MSU/CIBER Institute for Community College Faculty International Finance by Kirt C. Butler (MSU’s Department of Finance) : MSU/CIBER Institute for Community College Faculty International Finance by Kirt C. Butler (MSU’s Department of Finance)
Multinational financial management : Multinational financial management Multinational financial management is financial management conducted in more than one cultural, social, economic, or political environment
Topics of multinational finance : Multinational investment policy
Higher returns from existing investments
New investment opportunities in international markets
Multinational financial policy
Reduced capital costs through access to international capital markets Topics of multinational finance
Vivé la difference : Vivé la difference International business is necessarily interdisciplinary because business is affected by cross-border differences in:
- Language & culture - Human resource mgmt
- Accounting - Marketing
- Distribution - Logistics
- Financial markets - Corporate governance
- Other business conventions
(legal, accounting, taxation, regulation, etc.)
Multinational financial management : Multinational financial management Multinational finance is interdisciplinary within the field of finance
Multinational financial managers must be familiar with
Foreign exchange and Eurocurrency markets
International capital (debt & equity) markets
International markets for real assets
International portfolio investment
Derivatives securities
…where the art resides : …where the art resides The notes I handle no better
than many pianists,
but the pauses between the notes –
ah, that is where the art resides.
Arthur Schnabel
Topics in Finance for beginners : Topics in Finance for beginners International markets
International markets in goods & services
International financial markets
The FX game www.msu.edu/~butler/
Foreign market entry
Exporting, contracting, investing
Corporate governance
Mergers and acquisitions (M&A)
Corporate control
Publicly traded debt & equity (December 2001) : Publicly traded debt & equity (December 2001) Source: Organisation for Economic Co-operation and Development and Morgan Stanley Capital International.
Major domestic debt markets (billions) : Major domestic debt markets (billions) Source: Bank for International Settlements (December 2002)
Bank for International Settlements Click on: - Publications and statistics - International financial statistics : Bank for International Settlements Click on: - Publications and statistics - International financial statistics
Web resource www.bis.org
Major stock markets (billions) : Major stock markets (billions)
Source: Compiled from FTSE and MSCI Indices (May 2002)
Web resource www.msci.com Morgan Stanley Capital International : Web resource www.msci.com Morgan Stanley Capital International
Exchange rate systems : Exchange rate systems Pegged or fixed exchange rate systems
Forges a direct link between inflation differentials and employment levels
Can result in large adjustments
Floating exchange rate systems
Allows exchange rates to adjust for inflation differences
Allows employment levels and wages to equalize through the exchange rate mechanism
Recent exchange rate arrangements : Recent exchange rate arrangements FX regime Africa Asia/Pacific Europe/Mid East Americas
No separate WAEMU, Marshall Is, Euro Area Ecuador,
legal tender CAEMC Micronesia Panama
Currency Libya, China, HK, Iran, Kuwait, Argentina,
board or Sudan, Malaysia, Saudi Arabia, Bahamas,
fixed peg Zimbabwe Taiwan Syria Suriname
Crawling peg Egypt Denmark, Bolivia,
or horiz band Egypt, Israel Venezuela
Managed Algeria, India, Croatia, Iraq, Dom. Rep,
float Ethiopia, Indonesia, Russian Fed., Guatemala,
Kenya, Singapore, Yugoslavia Jamaica,
Nigeria Thailand Trinidad
Independent Mozambique, Afghanistan, Czech Rep, Norway, Brazil, Canada,
float S. Africa, Australia, Poland, Sweden, Chile, Colombia,
Uganda Japan, Turkey, Switzerland, Mexico, Peru,
S. Korea United Kingdom US
Source: International Financial Statistics, April 2003
The international monetary system : The international monetary system 1946 The Bretton Woods Conference
