Chapter 20 Corporate Finance

7/23/2019 Chapter 20 Corporate Finance

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20-1

I N T E R N ATI O N A L C O R P O R ATE F I N A N C E

Chapter 20

Copyright 2014 McGraw-Hill Education. All rights reser ed. !o reproduction or distri"ution without the prior written consent o# McGraw-Hill Education.


2/37

20-2

KEY CONCEPTS AND SKILLS

Interpret exchange rate quote an!!e cr"#e the"r $ean"ng D"%%erent"ate #et&een pot an! %or&ar!

rate

Spec"%' the !" t"nct"on #et&een purcha "ngpo&er par"t' an! "ntere t rate par"t'( an!the "$p)"cat"on %or change "n exchangerate

Art"cu)ate the #a "c o% "nternat"ona) cap"ta)#u!get"ng De cr"#e the "$pact o% po)"t"ca) r" * on

"nternat"ona) #u "ne "n+e t"ng


3/37

20-$

C,APTER O-TLINE

20./ Ter$"no)og'20.2 Fore"gn Exchange ar*et an!

Exchange Rate20.1 Purcha "ng Po&er Par"t'20. Intere t Rate Par"t'( -n#"a e! For&ar!

Rate ( an! the Internat"ona) F" herE%%ect

20.3 Internat"ona) Cap"ta) 4u!get"ng20.5 Exchange Rate R" *20.6 Po)"t"ca) R" *


4/37

20-4

20./ TER INOLO7Y

A$er"can Depo "tor' Rece"pt 8ADR9: a ecur"t'" ue! "n the -.S. to repre ent hare o% a %ore"gn

toc* Cro rate: the exchange rate #et&een t&o %ore"gn

currenc"e ( e.g .( the exchange rate #et&een ; an! < Euro 8=9: the "ng)e currenc' o% the European

onetar' -n"on &h"ch &a a!opte! #' e$#erState on / >anuar' /???.

Euro#on! : #on! !eno$"nate! "n a part"cu)arcurrenc' 8u ua))' the " uer@ ho$e currenc'9 an!" ue! "$u)taneou )' "n the #on! $ar*et o%

e+era) countr"e


5/37

20-%

TER INOLO7Y

Eurocurrenc': $one' !epo "te! "n a %"nanc"a)center out "!e the ho$e countr'. Euro!o))ar are!o))ar !epo "t he)! out "!e the -.S. Euro'enare 'en !eno$"nate! !epo "t he)! out "!e>apan.

Fore"gn #on! : #on! " ue! "n another nat"on@cap"ta) $ar*et #' a %ore"gn #orro&er

7")t : 4r"t" h an! Ir" h go+ern$ent ecur"t"e

LI4OR: the Lon!on Inter#an* O%%ere! Rate " therate $o t "nternat"ona) #an* charge oneanother %or )oan o% Euro!o))ar o+ern"ght "n theLon!on $ar*et


6/37

20-&

20.2 FOREI7N EBC,AN7E ARKETSAND EBC,AN7E RATES

"thout a !ou#t( the %ore"gn exchange$ar*et " the &or)!@ )arge t %"nanc"a)$ar*et.

In th" $ar*et( one countr'@ currenc' "tra!e! %or another@ . o t o% the tra!"ng ta*e p)ace "n a %e&

currenc"e :

-.S. !o))ar 8 9 4r"t" h poun! ter)"ng 8;9 >apane e 'en 8


7/3720-'

FOREB ARKET PARTICIPANTS

The FOREB $ar*et " a t&o t"ere! $ar*et: Inter#an* ar*et 8 ho)e a)e9

A#out 600 #an* &or)!&"!e tan! rea!' to $a*e a$ar*et "n Fore"gn exchange.

Non#an* !ea)er account %or a#out 20 o% the $ar*et. There are FB #ro*er &ho $atch #u' an! e)) or!er #ut

!o not carr' "n+entor' an! FB pec"a)" t . C)"ent ar*et 8Reta")9

ar*et part"c"pant "nc)u!e "nternat"ona) #an* ( the"rcu to$er ( non#an* !ea)er ( FOREB #ro*er ( an!centra) #an* .


