Final International Finance Review Chapter Slide 20,8-12

Barter

1- Barter is the direct exchange of goods between traders and requires a double coincidence of wants. 2- A clearinghouse arrangement is a form of barter in which the traders agree to buy a certain amount of goods from each other. They set up accounts with each other that are debited and credited as needed. At the maturity of the arrangement, the parties settle up in cash or merchandise.

Computation of Beta

1. Computation of Means P = 1/3 × ($1,372 + $1,500 + $1,712) = $1,528 S = 1/3 × ($1.40/€ + $1.50/€ + $1.60/€) = $1.50/€ 2. Computation of Variance and Covariance Var(S) = 1/3 × [($1.40/€ - $1.50/€)2 + ($1.50/€ - $1.50/€)2 + ($1.60/€ - 1.50/€)2] = $20.02/ €23 Cov(Pi S) = 1/3 ×[($1,372 - $1,528)($1.40/€ - $1.50/€) + ($1,500 - $1,528)($1.50/€ - $1.50/€) + ($1,712 - $1,528)($1.60/€ - $1.50/€)] = $234/€3 3. Computation of the Exposure Coefficient b = Cov(P,S) / Var(S) = ($234 / €3) / ($20.02 / €23) = €1,700 > 0

Math Portion of Exam

12 out of the 30 questions use formulas from the assignment she posted I do recommend checking that out.

Importers Forward Market Hedge

A U.S.-based importer of Italian shoes has just ordered next year's inventory. Payment of €1M is due in one year. If the importer buys €1M at the forward exchange rate of $1.150/€, the cash flows at maturity look like this EX Forward Contract Counterparty>>Sends 1,000,000 E Recieves 1,150,000 USD>> US IMPORTER >> sends 1,000,000 E recieves Shoes>> Italian Supplier

Bill of Lading

A bill of lading is a document issued by the common carrier specifying that it has received the goods for shipment; it can serve as the title for the goods.

Eurobond Practices: Primary Market

A borrower desiring to raise funds by issuing Eurobonds to the investing public will contact an investment banker and ask it to serve as the lead manager of an underwriting syndicate that will bring the bonds to market. The underwriting syndicate is a group of investment banks, merchant banks, and the merchant banking arms of commercial banks that specialize in some phase of a public issuance. The lead manager will sometimes invite co-managers to form a managing group to help negotiate terms with the borrower, ascertain market conditions, and manage the issuance.

Buy Back

A buy-back transaction involves a technology transfer via the sale of a manufacturing plant. The seller of the plant agrees to buy back some of the output of the plant once it is constructed.

Counter Purchase

A counterpurchase trade agreement is similar to a buy-back transaction, but differs in that the output that the seller of the plant agrees to buy is unrelated to the plant.

Global Bonds

A global bond is a very large international bond offering by a single borrower that is simultaneously sold in North America, Europe, and Asia. Global bond issues were first offered in 1989. Global bonds denominated in U.S. dollars and issued by U.S. corporations trade as Eurobonds overseas and domestic bonds in the U.S.

Letter of Credit

A guarantee from the importer's bank that it will act on behalf of the importer and pay the exporter for the merchandise if all relevant documents specified in the letter of credit are presented according to the terms of the letter of credit -Essentially, the importer's bank is substituting its creditworthiness for that of the importer.

Options

A motivated financial engineer can create almost any risk-return profile that a company might wish to consider. An important consideration when using options is the hedge ratio that we covered in the last chapter. Without due consideration of the hedge ratio, the careless use of options can undo attempts at hedging.

Exposure Netting

A multinational firm should not consider deals in isolation, but should focus on hedging the firm as a portfolio of currency positions. Once the residual exposure is determined, we hedge that. Multilateral netting is an efficient and cost-effective mechanism for settling interaffiliate foreign exchange transactions and thus determining the firm's residual exposure.

Dual-Currency Bonds

A straight fixed-rate bond with interest paid in one currency and principal in another currency. Japanese firms have been big issuers, with coupons in yen and principal in dollars. Good option for an MNC financing a foreign subsidiary.

Subsidiary and Affiliate Banks

A subsidiary bank is a locally incorporated bank wholly or partly owned by a foreign parent. An affiliate bank is one that is partly owned but not controlled by the parent. U.S. parent banks like foreign subsidiaries because they allow U.S. banks to underwrite securities.

Switch

A switch trade is the purchase by a third party of one country's clearing agreement balance for hard currency.