US dollar convertible into gold at $35/oz; other currencies are pegged to the dollar
Created the IMF and the World Bank
1971 Collapse of Bretton Woods
1979 European Monetary System created
1991 The Treaty of Maastricht
1999 Introduction of the euro (€)
Emu-zone currencies pegged
European bonds converted
Currency crises : Currency crises Currency crises during the 1990s
Mexican peso crisis of 1995
Asian contagion of 1997
Russian ruble crisis in 1998
Argentinian peso crisis of 1998
In each crisis, contributing factors included:
A fixed or pegged exchange rate system that overvalued the local currency
A large amount of foreign currency debt
Mexican peso crisis : Mexican peso crisis Mexican stock market value
(Dec 1993 = 1.00; in pesos) Mexican peso
($/peso)
The Asian contagion (Dec 1996 = 1.00) : The Asian contagion (Dec 1996 = 1.00) Thai bhat Korean won Indonesian rupiah
The Asian contagion (Dec 1996 = 1.00; in local currency) : Thailand Korea Indonesia The Asian contagion (Dec 1996 = 1.00; in local currency)
Russia’s currency crisis : Russia’s currency crisis Russia’s stock market value
(Dec 1995 = 1.0; in rubles) Currency value: $/ruble
(Dec 1995 = 1.0)
Argentina’s currency crisis : Argentina’s stock market value
(Dec 1998 = 1.0; in rubles) Currency value: $/peso
(Dec 1998 = 1.0) Argentina’s currency crisis
The debate over IMF lending : The debate over IMF lending Proponents of IMF lending policies believe
Short term loans help countries overcome temporary crises
Critics of IMF lending believe
Belt-tightening is counterproductive
Capital market liberalizations increase risks
Loans are often spent supporting unsustainable exchange rates
IMF loans last for decades
IMF remedies benefit developed countries
IMF lending and moral hazard : IMF lending and moral hazard Moral hazard
The existence of a contract can change the behaviors of parties to the contract
The IMF’s challenge
is to develop policies that promote economic stability
and ensure that the consequences of poor investment decisions are borne by investors and not taxpayers
Foreign exchange markets : Foreign exchange markets Spot market
Cash market with delivery in two business days
Forward market
Trade on a pre-arranged date and at a pre-arranged price
Volume
More than $1 trillion trades each day
75% of trade is in the interbank market
Spot exchange rate quotations and data series Click on: - Currency Tools - FXHistory : Spot exchange rate quotations and data series Click on: - Currency Tools - FXHistory
Web resource www.oanda.com
A classroom exercise to simulate the fx market www.msu.edu/~butler/ : A classroom exercise to simulate the fx market www.msu.edu/~butler/ Learning objectives
To develop practice in dealing with foreign exchange
To develop intuition regarding market forces, including arbitrage
Market participants
Dealers: make a market in foreign currency; that is, quote bid and offer (or ask) prices
Traders: trade for their own acct
Rules of the game : Rules of the game “Buy low and sell high”
One contract º One billion ringgits
Trades can be for up to 10 contracts
Record each transaction as a purchase or sale
Maximum bid-offer spread is 1 basis point
(1 bp = 0.01¢/Rg = $0.0001/Rg)
Dealer quotes are good for 2 minutes
Arbitrage profit in the fx market : Arbitrage profit in the fx market An example
Bank A:
“$0.26602/Rg bid and $0.26612/Rg offer”
Bank B:
“$0.26617/Rg bid and $0.26627/Rg offer”
Buy low and sell high : Buy low and sell high Bank A Bank B
$0.26627/Rg Offer $0.26617/Rg Bid $0.26612/Rg Offer $0.26602/Rg Bid Buy from A Sell to B Arbitrage profit
$0.00005/Rg
Riskless arbitrage profit : Riskless arbitrage profit Buy Rg1 billion from Bank A at their $0.26612/Rg offer price
Sells Rg1 billion to Bank B at their $0.26617/Rg bid price
Arbitrage Profit
= ($0.00005/Rg)(Rg1 billion)
= $50,000 with
NO NET INVESTMENT
NO RISK
Sample foreign exchange ledger : Sample foreign exchange ledger Rg 1 billion $/Rg Cumulative
Counterparty contracts price balance
1 Penn Square BUY 1 0.22004 +1
2 Citicorp BUY 3 0.22010 +4
3 Bk of Tokyo SELL 2 0.22016 +2
4 Bk of Tokyo SELL 4 0.22020 -2
5 . . .
