FIN 321 - Lecture notes 1-3 PDF

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Adam Stauffer, lecture notes...

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Class 1: Globalization and the multinational firm What sets international finance apart? 1. Foreign exchange risk and political risk a. Foreign exchange risk is the risk of facing uncertain future exchange rates i. It's important how they will move to see when you should buy it b. Political risk: arises from potential losses to the parent firm resulting from adverse developments in the host country i. Can range from tariffs to change in tax rules ii. Leader of countries can change the rules to affect trade partners 2. Market imperfections a. Various fricitions, such as transaction costs and legal restrictions, that prevent the markets from functioning perfectly i. Can restrict the ways people can diversify portfolios and exposures 3. Expanded opportunity set a. Firms benefit from an expanded opportunity set when they venture into the arena of global markets b. Greater economies of scales, you realize larger areas i. Able to seek out the lowest price goods and you can find the companies that will pay the most for your products Goal of management is getting the biggest shareholder wealth Emergence Globalization of the world's economy: ● Deregulation of forign exchange and capital markets ○ China ● Financial innovations ○ Multi currency bonds ○ International mutual fund ○ Index futures ● Advances in computer and telephone communication ○ Trading now is so much easier Emergence of the Euro: ● Momentous event in history of the world financial system ● More than 300 countries have one currency ○ Made flow of goods easy Trade liberalization and economic integration: comparative advantage: mutually beneficial to specialize in production of good they can produce most efficiently Trade agreements reduces trade restrictions Privatization: Country divesting itself of ownership and operations of business ventures by turning them over to the free market system The US govt privatising the post office Global financial crisis of 2008

Multinational corporations ● Has been Incorporated in one country and has production and sales operations in other countries ● Benefits from economies of scale

Class 3:Balance of payments Laissez Faire: abstention by governments, when govt does not influence market, purest free market Short Sale: sale of an asset or stock the seller doesn’t own Balance of payments:the record of a countries international transactions over a certain period of time presented in the form of a double entry bookkeeping system ● Used to evaluate the performance of a country ● Any transaction that results in a receipt of a foreigner ○ Sale of us goods- exports Four main types ● Current account- exports and imports ○ Divided into 4 categories ■ Goods trade ■ Services ■ Primary income ■ Secondary income ● Capital account- non financial accounts ● Financial account- purchase and sales of financial assets; stocks and bonds ● Official reserve account - all purchases and sales of international reserve assets ○ Gold ○ Transactions undertaken by the authorities Balance of Payments Identity :BOPI BCA+BKA+BFA+BRA=0: should balance to 0 Balance of Current account Balance of Capital Balance of Financial account Balance of Reserves account Class 5: FX Market Two tier: 1. Interbank (wholesale) 2. Client (retail) Market Spot rate quotations: Spot rate: currency quotations can be stated in direct or indirect form Direct quotations: Eur/USD: 1.22 Foreign currency prices in terms of domestic

Indirect quotations: USD/JPY 109.45 Price of 1 domestic currency in terms of a foreign currency Exchange traded currency funds Exchange traded fund A portfolio of financial assets in which shares represent fractional ownership of the fund trade on an organized exchange Class 6: What is a derivative? A financial security with a value that is reliant upon or derived from an underlying asset or group of assets Drives its price Futures contracts Both forward and futures contracts are derivatives or contingent claim securities because their valued are derived from or contingent upon the value of the underlying security options An option is a contract giving the owner the right but now the obligation, to buy or sell a given quantity of an asset at a specified price at some time in the future European options: only at expiration American: can be excercised at anytime prior to Class 7: When you buy a futures contract you don't have to spend any money Just put a small amount of money into a performance bond account (margin) An initial performance bond Must be deposited into a collateral account to establish a futures position You get a large amount of market exposure with only a little money A margin call is when you have to post more money if the euro was going down If there is a big move against you, your losses are significant Options a derivative: a contract giving the owner the right but not the obligation to buy or sell a given quantity of an asset at a specified price at some time in future Put option: as security goes down put option goes up Strike price is break even Function and structure of the FX market To assist clients and

Class 8: Three types of currency exposure 1. Transaction Exposure: when firm faces contractional cash flow

2. Economic exposure: possibility that cashflows maybe affetecd by unanticipated changes in FOREX 3. Translation exposure Hedging Foreign Currency Recievables Multiple ways to Hedge ● Forward contract: Forward market involves contracting today for the future purchase or sale of FX ○ Forward Market hedge: easiest way of hedging a transaction exposure by currency forward contracts ○ Sell foreign currency receivables forward to eliminate exchange risk exposure ○ Buy foreign currency payables forward to eliminate exchange risk exposure ○ Gain= (forward price- future price)*10 million euro (contract value) ● Money Market instruments ○ Money market Hedge ■ A firm may borrow in foreign currency to hedge its foreign currency receivable ■ Firm may lent in a forigen currency to hedge its foreign currency payables ● Options contract and or ● Swap contracts Currency payable: You can use a forward contract or money market hedge or an option Measuring Asset Exposure Beta refers to the sensitivity of a price with respect to a benchmark Measure of a risk: the higher the beta, the higher the excess risk caused by volatility y=a +bx Operating exposure Is the extent to which the firm's operating cash flows will be affected by changes in the exchange rate Exam study guide:...