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UncomplicatedBiography4321

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Shalom Theological University

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international finance financial markets exchange rates multinational corporations

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This document covers the fundamentals of international finance, including multinational corporations (MNCs), agency problems, and international business methods. Also included is a discussion of the balance of payments, exchange rates and the forces that drive them.

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**Chapter 1: Multinational Financial Management**  Understanding MNCs **What is a multinational corporation?** -Firms that engage in some form of international business **Why do firms become multinational? Three Theories:** **Theory of competitive advantage**: specialization increases productio...

**Chapter 1: Multinational Financial Management**  Understanding MNCs **What is a multinational corporation?** -Firms that engage in some form of international business **Why do firms become multinational? Three Theories:** **Theory of competitive advantage**: specialization increases production efficiency (trade will benefit both countries) **Imperfect markets theory**: production factors are kinda immobile = incentive to find foreign opportunities **Product cycle theory**: when firms mature, they recognize opportunities outside of domestic market **What are the main goals of MNCs?** **Agency Problems in International Business** **Study Questions:** **What unique agency problems do MNCs face?** Business risk, country risk, currency risk, operation risks, agency costs (deviation between agency and principal, agents run the firm, principals are shareholders) -**Agency costs**: costs of ensuring managers (agents) maximize shareholder wealth **How can these problems be controlled?** -**Parent control of agency problem**s: parent should clearly communicate goals for each subsidiary to ensure managers (agents) focus on maximizing value of subsidiary -**Corporate control of agency problems**: management of MNC is focused on maximizing shareholder wealth -**Sarbanes-Oxley Act (SOX)**: ensure transparent process for managers to report on productivity and financial condition of firm -establishes centralized database of info/ data -- no private info/ all reported -ensures data is consistently reported among subsidiaries -has system that automatically checks for discrepancies -speeds process by which departments and subsidiaries have access to data -makes executives more accountable for financial statements -Carrot: incentives (stock options) v.s. Stick (punitive, not best) **What role does corporate governance play?** **How are MNCs structured? Centralized v.s. Decentralized** **Methods of International Business** **Key Concepts to Master: LIFAJE (LFAJE apart of all international trade basics)** -on a scale, licensing is lower risk and mergers and acquisitions (M&A) are higher, foreign direct investments (FDI) are even higher risk (not always successful) International trade basics: relatively conservative, penetrate markets by exporting, obtain supplies at low costs by importing, minimal/ no capital risk Licensing: obligates firms to provide tech (copyrights/ patents) in exchange for fees/ benefits, firms able to generate more revenue from foreign countries without establishing production plants/ transporting goods in foreign countries (EX. AMD and Intel -- reinvent themselves) Franchising: obligates firms to provide specialized sales/strategies in exchange for periodic fees, requires direct investments in foreign operations (direct foreign investment) -- Starbucks Joint ventures: jointly owned/ operated by 2+ firms, firms can enter foreign market by joining joint venture with firms residing in foreign markets, allows 2 firms to apply cooperative advantages (EX. FDA) Foreign acquisitions: acquisitions of firms in foreign countries allow firms to have full control over foreign businesses (quickly obtain large foreign market share), higher investments results in higher risks, liquidation may be hard if foreign subsidiary performs badly, partial internal acquisitions require smaller investment/ limits potential loss if project fails, firms wont have complete control over foreign operations that are only partially required (larger firm is taking over smaller firm, liquidation is difficult, not compete control) Establishing foreign subsidiaries: firms can penetrate markets by establishing new operations in foreign countries, large investments needed, operations can be tailored to firms needs, firms wont be rewarded from