Forward Rate Agreements: Example

A three against nine FRA is a 3-month forward contract on a six-month interest rate for a six-month period beginning three months from now.

Time Draft

A time draft is a written order instructing the importer or his agent, the importer's bank, to pay the amount specified on its face on a certain date.

Forward Rate Agreements

An interbank contract that involves two parties, a buyer and a seller. The buyer agrees to pay the seller the increased interest cost on a notational amount if interest rates fall below an agreed rate. The seller agrees to pay the buyer the increased interest cost if interest rates increase above the agreed rate.

Empirical Findings on Cross-Listings and ADRs

An internationally diversified portfolio of ADRs outperforms both a U.S. stock market and a world stock market benchmark on a risk-adjusted basis. For most stocks, the home-market price and the ADR price is within 20-85 basis points—thus limiting any arbitrage opportunities.

Offset Transaction

An offset transaction can be viewed as a counterpurchase trade agreement involving the aerospace/defense industry.

Debt-for-Equity Swaps

As part of debt rescheduling agreements among the bank lending syndicates and the debtor nations, creditor banks would sell their loans for U.S. dollars at discounts from face value to MNCs desiring to make equity investment in subsidiaries or local firms in the LDCs. The LDC central bank would buy the bank debt from a MNC at a smaller discount than the MNC paid, but in local currency. The MNC would use the local currency to make pre-approved new investment in the LDC that was economically or socially beneficial to the LDC.

Bearer Bonds and Registered Bonds

Bearer bonds are bonds with no registered owner. As such they offer anonymity, but they also offer the same risk of loss as currency. Registered bonds are bonds where the owner's name is registered with the issuer. U.S. security laws require Yankee bonds sold to U.S. citizens to be registered.

Economic Exposure

Changes in exchange rates can affect not only firms that are directly engaged in international trade but also purely domestic firms. If the domestic firm's products compete with imported goods, then their competitive position is affected by the strength or weakness of the local currency.

Advantages of Counter Trade

Countertrade conserves cash and hard currency. The improvement of trade imbalances, the maintenance of export prices, enhanced economic development, increased employment, technology transfer, market expansion, increased profitability, less costly sourcing of supply reduction of surplus goods from inventory, and the development of marketing expertise.

CounterTrade

Countertrade is an umbrella term used to describe many different types of transactions in "which the seller provides a buyer with goods or services and promises in return to purchase goods or services from the buyer." Countertrade may or may not involve the use of currency, as in barter.

Cross-Hedging Minor Currency Exposure

Cross-hedging involves hedging a position in one asset by taking a position in another asset. The effectiveness of cross-hedging depends upon how well the assets are correlated. An example would be a U.S. importer with liabilities in Swedish krona hedging with long or short forward contracts on the euro. If the krona is expensive when the euro is expensive, or even if the krona is cheap when the euro is expensive, it can be a good hedge. But they need to co-vary in a predictable way.

Composite Currency Bonds

Denominated in a currency basket, like the SDRs or ECUs, instead of a single currency. Often called currency cocktail bonds. Typically straight fixed-rate debt.

Edge Act Banks

Edge Act banks are federally chartered subsidiaries of U.S. banks that are physically located in the U.S. and are allowed to engage in a full range of international banking activities. The Edge Act was a 1919 amendment to Section 25 of the 1914 Federal Reserve Act.

Clearing Procedures

Eurobond transactions in the secondary market require a system for transferring ownership and payment from one party to another. Two major clearing systems, Euroclear and Clearstream International, handle most Eurobond trades. Euroclear is based in Brussels and is operated by Euroclear Bank. Clearstream is located in Luxembourg.

Other Functions of the Clearing System

Euroclear and Clearstream perform other functions associated with the efficient operation of the Eurobond market. (1) The clearing systems will finance up to 90 percent of the inventory that a Eurobond market maker has deposited within the system. (2) The clearing systems will assist in the distribution of a new bond issue. The clearing systems will take physical possession of the newly printed bond certificates in the depository, collect subscription payments from the purchasers, and record ownership of the bonds. (3) The clearing systems will also distribute coupon payments. The borrower pays to the clearing system the coupon interest due on the portion of the issue held in the depository, which in turn credits the appropriate amounts to the bond owner's cash accounts.