8/3720-(

EBC,AN7E RATES

The pr"ce o% one countr'@ currenc' "n ter$o% another.

o t currenc' " quote! "n ter$ o% !o))ar . Con "!er the %o))o&"ng quote:

Euro /.2?/56 .66 /? The %"r t nu$#er 8/.2?/56 9 " ho& $an'

-.S. !o))ar "t ta*e to #u' / Euro The econ! nu$#er 8.66 /?9 " ho& $an'

Euro "t ta*e to #u' / The t&o nu$#er are rec"proca) o% each

other 8/G/.2?/56 H .66 /?9


9/3720-)

EBA PLE

Suppo e 'ou ha+e /0(000. 4a e! on therate "n F"gure 20./( ho& $an' S&" Franccan 'ou #u'

Exchange rate H /.0J2/ Franc per !o))ar 4u' /0(0008/.0J2/9 H /0(J2/ Franc

Suppo e 'ou are +" "t"ng 4o$#a' an! 'ou&ant to #u' a ou+en"r that co t /(000

In!"an Rupee . ,o& $uch !oe "t co t "n-.S. !o))ar Exchange rate H 3 .?53 rupee per !o))ar Co t H /(000 G 3 .?53 H /J./?


10/3720-10

CROSS RATES

Suppo e that S G; 809 H /.3 i.e .( /.30 H ;/.00 "n the pot $ar*et an! that S


11/3720-11

TRIAN7-LAR AR4ITRA7E

,

+

Credit Lyonnais

S $/ +/0 1.%0

Credit Agricole

S +/0 1(%

Barclays

S ,/0 120

uppose weo"ser e these

"an3s postingthese e changerates.

5irst calculate the

i6plied crossrates to see i# anarbitrage e ists.


12/3720-12


,

+

Credit Lyonnais

S $/ +/0 1.%0

Credit Agricole

S +/0 1(%

Barclays

S ,/0 120

7he implied S +cross rate is S +/0 1(0

Credit Agricole has posted a 8uote o#S / + 1(%* so

there is an ar"itrageopportunity.

So, how can we make money?

,1.%0+1

9120

,11(0

+1


13/37

20-1$


,

+

Credit

Lyonnais S $/ +/0 1.%0

Credit Agricole

S +/0 1(%

Barclays

S ,/0 120

As easy as 1 : 2 : $;

1. Sell o r $ !or ",

#. Sell o r " !or ,%. Sell those !or $.


14/37

20-14


Sell $1&',''' !or " at S $/ +/0 1.%0

recei e +100*000

Sell o r " 100*000 !or at S +/0 1(%

recei e 1(*%00*000

Sell 1(*%00*000 !or $ at S ,/0 120

recei e ,1%4*1&'

pro#it per round trip , 1%4*1&' : ,1%0*000 ,4*1&'


15/37

20-1%

TYPES OF TRANSACTIONS

Spot tra!e exchange currenc' "$$e!"ate)' Spot rate the exchange rate %or an

"$$e!"ate tra!e For&ar! tra!e agree to!a' to exchange

currenc' at o$e %uture !ate an! o$epec"%"e! pr"ce 8a) o ca))e! a %or&ar!contract9

For&ar! rate the exchange rate pec"%"e! "nthe %or&ar! contract

I% the %or&ar! rate " h"gher than the pot rate(the %ore"gn currenc' " e))"ng at a pre$"u$8&hen quote! a equ"+a)ent 9.

I% the %or&ar! rate " )o&er than the pot rate(

the %ore"gn currenc' " e))"ng at a !" count.


16/37

20-1&

A4SOL-TE P-RC,ASIN7 PO ERPARITY

Pr"ce o% an "te$ " the a$e regar!)e o% thecurrenc' u e! to purcha e "t.