investment until subsidiary is built/ customer base established (two firms making another firm, growing exponentially -- synergy (typically unsuccessful) Agency Costs: costs of ensuring that managers maximize shareholder wealth Agent: manager Principal: shareholders Direct Foreign Investment (DFI): any methods that increases international business requiring a direct investment in foreign operations (most are foreign acquisitions and establishment) **Chapter 2: International Flow of Funds** Balance of Payments Framework **Balance of Payments (BOP):** summary of transactions between domestic ands foreign residents for specific country over specified period / funds going in and out Framework: Study Questions: **What are the three main accounts in the BOP?** **Current Account:** balance of trade = exports -- imports **Financial Account:** **Capital Account**: summarizes flow of funds between one country and all other countries bc financial assets traversed across country borders by people who move to diff country (sales/ trademarks) **Events that increased trade volume** -removal of Berlin Wall (reductions of trade barriers in eastern europe) -single European act 1978 (improved access to supplies from firms in diff European countries) -NAFTA: allowed U.S. firms to penetrate product and labor markets previously not accessible -GATT: reduction/ elimination of trade barriers on specific imported goods over 10yr. period -European Union: free movement of products/ services/ capital -inception of Euro: avoid exposure to exchange rate risk \- U.S. established trade agreements with other countries **Impact of Outsourcing on Trade** **Outsourcing**: subcontracting to third party in a diff country to provide supplies or services that were previously produced internally ---two benefits of outsourcing: increased international trade activity bc MNCs can buy from other countries, lower operation costs and job creation **Managerial Decisions about Outsourcing** -managers of US MNC argue that they create jobs for U.S. workers -shareholders suggests managers aren't maximizing MNCs value as result of commitment to creating U.S. jobs -managers can consider potential savings of outsourcing -managers should consider publicity/ morales that could occur among U.S. workers **Trade Volume** -10-20% of international trade volume based on annual GDP, mostly Canada **How do these accounts interact?** **Why is the BOP important for MNCs?** Understanding Trade Flows Key Concepts to Master: **What affects international trade flows?** **How do exchange rates impact trade?** **Exchange Rates:** current account decreases if currency appreciates relative to other currencies EXAMPLE: exchange rate between US (USD) and UK (GBP) would look like GBPUSD -- fluctuates over 30 day period, so GBP is increasing in value and US is decreasing in value, so GBP in relation to USD is appreciating -- relative inflation If value increases, US citizen is purchasing goods from GBP at a higher value than 30 days prior, but UK citizens suffer bc currency exchange increased so they're losing more money in current account -you want to depreciate value by manipulating currency exchange by enticing people to buy more goods = increase in current account Depreciation = demand of goods increases = higher export levels = increased funds = increases current account **Why dis no work tho?** -Severe limitations -dollar is high demand/safe haven -can't manipulate currency bc we have no reserves -U.S. is import country **Solutions for Weak Home Currency** Competition: foreign companies can lower prices to be competitive Impact of currencies: country with balance of trade deficit with a lot of countries isn't likely to solve all defects as the same time Prearranged international trade transfers: international transactions can't be adjust immediately (18+ month lag = J curve) Intracompany trade: firms busy goods produced by subsidiaries, not affected by currency fluctuations EXAMPLE: trade agreement between parent and subsidiary (internally), current account assets are done in open market, so any assessment isn't happening at that level, not being tabulated, **J Curve:** surplus if J curve above 0, under 0 = deficit (18 months before you see change, worse before better) **Exchange Rates/ Internal Infliction: all governments can't weaken home currencies same time, actions by one gov to weaken currency = another countries currency to strengthen, gov attempts to influence exchange rates = international disputes** EXAMPLE: china manipulating currency = negative relationship = china stimulates import for US = export on China = accusing each other/ international disputes **How do exchange rates correct balance of trade deficit?