Ch. 16: Cash and Marketable Securities Management

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Chapter 15
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International Business Finance
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International Business Finance

• Exchange Rate the price of one currency in
  terms of another.

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Exchange Rates

• Exchange rates affect our economy and each of us
  because
• 1) When the dollar appreciates (strong dollar),
  the dollar becomes more valuable relative to
  other currencies.

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Exchange Rates

• Exchange rates affect our economy and each of us
  because
• 1) When the dollar appreciates (strong dollar),
  the dollar becomes more valuable relative to
  other currencies.
• Foreign products become cheaper to us.

6
Exchange Rates

• Exchange rates affect our economy and each of us
  because
• 1) When the dollar appreciates (strong dollar),
  the dollar becomes more valuable relative to
  other currencies.
• Foreign products become cheaper to us.
• U.S. products become more expensive overseas.

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Exchange Rates

• Exchange rates affect our economy and each of us
  because

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Exchange Rates

• Exchange rates affect our economy and each of us
  because
• 2) When the dollar depreciates (weak dollar),
  the dollar falls in value relative to other
  currencies.

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Exchange Rates

• Exchange rates affect our economy and each of us
  because
• 2) When the dollar depreciates (weak dollar),
  the dollar falls in value relative to other
  currencies.
• Foreign products become more expensive for us, and

10
Exchange Rates

• Exchange rates affect our economy and each of us
  because
• 2) When the dollar depreciates (weak dollar),
  the dollar falls in value relative to other
  currencies.
• Foreign products become more expensive for us,
  and
• U.S. products become cheaper overseas.

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Spot Exchange Rates

• / .6284 (it takes .6284 pounds to 1)
• / 1.5913 (it takes 1.5913 to 1 pound)
• / 102.98 (it takes 102.98 yen to 1)
• / .009711 ( it takes .009711 to 1 yen)
• Real Time Exchange Rates
• (note direct and indirect quotes are
  reciprocals)

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What Determines Exchange Rates?

• Floating Rate Currency System Since 1973, the
  world has allowed exchange rates to change daily
  in response to market forces.
• Exchange rates are affected by
• foreign investors,
• speculators,
• political conditions here and overseas,
• inflation,
• trade policies (tariffs and quotas), and

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What Determines Exchange Rates?

• Supply and Demand for currencies!
• Lets consider the / market.

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What Determines Exchange Rates?

• Supply and Demand for currencies!
• Lets consider the / market.

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What Determines Exchange Rates?

• Supply and Demand for currencies!
• Lets consider the / market.

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What Determines Exchange Rates?

• Suppose the British increase demand for U.S.
  products.
• British importers buy the U.S. products to sell
  in England. They buy dollars with pounds, so
  they can pay U.S. firms in dollars.
• The demand for dollars increases, and forces up
  the / exchange rate, which makes U.S.
  products more expensive in England.

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What Determines Exchange Rates?
/ (price of dollars)
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What Determines Exchange Rates?
/ (price of dollars)
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What Determines Exchange Rates?

• Another example
• Lets consider the / market.

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What Determines Exchange Rates?

• Another example
• Lets consider the / market.

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What Determines Exchange Rates?

• Another example
• Lets consider the / market.

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What Determines Exchange Rates?

• Suppose American demand for Japanese cars and
  stereos increases rapidly.
• American importers buy the Japanese products to
  sell in the U.S. They buy yen with dollars, so
  they can pay Japanese firms in yen.
• The supply of dollars increases, and forces down
  the / exchange rate, which makes Japanese
  products more expensive in the U.S.

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What Determines Exchange Rates?
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What Determines Exchange Rates?
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Foreign Exchange Markets

• Different exchange rates are used for different
  types of transactions
• 1) Spot Exchange Market deals with currency
  for immediate delivery.
• The exchange rate used in spot transactions is
  called the spot exchange rate.
• If you need 500,000 Norwegian Krones to buy
  imports, and the spot exchange rate is .1457, you
  would pay your bank 72,850.

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Foreign Exchange Markets

• 2) Forward Exchange Market deals with the
  future delivery of foreign currency.
• You can buy or sell currency for future delivery,
  usually in 1, 3, or 6 months.
• The exchange rate for forward transactions is
  called the forward exchange rate.
• Forward exchange contracts allow you to hedge
  foreign exchange risk!

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Forward Market Hedge

• Example You will import fish from Norway, to be
  delivered and paid in 6 months.
• You have agreed to a price of 500,000 krones.
  With the spot exchange rate of .1457, this comes
  to 72,850.
• Suppose the dollar weakens over the next 6
  months, and the /NOK exchange rate rises to .20.
• The fish would cost you 100,000. This is an
  example of foreign exchange risk!

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Forward Market Hedge

• You decide to hedge your risk with a forward
  exchange contract!
• The 6-months /NOK forward exchange rate is
  .1476. By agreeing to this forward rate with
  your bank, you lock in a price of 73,800 for
  500,000 krones, 6 months from now.
• Now it doesnt matter what happens to the /NOK
  exchange rate over the next 6 months.

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Money Market Hedge

• For the previous problem, another potential
  solution is the money market hedge.
• 1) Borrow 72,850 from your bank.
• 2) Buy the 500,000 kroners now (at the current
  spot exchange rate of .1457) for 72,850.
• 3) Invest the 500,000 kroners in interest-bearing
  Norwegian securities.
• 4)Complete your transaction after 6 months.
• Borrowing and investment rates determine cost of
  hedge

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Forward-Spot Differential

• If the forward rate the spot rate, the
  forward is trading at a premium.
• If the forward rate forward is trading at a discount.

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Forward-Spot Differential

• If the forward rate the spot rate, the
  forward is trading at a premium.
• If the forward rate forward is trading at a discount.
• premium forward - spot 12
  
• or discount spot
  n

x 100
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Forward-Spot Differential

• For our example,

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Forward-Spot Differential

• For our example,
• premium forward - spot 12
  
• or discount spot
  n

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Forward-Spot Differential

• For our example,
• premium forward - spot 12
  
• or discount spot
  n
• .1476 - .1457
  12
• .1457
  6

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Forward-Spot Differential

• For our example,
• premium forward - spot 12
  
• or discount spot
  n
• .1476 - .1457
  12
• .1457
  6
• 2.6. The forward is trading
  at a 2.6
• premium.

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Exchange Rate Risk

• Translation exposure - foreign currency assets
  and liabilities that, for accounting purposes,
  are translated into domestic currency using the
  exchange rate, are exposed to exchange rate risk.
• However, if markets are efficient, investors know
  that any translation losses are paper losses
  and are unrealized.

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Exchange Rate Risk

• Transaction exposure - refers to transactions in
  which the monetary value is fixed before the
  transaction actually takes place.
• Ex your firm buys foreign goods to be received
  and paid for at a later date. The exchange rate
  can change, which can affect the price actually
  paid.

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Direct Foreign Investment

• Risks
• Business Risk - firms must be aware of the
  business climate in both the US and the foreign
  country.
• Financial Risk - not much difference between
  financial risks of foreign operations and those
  of domestic operations.

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Direct Foreign Investment

• Risks
• Political Risk - firms must be aware that many
  foreign governments are not as stable as the U.S.
• Exchange Rate Risk - exchange rate changes can
  affect sales, costs of goods sold, etc. as well
  as the firms profit in dollars.

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