Requ"re$ent %or a# o)ute PPP to ho)!:

Tran act"on co t are ero No #arr"er to tra!e 8no taxe ( tar"%% ( etc.9 No !"%%erence "n the co$$o!"t' #et&een )ocat"on

For $o t goo! ( A# o)ute PPP rare)' ho)! "npract"ce.


17/37

20-1'

RELATIME P-RC,ASIN7 PO ERPARITY

Pro+"!e "n%or$at"on a#out &hat cau e change"n exchange rate .

The #a "c re u)t " that exchange rate !epen! on

re)at"+e "n%)at"on #et&een countr"e : E8S t 9 S 0 / 8h FC h -S 9QT

4ecau e a# o)ute PPP !oe n@t ho)! %or $an'goo! ( &e &")) %ocu on re)at"+e PPP %ro$ here on

out.


18/37

20-1(

EBA PLE

Suppo e the Cana!"an pot exchange rate " /./JCana!"an !o))ar per -.S. !o))ar. -.S. "n%)at"on "expecte! to #e 1 per 'ear( an! Cana!"an"n%)at"on " expecte! to #e 2 .

Do 'ou expect the -.S. !o))ar to apprec"ate or!eprec"ate re)at"+e to the Cana!"an !o))ar

S"nce "n%)at"on " h"gher "n the -.S.( &e &ou)! expect the-.S. !o))ar to !eprec"ate re)at"+e to the Cana!"an !o))ar.

hat " the expecte! exchange rate "n one 'ear

E8S / 9 H /./J / 8.02 .019Q/

H /./5J2


19/37

20-1)

20. INTEREST RATE PARITY

IRP " an arbitrage con!"t"on. I% IRP !"! not ho)!( then "t &ou)! #e po "#)e %or

an a tute tra!er to $a*e un)"$"te! a$ount o%

$one' exp)o"t"ng the ar#"trage opportun"t'. S"nce &e !on@t t'p"ca))' o# er+e per " tent

ar#"trage con!"t"on ( &e can a%e)' a u$e thatIRP ho)! .


20/37

20-20

INTEREST RATE PARITYSuppo e 'ou ha+e /00(000 to "n+e t %or one 'ear.You can e"ther

/. In+e t "n the -.S. at i $ .Future +a)ue H /00(000 8/ i $92. Tra!e 'our !o))ar %or 'en at the pot rate(

"n+e t "n >apan at i an! he!ge 'our exchangerate r" * #' e))"ng the %uture +a)ue o% the>apane e "n+e t$ent %or&ar!.

(

S

9 /1 < i /1 < i$

(

S 9 /1 < i 5uture alue ,100*000 9

ince "oth o# these in est6ents ha e the sa6e ris3* they 6ustha e the sa6e #uture alue;


21/37

20-21

INTEREST RATE PARITY

For$a))'(

=>? is so6eti6es appro)imated as

( S

9 /1 < i /1 < i$

( S

/1 < i$/1 < i

or i# you pre#er*

i$ : i * ( + S

S


22/37

20-22

IRP AND COMERED INTERESTAR4ITRA7EI% IRP %a")e! to ho)!( an ar#"trage opportun"t' &ou)!

ex" t. It@ ea "e t to ee th" "n the %or$ o% anexa$p)e.

Con "!er the %o))o&"ng et o% %ore"gn an! !o$e t"c"ntere t rate an! pot an! %or&ar! exchangerate .

pot e change rate S +/0 ,1.2% +

$&0-day #orwardrate

( +/$&0 ,1.20 +

@. . discount rate i, '.10

British discountrate

i+ 11.%&


23/37

20-2$

IRP AND COMERED INTERESTAR4ITRA7E

A tra!er &"th /(000 to "n+e t cou)! "n+e t "n the-.S. "n one 'ear h" "n+e t$ent &")) #e &orth

/(06/ H /(000 8/ i 9 H /(000 8/.06/9.