** When home currency is exchanged for foreign currency to buy foreign goods, home currency faces downward pressure = increased foreign demand for country's products **How exchange rates my not correct balance of trade deficit?** They wont automatically correct any international trade balances when other forces are at work **Why don\'t exchange rates automatically fix trade imbalances?**  Role of Government Policy Focus Areas: **Types of trade restrictions** **Impact of government controls** **International trade agreements** **Chapter 3: International Financial Markets -- watch last ten mins if video** -finance has three main levels: equity, debt/ fixed income, derivatives/ options/ forwards/ futures -shadow market = foreign exchange market, catalyst for foreign exchange -global market = equity like 30%, fixed income like 60%, derivatives like 10%, outside of these is the foreign exchange market -participants in market: speculators (looks for value), hedgers (looks for stability), arbitrageur (looks for fair pricing) **Arbitrage**: simultaneous buying and selling of the same asset (separate int assets into two, buying and selling within market), the fair price is in the middle Golden Standard: each currency was convertible into gold as a specified rate, weight would be exchange rate -- weight gold in dollars / weight gold in pounds Fixed change rates: kept within bounds (1% on each side of bound, if it fluctuates, there's needs to be intervention to get it back into bounds), they started changing bounds (bretten woods/ Smithsonian) Floating Exchange Rate System: widely traded currencies were allowed to fluctuate in accordance with market forces -- line with fixed (managed fixed) on side and managed float (everything free, no interventions) on the other side -- in between is currency board, crawling peg, and IMF in middle **Foreign Exchange Market:** allows for exchange of one currency to another -over the counter = telecommunications network where companies exchanged one currency for another -foreign exchange dealers are intermediaries in foreign exchange market Study Questions: **How does the spot market work?** **Spot Market:** foreign exchange transaction for immediate exchange (change rate = spot rate) **Spot Market Structure:** trading between banks (interbank market) **Spot Prices:** prices that are constantly -use of dollars in spot market: commonly accepted medium of exchange in spot market, especially with weak or restrictive home countries -spot market time zones: foreign exchange trade is only open during normal business hours (every Wednesday a bank is open) -spot market liquidity: more buyers + more sellers = more liquidity (easy to convert currency into cash, EX. Not big market for Pesos) -spot price cant be captured in time **What determines bid-ask spreads?** -at any given time, a banks bid (buy) quote for a foreign currency will be less than ask (sell) quote -- spread covers banks cost of conducting foreign exchange transactions -difference between bid quote and ask quote will be smaller for lesser value currencies -bid/ ask spread = (ask rate -- bid rate) / ask rate **Factors that Affect the Spread:** Spread = (order costs + inventory costs -competition -- volume + currency risk) -order costs = cost of processing orders (clearing/ recording transactions) -inventory costs = costs of maintaining currency inventory -competition: more competition = smaller spread quoted by intermediaries -volume = currencies with large trading volume = more liquid bc lots of buyers/ sellers -currency risk: economic/ political conditions that cause supply and demand for currency to change **Direct v.s. Indirect** \- direct quote = if you're in U.S., and looking at GBPUSD for 1.4612 -indirect quote = when you're in U.S., and looking at USDGBP for 1/1.4612 =.6844 (indirect bc you're not in country you're using that currency for) **Why do exchange rates change?** **International Money and Credit Markets** International Credit Market: LIBOR, syndicated loans Credit Markets: after credit crisis, firms financial institutions are cautious with their funds/ less// less willing to lend funds to MNCs Key Concepts: **Short-term vs. long-term markets** **Short-term:** denominated in currency different from home currency -international money market has grown bc firms: may need to borrow funds for imports denominated in foreign currency, may choose to borrow currency with lower interest rate, may choose to borrow in currency that's expected to depreciate against home currency **Role of interest rates -- money market interest rates** -money market interest rates are dependent on demand for short-term funds by borrowers relative to supply of available short term funds provided by savers -money market