Eurocredits

Eurocredits are short- to medium-term loans of Eurocurrency. The loans are denominated in currencies other than the home currency of the Eurobank. Often the loans are too large for one bank to underwrite; a number of banks form a syndicate to share the risk of the loan. Eurocredits feature an adjustable rate.

International Money Market

Eurocurrency is a time deposit in an international bank located in a country different than the country that issued the currency. For example, Eurodollars are U.S. dollar-denominated time deposits in banks located abroad. Euroyen are yen-denominated time deposits in banks located outside of Japan. The foreign bank doesn't have to be located in Europe.

Euronotes

Euronotes are short-term notes underwritten by a group of international investment banks or international commercial banks. They are sold at a discount from face value and pay back the full face value at maturity. Maturity is typically three to six months.

Economic Exposure

Exchange rate risk is applied to the firm's competitive position. Any anticipated changes in the exchange rates would already have been discounted and reflected in the firm's value. Economic exposure can be defined as the extent to which the value of the firm would be affected by unanticipated changes in exchange rates.

International Bond Market Credit Ratings

Fitch IBCA, Moody's, and Standard & Poor's sell credit rating analysis. Focus on default risk, not exchange rate risk. Assessing sovereign debt focuses on political risk and economic risk.

Government Assistance in Exporting

For political reasons (having to do with mercantilism), most developed countries offer competitive assistance to domestic exporters. This assistance often takes the form of subsidized credit that can be extended to exporters. Also, credit insurance programs that guarantee financing extended by private financial institutions are common.

American Depository Receipts

Foreign stocks often trade on U.S. exchanges as ADRs. It is a receipt that represents the number of foreign shares that are deposited at a U.S. bank. The bank serves as a transfer agent for the ADRs.

Forfaiting

Forfaiting is a type of medium-term financing used to finance the sale of capital goods. It involves the sale of promissory notes signed by the importer in favor of the exporter. The forfait, usually a bank, buys the notes at a discount from face value from the exporter. The exporter gets paid and does not have to carry the financing.

Other Hedging Strategies

Hedging through invoice currency. The firm can shift, share, or diversify: Shift exchange rate risk by invoicing foreign sales in home currency Share exchange rate risk by pro-rating the currency of the invoice between foreign and home currencies Diversify exchange rate risk by using a market basket index Hedging via lead and lag. If a currency is appreciating, pay those bills denominated in that currency early; let customers in that country pay late as long as they are paying in that currency. If a currency is depreciating, give incentives to customers who owe you in that currency to pay early; pay your obligations denominated in that currency as late as your contracts will allow.

Forward Market Hedge: Exports

If you are going to receive foreign currency in the future, agree to sell the foreign currency in the future at a set price by entering into short position in a forward contract.

Forward Market Hedge: Imports

If you expect to owe foreign currency in the future, you can hedge by agreeing today to buy the foreign currency in the future at a set price by entering into a long position in a forward contract.

Process of Typical Foreign Trade Transaction

Importer>>"purchase Order" >> Exporter Importer>>"L/c Application" >> Importers Bank Importers Bank>> "Letter of Credit">> Exporters Bank Exporters Bank>>"L/c Notification" >> Exporter Exporter>> "Shipment of Goods">> Importer Exporter>> "Shipping Documents">>Exporters Bank Exporters Banks>> "Shipping Documents and Time Draft">> Importers Bank Importers Bank>>"Payment Discounted at B/A">>Exporters Bank

The Export-Import Bank and Affiliated Organizations

In 1934 the Eximbank of the United States was founded as an independent government agency to facilitate and finance U.S. export trade. Eximbank's purpose is to provide financing in situations where private financial institutions are unable or unwilling to because: The loan maturity is too long. The amount of the loan is too large. The loan risk is too great. The importing firm has difficulty in obtaining hard currency.

International Banking Services

International banks do everything domestic banks do and: Arrange trade financing. Arrange foreign exchange. Offer hedging services for foreign currency receivables and payables through forward and option contracts. Offer investment banking services (where allowed).

Disadvantages to Counter Trade

It is inefficient. Some claim that such transactions tamper with the fundamental operation of free markets, and therefore resources will be used inefficiently. Transactions that do not make use of money represent a huge step backwards in economic development.