A)ternat"+e)'( th" tra!er cou)!:/. Exchange /(000 %or ;J00 at the pre+a")"ng pot

rate( 8note that ;J00 H /(000 /.23G;92. In+e t ;J00 at i ; H //.35 %or one 'ear to

ach"e+e ;J?2. J.1. Tran )ate ;J?2. J #ac* "nto !o))ar at F ; 81509 H

/.20G; the ;J?2. J &")) #e exact)' /(06/.


24/37

20-24

IRP AND COMERED INTERESTAR4ITRA7E

can in est in the @. .

=n one year his in est6entwill "e worth

,1*0'1 ,1*000 /1.0'1 ,1*000 /1< i,

A trader with ,1*000 to in est


25/37

20-2%

,1*0'1 +()2.4( 9 +1,1.20

Bring it on "ac3to the @. .A.

IRP AND COMERED INTEREST AR4ITRA7E

,1*000

+(00+(00 ,1*0009 ,1.2%

+1 =n est +(00 ati+ 11.%&

=n one year +(00will "e worth

+()2.4( ,1*000 /1< i+

Do6estic 5 ,1*0'1 and British5 ,1*0'1


26/37

20-2&

REASONS FOR DEMIATIONS FRO IRP

Tran act"on Co t The "ntere t rate a+a")a#)e to an ar#"trageur %or

#orro&"ng( i b($a' excee! the rate he can )en!at( i l .

There $a' #e #"! a * prea! to o+erco$e(F b /S a F/S Thu

8F b GS a98/ i l 9 8/ i b9 0

Cap"ta) Contro) 7o+ern$ent o$et"$e re tr"ct "$port an!

export o% $one' through taxe or outr"ght #an .


27/37

20-2'

INTERNATIONAL FIS,ER EFFECT

Co$#"n"ng PPP an! -IP &e can get theInternat"ona) F" her E%%ect:

R-S h -S H R FC h FC

The Internat"ona) F" her E%%ect te)) u that therea) rate o% return $u t #e con tant acrocountr"e .

I% "t " not( "n+e tor &")) $o+e the"r $one' to the

countr' &"th the h"gher rea) rate o% return.


28/37

20-2(

20.3 INTERNATIONAL CAPITAL4-D7ETIN7

,o$e Currenc' Approach E t"$ate ca h %)o& "n %ore"gn currenc' E t"$ate %uture exchange rate u "ng -IP

Con+ert %uture ca h %)o& to !o))ar D" count u "ng !o$e t"c requ"re! return

Fore"gn Currenc' Approach E t"$ate ca h %)o& "n %ore"gn currenc'

- e the IFE to con+ert !o$e t"c requ"re! returnto %ore"gn requ"re! return D" count u "ng %ore"gn requ"re! return Con+ert NPM to !o))ar u "ng current pot rate


29/37

20-2)

,O E C-RRENCY APPROAC,

Your co$pan' " )oo*"ng at a ne& proUect "nex"co. The proUect &")) co t ? $"))"on pe o . The

ca h %)o& are expecte! to #e 2.23 $"))"on pe oper 'ear %or 3 'ear . The current pot exchangerate " ?.0J pe o per !o))ar. The r" * %ree rate "nthe -S " ( an! the r" * %ree rate "n ex"coJ . The !o))ar requ"re! return " /3 .

Shou)! the co$pan' $a*e the "n+e t$ent


30/37

20-$0

FOREI7N C-RRENCY APPROAC,

- e the a$e "n%or$at"on a the pre+"ouexa$p)e to e t"$ate the NPM u "ng the Fore"gnCurrenc' Approach

ex"can "n%)at"on rate %ro$ the Internat"ona) F" herE%%ect " J H

Requ"re! Return H /3 H /? PM o% %uture ca h %)o& H 5(J6?(56? NPM H 5(J6?(56? ?(000(000 H 2(/20(12/ pe o NPM H 2(/20(12/ G ?.0J H 211(3/5


31/37

20-$1

20.5 EBC,AN7E RATE RISK

Short Run Expo ure Long Run Expo ure

Tran )at"on Expo ure


32/37

20-$2

S,ORT R-N EBPOS-RE

R" * %ro$ !a' to !a' %)uctuat"on "n exchangerate an! the %act that co$pan"e ha+e contractto #u' an! e)) goo! "n the hort run at %"xe!pr"ce

anag"ng r" * Enter "nto a %or&ar! agree$ent to guarantee the

exchange rate. - e %ore"gn currenc' opt"on to )oc* "n exchange rate "%

the' $o+e aga"n t 'ou( #ut #ene%"t %ro$ rate "% the'$o+e "n 'our %a+or.


