasting Techniques, 301
9-2a Technical Forecasting, 301
9-2b Fundamental Forecasting, 301
9-2c Market-Based Forecasting, 305
9-2d Mixed Forecasting, 307
9-3 Assessment of Forecast Performance, 309
9-3a Measurement of Forecast Error, 309
9-3b Forecast Errors among Time Horizons, 309
9-3c Forecast Errors among Currencies, 310
9-3d Comparing Forecast Errors among Forecast Techniques, 310
9-3e Graphic Evaluation of Forecast Bias, 311
9-3f Statistical Test of Forecast Bias, 313
9-3g Shifts in Forecast Bias over Time, 313
9-4 Accounting for Uncertainty Surrounding Forecasts, 313
9-4a Sensitivity Analysis Applied to Fundamental Forecasting, 314
9-4b Interval Forecasts, 314
10: Meas uri ng Exposure to Exchange Rate Fluctuati ons 325
10-1 Relevance of Exchange Rate Risk, 325
10-2 Transaction Exposure, 326
10-2a Estimating “Net” Cash Flows in Each Currency, 328
10-2b Transaction Exposure of an MNC’s Portfolio, 329
10-2c Transaction Exposure Based on Value at Risk, 331
10-3 Economic Exposure, 334
10-3a Exposure to Foreign Currency Depreciation, 335
10-3b Exposure to Foreign Currency Appreciation, 336
10-3c Measuring Economic Exposure, 336
10-4 Translation Exposure, 339
10-4a Determinants of Translation Exposure, 339
10-4b Exposure of an MNC’s Stock Price to Translation Effects, 341
11: Managing Tra nsacti on Exposure 355
11-1 Policies for Hedging Transaction Exposure, 355
11-1a Hedging Most of the Exposure, 355
11-1b Selective Hedging, 355
11-2 Hedging Exposure to Payables, 356
11-2a Forward or Futures Hedge on Payables, 356
11-2b Money Market Hedge on Payables, 357
11-2c Call Option Hedge on Payables, 358
11-2d Comparison of Techniques for Hedging Payables, 360
11-2e Evaluating Past Decisions on Hedging Payables, 363
11-3 Hedging Exposure to Receivables, 363
11-3a Forward or Futures Hedge on Receivables, 364
11-3b Money Market Hedge on Receivables, 364
11-3c Put Option Hedge on Receivables, 364
11-3d Comparison of Techniques for Hedging Receivables, 367
11-3e Evaluating Past Decisions on Hedging Receivables, 370
11-3f Summary of Hedging Techniques, 370
11-4 Limitations of Hedging, 371
11-4a Limitation of Hedging an Uncertain Payment, 371
11-4b Limitation of Repeated Short-Term Hedging, 371
11-5 Alternative Methods to Reduce Exchange Rate Risk, 373
11-5a Leading and Lagging, 373
11-5b Cross-Hedging, 374
11-5c Currency Diversification, 374
Appendix 11: Nontraditional Hedging Techniques, 388
12: Managing Economi c Exposure and Tra nslati on Exposure 393
12-1 Managing Economic Exposure, 393
12-1a Assessing Economic Exposure, 393
12-1b Restructuring to Reduce Economic Exposure, 394
12-1c Limitations of Restructuring Intended to Reduce Economic Exposure, 398
12-2 A Case Study on Hedging Economic Exposure, 398
12-2a Savor Co.’s Assessment of Economic Exposure, 398
12-2b Using a Financing Strategy to Hedge Economic Exposure, 400
12-3 Managing Exposure to Fixed Assets, 400
12-4 Managing Translation Exposure, 401
12-4a Hedging Translation Exposure with Forward Contracts, 401
12-4b Limitations of Hedging Translation Exposure, 402
Part 3 Integrative Problem: Exchange Risk Management, 411
Part 4: Long-Term Asset and Liability Management 413
13: Dire ct Forei gn Investme nt 415
13-1 Motives for Direct Foreign Investment, 415
13-1a Revenue-Related Motives, 415
13-1b Cost-Related Motives, 416
13-1c Comparing Benefits of DFI among Countries, 418
13-2 Benefits of International Diversification, 418
13-2a Diversification Analysis of International Projects, 420
13-3 Host Government Impact on DFI, 422
13-3a Incentives to Encourage DFI, 422
13-3b Barriers to DFI, 422
13-4 Assessing the Feasibility of Potential DFI, 424
13-4a A Case Study of Assessing Potential DFI, 424
13-4b Evaluating DFI Opportunities That Pass the First Screen, 426
14: Multi nati onal Capital Budgeti ng 435
