International Finance & Financial Markets Maf306: I R D I M 14 H (Libid Libor) 15

INTERNATIONAL FINANCE & FINANCIAL
MARKETS MAF306
EXAM SUMMARY NOTES
TOPIC 1 - INTRODUCTION 4
GLOBAL OPERATION 4
TYPES OF MULTI-NATIONAL CORPORATIONS (MNC) 4
WHY FOREIGN DIRECT INVESTMENT (FDI) 4
GLOBALIZATION EFFECT ON INDUSTRY CONSOLIDATION 5
COSTS AND BENEFITS OF INTERNATIONALISATION 5
TOPIC 2 – EXCHANGE RATE & DETERMINATION OF EXCHANGE RATES 7

VALUE OF THE DOLLAR WILL APPRECIATE, DEPRECIATE, OR REMAIN 7
ADOPTING AN EASIER MONETARY POLICY 7
FOREIGN EXCHANGE MARKET INTERVENTION 8
STERILIZATION 8
CAPITAL INFLOWS 8
CHANGES IN THE EXCHANGE RATE 9
CURRENCY INTERVENTION 9
TOPIC 3 – INTERNATIONAL MARKETS & EURO CURRENCY MARKETS 11

SECURITIZATION 11
MULTI-NATIONAL CORPORATIONS (MNC) 11
LISTING SHARES ON FOREIGN STOCK EXCHANGES 12
ISSUING FOREIGN CURRENCY DEBT 12
DEFINITIONS: EUROBOND, EUROCURRENCY LOAN, FOREIGN BOND, EURODOLLAR MARKET, EUROBANKS,
NOTE ISSUANCE FACILITIES (NIF) 12
INTERBANK MARKETS 14
INTEREST RATE DETERMINATION IN THE INTERBANK MARKET 14
HOW INTEREST RATES (LIBID AND LIBOR) ARE DETERMINED 15
TOPIC 4 – FOREIGN DIRECT INVESTMENT (FDI) 17

SEQUENTIAL STRATEGY 17
EXPORTING 17
FOREIGN PRODUCTION 17
LICENSING 17
FACTORS IN DECIDING HOW TO ENTER A MARKET 18
ADVANTAGES & DISADVANTAGES OF FDI TO HOST COUNTRY 18
ADVANTAGES & DISADVANTAGES OF FDI TO HOME COUNTRY 19
OLI THEORY (OWNERSHIP, LOCATION, INTERNALISATION) 19
TOPIC 5 – COUNTRY RISK 21

NEW MEXICAN MODEL 21
ECONOMIC CONSEQUENCES OF POLICY CHANGE 22
1
TOPIC 6 – MNC CAPITAL BUDGETING, STRUCTURE & COST OF CAPITAL (COC) 24
COST OF CAPITAL FOR FOREIGN INVESTMENT 24
FACTORS - COC FOR FOREIGN AFFILIATE 24
HIGHLY LEVERAGED FOREIGN SUBSIDIARY - ADVANTAGES & DISADVANTAGES 24
WEIGHTED AVERAGE COST OF CAPITAL (WACC) 25
COST OF CAPITAL (COC) 25
PECKING ORDER THEORY 26
MM’S IRRELEVANCE PROPOSITION (1958) 26
DOMESTIC NPV CALCULATION 26
TOPIC 7 – FOREIGN EXCHANGE MARKETS 28

TYPES OF FOREIGN EXCHANGE (FX) TRANSACTIONS 28
FX RATES & QUOTATION 28
CROSS RATES 29
THE FORWARD MARKET – DIRECT AND INDIRECT FORMULAS 29
EXAMPLE QUESTIONS 30
TOPIC 8 – INTERNATIONAL PARITY CONDITIONS (IPC) 31

LAW OF ONE PRICE (LOP) – ‘BIG MAC STANDARD’ 31
ARBITRAGE 31
FIVE PARITY CONDITIONS FROM INTERNATIONAL ARBITRAGE ACTIVITIES 31
1. PURCHASING POWER PARITY (PPP) 31
2. FISHER EFFECT (FE) 33
3. INTERNATIONAL FISHER EFFECT (IFE) 33
4. INTEREST RATE PARITY (IRP) 34
5. COVERED INTEREST ARBITRAGE (CIA) 34
EXAMPLE – IRP, CIA & ARBITRAGE OPPORTUNITY 35
TOPIC 9 – FOREIGN EXCHANGE DERIVATIVES 37

FUTURES 37
FORWARDS VS FUTURES 37
CURRENCY FUTURES - HEDGING 38
CURRENCY OPTIONS 38
STATUS OF AN OPTION 38
FOREIGN EXCHANGE OPTIONS V FORWARDS 39
OPTION PRICING & VALUATION 39
• HEDGING USING OPTIONS 39
• SPECULATION USING OPTIONS 39
• ARBITRAGE 39
ADVANTAGES & DISADVANTAGES OF USING CURRENCY FUTURES V CURRENCY OPTIONS TO HEDGE: 40
TOPIC 10 – FOREIGN EXCHANGE RISK MANAGEMENT 41