Reasons for International Banking

Low marginal costs Managerial and marketing knowledge developed at home can be used abroad with low marginal costs. Knowledge advantage The foreign bank subsidiary can draw on the parent bank's knowledge of personal contacts and credit investigations for use in that foreign market. Home nation information services Local firms in a foreign market may be able to obtain more complete information on trade and financial markets in the multinational bank's home nation than is obtainable from foreign domestic banks. Prestige Very large multinational banks have high perceived prestige, which can be attractive to new clients. Regulatory advantage Multinational banks are often not subject to the same regulations as domestic banks.

Should the Firm Hedge?

Not everyone agrees that a firm should hedge.

Settling a FRA

Notional amount x (SR-AR) x days/360)/(1+(SRxdays/360)

Market Structure, Trading Practices, and Costs

Primary markets Shares offered for sale directly from the issuing company. Secondary markets Provide market participants with marketability and share valuation. Market order An order to your broker to buy or sell share immediately at the market price. Limit order An order to your broker to buy or sell at a price you want, when and if he can. If immediate execution is more important than the price, use a market order. Dealer market The stock is sold by dealers, who stand ready to buy and sell the security for their own account. In the U.S., the OTC market is a dealer market. Auction market Organized exchanges have specialists who match buy and sell orders. Buy and sell orders may get matched without the specialist buying and selling as a dealer. Automated exchanges Computers match buy and sell orders.

Withholding Taxes

Prior to 1984, the United States required a 30 percent withholding tax on interest paid to nonresidents who held U.S. government or U.S. corporate bonds. The repeal of this tax led to a substantial shift in the relative yields on U.S. government and Eurodollar bonds. This lends credence to the notion that market participants react to tax code changes.

Determinants of Operating Exposure

Recall that operating exposure cannot be readily determined from the firm's accounting statements as can transaction exposure. The firm's operating exposure is determined by: The market structure of inputs and products; how competitive or how monopolistic the markets facing the firm are. The firm's ability to adjust its markets, product mix, and sourcing in response to exchange rate changes.

Hedging Recurrent Exposure with Swaps

Recall that swap contracts can be viewed as a portfolio of forward contracts. Firms that have recurrent exposure can usually hedge their exchange risk at a lower cost with swaps than with a program of hedging each exposure as it comes along. It is also the case that swaps are available in longer-terms than futures and forwards.

Managing Operating Exposure

Selecting Low Cost Production Sites Flexible Sourcing Policy Diversification of the Market R&D and Product Differentiation Financial Hedging Tools

Netting with Central Depository

Some firms use a central depository as a cash pool to facilitate funds mobilization and reduce the chance of misallocated funds.

Industrial Structure

Studies examining the influence of industrial structure on foreign equity returns are inconclusive.

Operating Exposure: Definition

The effect of random changes in exchange rates on the firm's competitive position, which is not readily measurable with statistical tools, (remember economic exposure is). A good definition of operating exposure is the extent to which the firm's operating cash flows are affected by the exchange rate.

Bankers Acceptance

The exporter's bank presents the shipping documents and the time draft to the importer's bank. After taking the title for the goods via the bill of lading, the importer's bank accepts the time draft. At this point the banker's acceptance is created. It is a negotiable money market instrument. A secondary market exists for banker's acceptances. Banker's acceptances can be held to maturity by the exporter. The exporter can also sell them (at a discount) in the money market. Since the risks are similar, B/As trade at rates comparable to certificates of deposit. SO, a typical foreign trade transaction requires three basic documents: letter of credit, time draft, and bill of lading.

Deutsche Telekom Global Bond

The largest corporate global bond issue to date is the $14.6 billion Deutsche Telekom multicurrency offering. The issue includes: Three U.S. dollar tranches with 5-, 10-, and 30-year maturities totaling $9.5 billion. Two euro tranches with 5- and 10-year maturities totaling €3 billion. Two British pound sterling tranches with 5- and 30-year maturities totaling £950 million. One 5-year Japanese yen tranche of ¥90 billion.

Cross-Hedging Minor Currency Exposure

The major world currencies are the U.S. dollar, Canadian dollar, British pound, euro, Swiss franc, Mexican peso, and Japanese yen. Everything else is a minor currency (for example, the Swedish krona). It is difficult, expensive, and sometimes even impossible to use financial contracts to hedge exposure to minor currencies.

Eurobond Practices: Primary Market

The managing group, along with other banks, will serve as underwriters for the issue. They will commit their own capital to buy the issue from the borrower at a discount from the issue price. The discount, or underwriting spread, is typically in the 2 to 2.5 percent range. By comparison, the spread averages about 1 percent for domestic issues. Most of the underwriters, along with other banks, will be part of a selling group that sells the bonds to the investing public.