rates vary bc differences in interaction of total supply of short term funds available in diff country vs total demand for short term borrowers in that country Global integrations of money market interest rates: money market interest rates are highly correlated over time, when economic conditions weaken corporate need for liquidity declines and corps reduce amount of short term funds they're willing to pay, when economic conditions strengthen there is an increase in corp expansion and corps need additional liquidity to support expansion (higher demand = rates up, expand long term funding on short term basis) -risk of international money market securities: debt securities issued by MNCs and gov agencies with short term maturity (safe securities, not exposed to credit risk, still risks) **Impact of country risk** **International Stock Markets:** Issuance of stock on foreign markets: U.S. firms issuing stock in foreign markets to enhance global image (EX. Euro = more stock offerings in europe by U.S.) Issuance of foreign stock in U.S. markets: -yankee stock offerings: non-U.S. corps that need large funds issue in stock in U.S. American depository receipts: certs representing bundles of stock (like stock shares) -cross listing, expensive, investors buying stocks outside of home country **LIBOR**, syndicated loans Focus Areas: **Different ways to invest internationally** **Role of ADRs and cross-listings** **Market integration issues** **Forward Contracts:** agreements between foreign exchange dealer and MNC that says exchanges currencies, exchange rate, and transaction date -forward rate = exchange rate specified by foreign contract -forward market = over the counter market where forward contracts are traded -currency future contracts: specific es -**future price:** a negotiated price into the future (30 days) -**currency call:** provides right to sell/ buy specific currency in specific period at specific price **Exchange Rate:** specifies rate that one currency can be exchanged for another **EXAMPLE**: two currencies (UK uses GBP and US uses USD) relationship between them (ISO) would be GBPUSD with a current rate of 1.4618, one GBP (base) would be defined of USD (term) -one unit of GBP in terms of dollars would be a price of 1.4618 -GBPUSD would be 1/1.4618 =.6841 -base = unit that you're evaluating -term = that you based unit on **EXAMPLE:** GBPUSD with a bid (sell price) price of 1.4618 and ask price (price that you're buying) of 1.4821, but if you sell it at 1.4618, turning USD into GBP (taking GBP and turning it back into USD) -if you're buying one USD for one GBP, your ask price would be 1.4618, but if you sell it (spread) Spread: difference between bid and ask -ask \> bid price -small spread = high liquid assets (dollar, euro, pound, yen) -large spread =low liquid assets, HIGH VOLUME? emerging markets **OANDA** -source of exchange rate quotations/ exchange rates changes **Cross Rates**: create a new quote based on two existing ones (amount of one foreign currency per unit of another foreign currency) EXAMPLE: Value of Peso in Canadian Dollars = value of peso in USD / value of Canadian dollars in USD Cross exchange rates over time: as exchanges rates between currencies change against USD over time, exchange rate of these currencies can change **Chapter 4: Exchange Rate Determination** -depreciation: decline in currency value (negative percent change) -appreciation: increase in currency value (positive percent change) Percentage Change in foreign currency values = (S -- St+1) / (St+1) EXAMPLE: EURUSD -EUR = St-1 = 1.1018 -USD = St = 1.0934 change in foreign currency value = (1.0924 -- 1.1018) / 1.1018 = -0.0085 or -- 0.85% = depreciation -EUR is depreciating in terms of USD (decreasing value) -USD is appreciating (increasing value) ef = (S / St-1) -- 1 -HPR = P1 -P1 / P0 -timeline with P0 (St+1) on left and P1 (St) on right \| change in value = (S -St-1) / St-1 **Exchange Rate Equilibrium:** price of currency (rate that one currency is exchanged for another) **Exchange Rate Fundamentals** Study Questions: **What factors** **determine exchange rates?