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• Cover
• Half title
• Title page
• Imprints page
• Contents
• Preface
• This Book’s Approach: Making Better Decisions by Blending Theory and Practice with Real-World Data Analysis
• Pedagogy for Students
• Acknowledgments
• 1 Globalization and the Multinational Corporation
• 1.1 Introduction
• 1.2 Globalization and the Growth of International Trade and Capital Flows
• The Growth of International Trade
• Trade Liberalization
• International Efforts to Promote Free Trade
• The Growth in Trade
• How Multinational Corporations Are Affecting Trade
• The Globalization of Financial Markets
• Trends in Financial Openness
• The New Financial Landscape
• A Global Financial Crisis
• Ramifications of the Crisis
• 1.3 Multinational Corporations
• How Multinational Corporations Enter Foreign Markets
• The Goals of an MNC
• The Investment Time Horizon
• The Stakeholder Alternative
• Agency Theory and Corporate Governance
• Corporate Scandals
• Corporate Governance Around the World
• An Independent Board of Directors
• Concentrated Ownership
• Executive Compensation
• Shareholder Activism and Litigation
• Hostile Takeovers
• The Sarbanes-Oxley Act
• What the Data Show
• Multinational Corporations and Foreign Direct Investment
• International Mergers and Acquisitions
• 1.4 Other Important International Players
• International Banks
• International Institutions
• The International Monetary Fund
• The World Bank
• Multilateral Development Banks
• The World Trade Organization
• The Organisation for Economic Co-operation and Development
• The Bank for International Settlements
• The European Union
• Governments
• Individual and Institutional Investors
• Individual Investors
• Institutional Investors
• Sovereign Wealth Funds
• Hedge Funds and Private Equity Firms
• 1.5 Globalization and the Multinational Firm: Benefactor or Menace?
• A Rocky Road to Free Trade
• Trade Openness and Economic Risk
• Fairer Trade Openness?
• Do International Capital Flows Cause Havoc?
• Benefits of Financial Openness
• Costs of Financial Globalization
• What the Data Show
• The Anti-Globalist Movement and MNCs
• What Are Anti-Globalists?
• Why Do Anti-Globalists Dislike Multinationals So Much?
• The Economic Effects of FDI and Multinational Activity
• Some Final Thoughts on Globalization
• 1.6 Overview of the Book
• Part I: Introduction to Foreign Exchange Markets and Risks
• Part II: International Parity Conditions and Exchange Rate Determination
• Part III: International Capital Markets
• Part IV: International Corporate Finance
• Part V: Managing Ongoing Operations
• Part VI: Foreign Currency Derivatives
• A Final Introduction
• 1.7 Summary
• Questions
• Problems
• Bibliography
• Part I Introduction to Foreign Exchange Markets and Risks
• 2 The Foreign Exchange Market
• 2.1 The Organization of the Foreign Exchange Market
• Size of the Market
• Types of Contracts Traded
• Foreign Exchange Dealers
• Foreign Exchange Brokers
• Other Participants in the Forex Market
• Electronic Foreign Exchange Trading (eFX)
• The Competitive Marketplace
• 2.2 Currency Quotes and Prices
• Exchange Rates
• Exchange Rate Quotes
• Vehicle Currencies and Currency Cross-Rates
• Triangular Arbitrage
• 2.3 Inside the Interbank Market I: Bid–Ask Spreads and Bank Profits
• Bid–Ask Spreads
• The Magnitude of Bid–Ask Spreads
• 2.4 Inside the Interbank Market II: Communications and Fund Transfers
• Communication Systems
• Cross-Currency Settlement (or Herstatt) Risk
• 2.5 Describing Changes in Exchange Rates
• Rates of Appreciation and Depreciation
• Continuously Compounded Rates of Appreciation (Advanced)
• 2.6 Summary
• Questions
• Problems
• Appendix 2.1 Logarithms
• Bibliography