33/37

20-$$

LON7 R-N EBPOS-RE

Long run %)uctuat"on co$e %ro$ unant"c"pate!change "n re)at"+e econo$"c con!"t"on

Cou)! #e !ue to change "n )a#or $ar*et orgo+ern$ent

ore !"%%"cu)t to he!ge Tr' to $atch )ong run "n%)o& an! out%)o& "n the

currenc' 4orro&"ng "n the %ore"gn countr' $a' $"t"gate

o$e o% the pro#)e$


34/37

20-$4

TRANSLATION EBPOS-RE

Inco$e %ro$ %ore"gn operat"on $u t #etran )ate! #ac* to -.S. !o))ar %or account"ngpurpo e ( e+en "% %ore"gn currenc' " not actua))'con+erte! #ac* to !o))ar .

I% ga"n an! )o e %ro$ th" tran )at"on %)o&e!through !"rect)' to the "nco$e tate$ent( there&ou)! #e "gn"%"cant +o)at")"t' "n EPS.

Current account"ng regu)at"on requ"re that a))

ca h %)o& #e con+erte! at the pre+a")"ngexchange rate ( &"th currenc' ga"n an! )o eaccu$u)ate! "n a pec"a) account &"th"n

hareho)!er equ"t'.


35/37

20-$%

ANA7IN7 EBC,AN7E RATE RISK

Large $u)t"nat"ona) %"r$ $a' nee! to $anagethe exchange rate r" * a oc"ate! &"th e+era)!"%%erent currenc"e .

The %"r$ nee! to con "!er "t net expo ure tocurrenc' r" * "n tea! o% Uu t )oo*"ng at eachcurrenc' eparate)'.

,e!g"ng "n!"+"!ua) currenc"e cou)! #e expen "+ean! $a' actua))' "ncrea e expo ure.


36/37

20-$&

20.6 POLITICAL RISK

Change "n +a)ue !ue to po)"t"ca) act"on "nthe %ore"gn countr' In+e t$ent "n countr"e that ha+e un ta#)e

go+ern$ent hou)! requ"re h"gher return . The extent o% po)"t"ca) r" * !epen! on the

nature o% the #u "ne : The $ore !epen!ent the #u "ne " on other

operat"on &"th"n the %"r$( the )e +a)ua#)e"t " to other .

Natura) re ource !e+e)op$ent can #e +er'+a)ua#)e to other ( e pec"a))' "% $uch o% thegroun! &or* "n !e+e)op"ng the re ource haa)rea!' #een !one.

Loca) %"nanc"ng can o%ten re!uce po)"t"ca)r" *.


37/37

V-ICK V-IW

hat !oe an exchange rate te)) u hat " tr"ang)e ar#"trage hat are a# o)ute purcha "ng po&er par"t' an!

re)at"+e purcha "ng po&er par"t' hat are co+ere! "ntere t ar#"trage an! "ntere t rate

par"t' hat are unco+ere! "ntere t par"t' an! the

Internat"ona) F" her E%%ect hat are the t&o $etho! %or "nternat"ona) cap"ta)

#u!get"ng hat " the !"%%erence #et&een hort run "ntere t rate

expo ure an! )ong run "ntere t rate expo ure ,o&can 'ou he!ge each t'pe hat " po)"t"ca) r" * an! &hat t'pe o% #u "ne %ace

the greate t r" *

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Chapter 20 Corporate Finance

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