Opening prices: $0.21945/Rg BID & $0.21950/Rg OFFER : Opening prices: $0.21945/Rg BID & $0.21950/Rg OFFER News announcements
The member nations of the G7 have announced that they are buying dollars in an effort to stabilize the dollar
The U.S. Federal Reserve announces that in an effort to stimulate economic activity it is lowering the discount rate on overnight loans to commercial banks
The U.S. government reports that the U.S. money supply M1 increased by $1 billion more than expected in the most recent quarter
The Impact of News Events The G7 announces that they are buying dollars in an effort to stabilize the dollar : The Impact of News Events The G7 announces that they are buying dollars in an effort to stabilize the dollar
Value of the U.S. dollar
As the demand for dollars rises, the Malaysian ringgit will depreciate and the spot rate S$/Rg will fall P$ P’$ S$ D’$ D$ Q$
The Impact of News Events The U.S. Federal Reserve announces that it is lowering the fed funds rate in an effort to stimulate economic activity : The Impact of News Events The U.S. Federal Reserve announces that it is lowering the fed funds rate in an effort to stimulate economic activity This makes it easier for U.S. businesses to borrow and increases economic activity. If this also increases U.S. inflation, then the value of the U.S. dollar should fall. This will result in an appreciation of the ringgit against the dollar.
Increases in the domestic discount rate
usually, but not always, lead to increases
in the value of the domestic currency.
The Impact of News Events The U.S. government reports that U.S. money supply M1 increased by $1 billion more than expected in the most recent quarter : The Impact of News Events The U.S. government reports that U.S. money supply M1 increased by $1 billion more than expected in the most recent quarter This would appear to result in a larger supply of dollars and hence a lower value for the dollar. However, the increase in the money supply has already occurred and should already be reflected in the market price of the dollar.
On the other hand, if the U.S. Federal Reserve is likely to increase the discount rate to slow down the economy, then the dollar could rise in anticipation of Fed policy.
If the dollar rises against the ringgit,
then the ringgit will fall against the dollar.
Hints : Hints Getting started: Set an example by jumping in and making a few trades yourself.
Market segmentation: Separate large classes into two markets that trade independently. Later, allow trade in either market. Cross-market arbitrage can yield big profits.
Fixed fx rates: Quietly ask one bank to serve as the Malaysian central bank and “defend its currency” with artificially high bid and offer quotes. This bank will soon run out of fx reserves as the bank is forced to buy ringgits with its foreign currency reserves.
Foreign market entry : Foreign market entry Listen up, my Cossack brethren. We’ll ride into the valley like the wind, the thunder of our horses and the lightning of our steel striking fear in the hearts of our enemies! …And remember - stay out of Mrs. Caldwell’s garden.
Gary Larsen, The Far Side
Foreign market entry : Foreign market entry Export or import entry
Agents or distributors (foreign or domestic)
Foreign sales branches or subsidiaries
Contract-based entry
Licensing or franchising
Investment-based entry
Foreign direct investments
Mergers and acquisitions
Strategic alliances or joint ventures
Investment-based entry : Investment-based entry International joint ventures Mergers and acquisitions FDI: plant expansions FDI: new investment Source: Ernst & Young
M&A activity :
Compiled from Mergers and Acquisitions. M&A activity
Corporate governance : Corporate governance Corporate governance refers to the way in which stakeholders exert control over the corporation
There are 3 ways to obtain control over another firm’s assets
acquisition of another firm’s assets
acquisition of another firm’s stock
merger or consolidation
Mergers and acquisitions are becoming increasingly important
Governance of the MNC : Governance of the MNC
Corporate governance systems : Corporate governance systems Families or the State
State China N. Korea Singapore
Family Mexico Italy Spain
Family-State Indonesia S. Korea Saudi Arabia
Bank-based
Germany Japan
Market-based
Australia Canada Ireland
U.K. U.S.A.
Corporate governance systems : Corporate governance systems
Slide48 : The gentle reader will never, never know what a consummate ass he can become, until he goes abroad.
Mark Twain