FOREIGN EXCHANGE EXPOSURE 41
TRANSLATION EXPOSURE (ACCOUNTING EXPOSURE) 41
EXAMPLE - FX EXPOSURE 42
ECONOMIC/OPERATING EXPOSURE 42
MANAGEMENT OF FX RISK EXPOSURE - HEDGING 43
HEDGING WITH FUTURE MARKET 43
MONEY MARKET HEDGE 44
HEDGING USING OPTIONS 44
2
NATURAL HEDGES 45
RISK SHIFTING 45
EXPOSURE NETTING 45
CURRENCY RISK-SHARING 45
LEAD & LAG 45
3
Topic 1 - Introduction
Global Operation
• Advantages from global operations: Access to markets worldwide, global

reach to find less expensive materials abroad and intellectual capital, thereby
lowering its cost of designing and manufacturing products.
• New profit opportunities from global operations: Lower costs of goods
sourced from countries with weakened currencies, more opportunities for lower
cost outsourcing, expansion of industrial and financial services activities through
purchases of companies or assets at reduced prices and lower U.S. debt financing
costs.
• Risks from global operations: Currency risks, higher receivables delinquencies
and bad debts, delays or cancellation of sales and orders, higher local currency
financing costs, and a slowdown in established financial services activities.
o Increased competition – abroad and domestic
Types of Multi-National Corporations (MNC)
• Raw material seeker: go abroad to exploit the raw materials that can be found
there.
o First type of MNC to exist.
• Market seeker: go overseas to produce and sell in foreign markets.
• Cost minimiser: invest in lower-cost production sites overseas to remain cost
competitive both at home and abroad.
• Knowledge seeker: Related to human capital and advanced technology.
Corporations might recruit a CEO with multinational exposure (example:
recruitment of Nissan’s CEO, who was working in Europe) or acquire a company
to gain access to knowledge and experience of the company working abroad.
Why Foreign Direct Investment (FDI)
• FDI is most likely to be economically viable where the possibility of opportunism

on the part of unrelated parties or contractual difficulties make it especially costly
to coordinate economic activities via arm's length transactions in the marketplace.
4
They go overseas to more fully utilize their skills and other tangible and intangible
assets.
• Raw material seeker:
o Must have intangible capabilities in the form of technical skills and face
contractual difficulties in the form of an inability to price their know-how
or to write, monitor, and enforce use restrictions governing technology
transfer arrangements;
o Face problems of opportunism that make it very expensive to enter into
long-term purchase contracts to fully utilize their production or
distribution capability.
• Market seeker: These firms usually have intangible capital in the form of
organizational skills that are inseparable from the firm itself.
o Since it would be difficult, if not impossible, to unbundle these services and
sell them apart from the firm, this form of market imperfection often leads
to corporate attempts to exert control directly via the establishment of
foreign affiliates.
• Cost minimiser:
o The production or marketing edge they possess cannot be purchased or
duplicated by local competitors.
Globalization effect on industry consolidation
• Companies must take advantage of economies of scale – increasing competition –

increasing industry consolidation worldwide.
• Companies can be low-cost producers – becoming more competitive. To realise
low costs, companies are forced to spread fixed costs over a large sales volume.
Costs and Benefits of internationalisation
• Costs:
o Loss of national autonomy;
o Loss of central bank control over MP and domestic banking;
o Increased fragility and instability in financial markets, products and
financial system.
• Benefits:
o Gains from I/N trade – we get more of everything at lower cost;

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INTERNATIONAL FINANCE & FINANCIAL

EXAM SUMMARY NOTES

TOPIC 2 – EXCHANGE RATE & DETERMINATION OF EXCHANGE RATES 7

TOPIC 3 – INTERNATIONAL MARKETS & EURO CURRENCY MARKETS 11

TOPIC 4 – FOREIGN DIRECT INVESTMENT (FDI) 17

TOPIC 5 – COUNTRY RISK 21

TOPIC 7 – FOREIGN EXCHANGE MARKETS 28

TOPIC 8 – INTERNATIONAL PARITY CONDITIONS (IPC) 31

TOPIC 9 – FOREIGN EXCHANGE DERIVATIVES 37

TOPIC 10 – FOREIGN EXCHANGE RISK MANAGEMENT 41

• Advantages from global operations: Access to markets worldwide, global

Types of Multi-National Corporations (MNC)

Why Foreign Direct Investment (FDI)

• FDI is most likely to be economically viable where the possibility of opportunism

Globalization effect on industry consolidation

• Companies must take advantage of economies of scale – increasing competition –

Costs and Benefits of internationalisation

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