14-1 Subsidiary versus Parent Perspective, 435
14-1a Tax Differentials, 435
14-1b Restrictions on Remitted Earnings, 436
14-1c Exchange Rate Movements, 436
14-1d Summary of Factors That Distinguish the Parent Perspective, 436
14-2 Input for Multinational Capital Budgeting, 437
14-3 Multinational Capital Budgeting Example, 439
14-3a Background, 439
14-3b Analysis, 440
14-4 Other Factors to Consider, 442
14-4a Exchange Rate Fluctuations, 442
14-4b Inflation, 445
14-4c Financing Arrangement, 446
14-4d Blocked Funds, 448
14-4e Uncertain Salvage Value, 450
14-4f Impact of Project on Prevailing Cash Flows, 451
14-4g Host Government Incentives, 451
14-4h Real Options, 452
14-5 Adjusting Project Assessment for Risk, 452
14-5a Risk-Adjusted Discount Rate, 452
14-5b Sensitivity Analysis, 453
14-5c Simulation, 456
Appendix 14: Incorporating International Tax Law in Multinational
Capital Budgeting, 468
15: Inter nati onal Corp orate Gover nance and Contr ol 475
15-1 International Corporate Governance, 475
15-1a Governance by Board Members, 475
15-1b Governance by Institutional Investors, 476
15-1c Governance by Shareholder Activists, 476
15-2 International Corporate Control, 477
15-2a Motives for International Acquisitions, 477
15-2b International Acquisition Process, 477
15-2c Barriers to International Corporate Control, 478
15-2d Model for Valuing a Foreign Target, 478
15-3 Factors Affecting Target Valuation, 480
15-3a Target-Specific Factors, 480
15-3b Country-Specific Factors, 481
15-4 A Case Study of Valuing a Foreign Target, 482
15-4a International Screening Process, 482
15-4b Estimating the Target’s Value, 483
15-4c Uncertainty Surrounding the Target’s Valuation, 484
15-4d Changes in Market Valuation of the Target over Time, 485
15-5 Disparity in Foreign Target Valuations, 486
15-5a Expected Cash Flows of the Foreign Target, 486
15-5b Exchange Rate Effects on Remitted Earnings, 486
15-5c Required Return of Acquirer, 487
15-6 Other Corporate Control Decisions, 487
15-6a International Partial Acquisitions, 487
15-6b International Acquisitions of Privatized Businesses, 488
15-6c International Divestitures, 488
15-7 Corporate Control Decisions as Real Options, 490
15-7a Call Option on Real Assets, 490
15-7b Put Option on Real Assets, 491
16: Countr y Ris k Anal ysis 501
16-1 Country Risk Characteristics, 501
16-1a Political Risk Characteristics, 501
16-1b Financial Risk Characteristics, 504
16-2 Measuring Country Risk, 505
16-2a Techniques for Assessing Country Risk, 506
16-2b Deriving a Country Risk Rating, 507
16-2c Comparing Risk Ratings among Countries, 509
16-3 Incorporating Risk in Capital Budgeting, 510
16-3a Adjustment of the Discount Rate, 510
16-3b Adjustment of the Estimated Cash Flows, 510
16-3c Analysis of Existing Projects, 513
16-4 Preventing Host Government Takeovers, 514
16-4a Use a Short-Term Horizon, 514
16-4b Rely on Unique Supplies or Technology, 514
16-4c Hire Local Labor, 514
16-4d Borrow Local Funds, 514
16-4e Purchase Insurance, 515
16-4f Use Project Finance, 515
17: Multi nati onal Capital Str ucture and Cost of Capital 525
17-1 Components of Capital, 525
17-1a Retained Earnings, 525
17-1b Sources of Debt, 526
17-1c External Sources of Equity, 527
17-2 The MNC’s Capital Structure Decision, 528
17-2a Influence of Corporate Characteristics, 529
17-2b Influence of Host Country Characteristics, 529
17-2c Response to Changing Country Characteristics, 530
17-3 Subsidiary versus Parent Capital Structure Decisions, 531
17-3a Impact of Increased Subsidiary Debt Financing, 531
17-3b Impact of Reduced Subsidiary Debt Financing, 531
17-3c Limitations in Offsetting a Subsidiary’s Leverage, 532
17-4 Multinational Cost of Capital, 532
17-4a MNC’s Cost of Debt, 532
17-4b MNC’s Cost of Equity, 532
17-4c Estimating an MNC’s Cost of Capital, 533