Global Registered Shares

The merger of Daimler Benz AG and Chrysler Corporation in November 1998 created DaimlerChrysler AG, a German firm. The merger simultaneously created a new type of equity share, called Global Registered Shares (GRSs). GRSs are traded globally, unlike ADRs, which are traded on foreign markets. The company was renamed Daimler AG in October 2007 when it spun off Chrysler. The primary exchanges for Daimler GRSs are the Frankfurt Stock Exchange and the NYSE; however, they are traded on a total of 20 exchanges worldwide. The shares are fully fungible—a GRS purchased on one exchange can be sold on another. They trade in both U.S. dollars and euro. The main advantage of GRSs over ADRs appears to be that all shareholders have equal status and direct voting rights. The main disadvantage of GRSs appears to be the greater expense in establishing the global registrar and clearing facility. GRSs have met with limited success; many companies that considered them opted instead for ADRs. Deutsche Bank, UBS, and NYSE Euronext also trade as GRSs.

The World's Bond Markets: A Statistical Perspective

The total market value of the world's bond markets are about 50% larger than the world's equity markets. The U.S. dollar, the euro, the pound sterling, and the yen are the four currencies in which the majority of domestic and international bonds are denominated. Proportionately more domestic bonds than international bonds are denominated in the U.S. dollar (44.0 percent versus 40.4 percent) and the yen (14.1 percentversus 2 percent) while more international bonds than domestic bonds are denominated in the euro (41.5 percent versus 14.7 percent), and the pound sterling (9.3 percent versus 5.6 percent).

Generalizations of Counter Trade

There are advantages and disadvantages associated with countertrade. It can benefit both parties and in some circumstances is the only trade possible. Whether or not countertrade transactions are good or bad for the global economy, it appears certain that they will increase in the near future as world trade increases.

Market Consolidations And Mergers

There are approximately 80 major national stock markets. Western and Eastern Europe once had more than 20 national stock exchanges where at least 15 different languages were spoken. It appears that over time a European stock exchange will eventually develop. However, a lack of common securities regulations, even among the countries of the European Union, is hindering this development. Today, stock markets around the world are under pressure from clients to combine or buy stakes in one another to trade shares of companies anywhere, at a faster pace.

Advantages of ADRs

There are many advantages to trading ADRs as opposed to direct investment in the company's shares: ADRs are denominated in U.S. dollars, trade on U.S. exchanges, and can be bought through any broker. Dividends are paid in U.S. dollars. Most underlying stocks are bearer securities and the ADRs are registered. ADR trades clear in 3 business days whereas settlement practices for the underlying stock vary in foreign countries.

International Bond Market Indices

There are several international bond market indices. JPMorgan and Company Domestic bond indices. International government bond index for 18 countries. Widely referenced and often used as a benchmark. Appears daily in The Wall Street Journal.

The Asian Crisis

This crisis followed a period of economic expansion in the region financed by record private capital inflows. Bankers from the G-10 countries actively sought to finance the growth opportunities in Asia by providing businesses with a full range of products and services. This led to domestic price bubbles in East Asia, particularly in real estate. Additionally, the close interrelationships common among commercial firms and financial institutions in Asia resulted in poor investment decision making. The Asian crisis is only the latest example of banks making a multitude of poor loans—spurred on by competition from other banks to make loans in the "hot" region.

Eurocommercial Paper

Unsecured short-term promissory notes issued by corporations and banks. Placed directly with the public through a dealer. Maturities typically range from one month to six months. Eurocommercial paper, while typically U.S. dollar denominated, is often of lower quality than U.S. commercial paper—as a result yields are higher.

Eurodollar Interest Rate Futures Contract

Widely used futures contract for hedging short-term U.S. dollar interest rate risk. The underlying asset is a hypothetical $1,000,000 90-day Eurodollar deposit—the contract is cash settled. Traded on the CME and the Singapore International Monetary Exchange. The contract trades in the March, June, September, and December cycle.

National Security Registrations

Yankee bonds must meet the requirements of the SEC, just like U.S. domestic bonds. Many borrowers find this level of regulation burdensome and prefer to raise U.S. dollars in the Eurobond market. Eurobonds sold in the primary market in the United States may not be sold to U.S. citizens. Of course, a U.S. citizen could buy a Eurobond on the secondary market.