** **Relative Inflation Rates**: increase in U.S. inflation = increase in U.S. demand for foreign goods = increase demand for foreign currency = increased exchange rate for foreign currency **Relative Interest Rates:** increase in U.S. rates = increase in demand for U.S. deposits/ decrease in demand for foreign deposits = increased demand for dollar/ increased exchnage rate for dollar EXAMPLE: high U.S inflation, UK products in higher demand, higher demand for pounds -less demand for dollars = lower supply for pounds = value increases -higher U.S inflation rates = lower value -higher U.S. interest rates = higher value -higher U.K. inflation rates = higher value -higher U.K. interest rates = lower value -high inflation in U.S. and low inflation in U.K. = pounds increase (appreciate) in value and dollar decreases (depreciates) in value -if U.S. high relative interest rates (high return on dollar denominated investments), U.K. has lower rates, upward sloping supply, downward sloping demand = less demand for pounds (decreasing) = more U.S. investments = more dollars demanded = supply for pounds increases = value for pound decreases (depreciation) **Fisher Effect:** real interest rate = nominal -- inflation **Relative Income:** increase in U.S. income levels = increase in U.S. demand for foreign goods = increase for foreign currency relative to USD = increased exchnage rate **Government Controls:** foreign exchange/ trade barriers, intervening in foreign exchange markets, affecting macro variables (inflation, interest) **Expectations:** EXAMPLES -if investors expect rates in one country to rise, they may invest in that country = rise in demand for foreign currency = increase in exchnage rate for foreign currency (favorable) -speculations can place downward pressure on currency if they expect depreciation (unfavorable) -speculators may overreact to market signals, currency over or under valued (signals) -some place upward or downward pressure (interaction of factors) -common for European currencies to move same direction as U.S. (influence across multiple markets) -if currency's spot market is liquid, exchange rate won't be highly sensitive to a single large purchase/ sale (liquidity) -is U.S. income level increases, UK products in higher demand = demand for pounds increases = supply is same -increase in demand schedule = banks increase exchange to level that amount demanded is equal to amount supplied -decrease in demand schedule = banks decrease exchange to level that amount demanded is equal to amount supplied -increase in supply schedule = banks decrease exchange to level that amount demanded is equal to amount supplied -decrease in supply schedule = banks increase exchange to level that amount demanded is equal to amount supplied in foreign exchange market ---if bank releases currency to open market, there is an increased supply ---if bank deposits currency to open market, there is a deceased supply **How do supply and demand affect rates?** Demand for currency increases when value of currency decreases = downward sloping demand schedule Supply of currency (for sale) increases when value increases = upward sloping supply schedule -low quantity (demand) = high value = demand more - downward sloping -high quantity (demand) = low value = supply less - upward sloping Equilibrium: quantity of pounds demanded with supply of pounds for sale -increased demand = right shift in curve -increased supply = right shift in curve -value is not changing, quantity is **Why do rates change over time?** **Key Exchange Rate Influences** Remember these factors: **Inflation rates** -- change in differential between U.S. inflation and foreign country's inflation (INF) **Interest rates** -- change in differential between U.S. interest rate and foreign country interest rate (INT) **Income levels** -- change in differential between U.S. income level and foreign country income level (INC) **Government controls** -- change in gov controls (GC) **Market expectations** -- change in expectations of future exchange rates (EXP) **Cross Exchange Rates** Key Concepts: **How rates relate to each other** **Impact of currency movements** **Market adjustments** -if currency A and B move in same direction, there's no change across exchnage rates -if currency A appreciates against dollar by greater (smaller) degree then B, A appreciates and depreciates against B -if currency A appreciates and depreciates against dollar, currency B is unchanged, cutrency A appreciates and depreciates against currency B by same degree it appreciates and depreciates against dollar -cross rates move in same way as supply and demand Chapter 1 - Agency problems - Entering the international realm Chapter 2 - Balance of payments - Current account - Financial account - Capital account - Factors affecting the current account - Impact of exchange rates - Exchange rate correction and limitations (J-curve) Chapter 3 - Spot market and future markets - Bid /ask prices - Overview of OANDA (screen capture video) - Cross rates - International stock market - Mutual funds - ETF - ADR - Cross listing - Euro markets Chapter 4 - Supply and demand for a currency - Factors affecting the exchange rates - Relative inflation - Relative Interest rates - Relative Income levels - Government controls - Expectations

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