17-4d Comparing Costs of Debt and Equity, 533
17-4e Cost of Capital for MNCs versus Domestic Firms, 534
17-4f Cost-of-Equity Comparison Using the CAPM, 536
17-5 Cost of Capital Across Countries, 537
17-5a Country Differences in the Cost of Debt, 538
17-5b Country Differences in the Cost of Equity, 540
18: Long-Term Debt Financing 551
18-1 Debt Denomination Decisions of Foreign Subsidiaries, 551
18-1a Foreign Subsidiary Borrows Its Local Currency, 551
18-1b Foreign Subsidiary Borrows Dollars, 553
18-2 Debt Denomination Analysis: A Case Study, 553
18-2a Analyzing Debt Denomination Alternatives, 554
18-3 Strategies to Hedge Foreign Financing, 555
18-3a Using Currency Swaps, 555
18-3b Using Parallel Loans, 556
18-4 Debt Maturity Decision, 559
18-4a Assessment of the Yield Curve, 559
18-4b Financing Costs of Loans with Different Maturities, 560
18-5 Fixed-Rate versus Floating-Rate Debt Decision, 561
18-5a Financing Costs of Fixed-Rate versus Floating-Rate Loans, 561
18-5b Hedging Interest Payments with Interest Rate Swaps, 562
Part 4 Integrative Problem: Long-Term Asset and Liability Management, 573
Part 5: Short-Term Asset and Liability Management 575
19: Financing Inter nati onal Tra de 577
19-1 Payment Methods for International Trade, 577
19-1a Prepayment, 577
19-1b Letters of Credit, 578
19-1c Drafts, 580
19-1d Consignment, 581
19-1e Open Account, 581
19-1f Impact of the Credit Crisis on Payment Methods, 581
19-2 Trade Finance Methods, 581
19-2a Accounts Receivable Financing, 582
19-2b Factoring, 582
19-2c Letters of Credit, 583
19-2d Banker’s Acceptances, 583
19-2e Medium-Term Capital Goods Financing (Forfaiting), 586
19-2f Countertrade, 586
19-3 Agencies that Facilitate International Trade, 587
19-3a Export-Import Bank of the United States, 587
19-3b Private Export Funding Corporation, 589
19-3c Overseas Private Investment Corporation, 589
20: Short -Term Financing 595
20-1 Sources of Foreign Financing, 595
20-1a Internal Short-Term Financing, 595
20-1b External Short-Term Financing, 596
20-2 Financing with a Foreign Currency, 596
20-2a Motive for Financing with a Foreign Currency, 597
20-2b Potential Cost Savings from Financing with a Foreign Currency, 597
20-2c Risk of Financing with a Foreign Currency, 598
20-2d Hedging the Foreign Currency Borrowed, 599
20-2e Reliance on the Forward Rate for Forecasting, 600
20-2f Use of Probability Distributions to Enhance the Financing Decision, 601
20-3 Financing with a Portfolio of Currencies, 602
21: Inter nati onal Cas h Manageme nt 611
21-1 Multinational Working Capital Management, 611
21-1a Subsidiary Expenses, 611
21-1b Subsidiary Revenue, 612
21-1c Subsidiary Dividend Payments, 612
21-1d Subsidiary Liquidity Management, 612
21-2 Centralized Cash Management, 612
21-2a Accommodating Cash Shortages, 613
21-3 Optimizing Cash Flows, 614
21-3a Accelerating Cash Inflows, 614
21-3b Minimizing Currency Conversion Costs, 614
21-3c Managing Blocked Funds, 616
21-3d Managing Intersubsidiary Cash Transfers, 617
21-4 Investing Excess Cash, 617
21-4a Benefits of Investing in a Foreign Currency, 617
21-4b Risk of Investing in a Foreign Currency, 618
21-4c Hedging the Investment in a Foreign Currency, 619
21-4d Break-Even Point from Investing in a Foreign Currency, 620
21-4e Using a Probability Distribution to Enhance the Investment Decision, 621
21-4f Investing in a Portfolio of Currencies, 622
21-4g Dynamic Hedging, 624
Part 5 Integrative Problem: Short-Term Asset and Liability Management, 631
Final Self-Exam, 633
Appendix A: Answers to Self-Test Questions, 643
Appendix B: Supplemental Cases, 656
Appendix C: Using Excel to Conduct Analysis, 676
Appendix D: International Investing Project, 684
Appendix E: Discussion in the Boardroom, 687
Appendix F: Use of Bitcoin to Conduct International Transactions, 695
Glossary, 698
Index, 705