• 3 Forward Markets and Transaction Exchange Risk
• 3.1 Transaction Exchange Risk
• 3.2 Describing Uncertain Future Exchange Rates
• Assessing Exchange Rate Uncertainty Using Historical Data
• The Probability Distribution of Future Exchange Rates
• Conditional Means and Volatilities
• Assessing the Likelihood of Particular Future Exchange Rate Ranges
• 3.3 Hedging Transaction Exchange Risk
• Forward Contracts and Hedging
• Hedging Currency Risk of Fancy Foods
• Hedging at Nancy Foods
• Exposure of Hedged Versus Unhedged Strategies
• The Costs and Benefits of a Forward Hedge
• Examples of Using Forward Contracts to Hedge Transaction Risk
• 3.4 The Forward Foreign Exchange Market
• Market Organization
• Forward Contract Maturities and Value Dates
• Forward Market Bid–Ask Spreads
• Liquidity in the Forward Market
• Net Settlement
• The Foreign Exchange Swap Market
• How Swap Prices Are Quoted
• A Rule for Using Swap Points
• Cash Flows in a Swap
• 3.5 Forward Premiums and Discounts
• Sizes of Forward Premiums or Discounts
• Forward Premiums and Swap Points
• 3.6 Changes in Exchange Rate Volatility (Advanced)
• Volatility Clustering
• 3.7 Summary
• Questions
• Problems
• Appendix
• Appendix 3.1 A Statistics Refresher
• Bibliography
• 4 The Balance of Payments
• 4.1 The Balance of Payments: Concepts and Terminology
• Major Accounts of the BOP
• A Double-Entry Accounting System
• An Intuitive Rule for Determining Credits and Debits
• Current Account Transactions
• Interest and Dividend Receipts and Payments
• Transfer Payments Between Countries
• Capital Account Transactions
• Capital Outflows
• Capital Inflows
• Summarizing Capital Account Transactions
• Official Reserves Account Transactions
• Implications for Fixed Exchange Rates
• 4.2 Surpluses and Deficits in the Balance of Payments Accounts
• An Important BOP Identity
• The US Current Account
• Services
• Balance on Goods and Services
• Investment Income
• Unilateral Current Transfers, Net
• Balance on Current Account
• The US Capital and Financial Accounts
• US-Owned Assets Abroad, Net
• Foreign Assets in the US, Net
• Financial Derivatives, Net
• Capital Account Transfers
• Balance on the Capital Account
• The Official Settlements, or Reserves, Account
• BOP Deficits and Surpluses and the Official Settlements Account
• BOP Statistics Around the World
• 4.3 The Dynamics of the BOP
• The Trade Account and the Investment Income Account
• Countries as Net Creditors or Net Debtors
• The US Net International Investment Position
• 4.4 Savings, Investment, Income, and the BOP
• Linking the Current Account to National Income
• National Savings, Investment, and the Current Account
• Current Accounts and Government Deficits
• What Causes Current Account Deficits and Surpluses?
• Ricardian Equivalence
• Individuals’ Intertemporal Budget Constraints
• Investment Spending
• Assessing the Openness of International Capital Markets
• 4.5 Summary
• Questions
• Problems
• Appendix 4.1 A Primer on National Income and Product Accounts
• Gross Domestic Production and Expenditures
• Consumption Expenditures (C)
• Gross Private Domestic Investment (I)
• Government Purchases (G)
• Net Exports (NX)
• Gross Domestic Product and Expenditures
• From Gross Domestic Product to Gross National Income
• Biblography
• 5 Exchange Rate Systems
• 5.1 Alternative Exchange Rate Arrangements and Currency Risk
• Exchange Rate Systems Around the World
• Floating Currencies
• Managed Floating
• Fixed, or Pegged, Currencies
• No Separate Legal Tender
• Currency Boards
• Target Zones and Crawling Pegs
• Currency Risks in Alternative Exchange Rate Systems
• Quantifying Currency Risks
• Currency Risks in Floating Exchange Rate Systems
• Currency Risk in Target Zones
• Currency Risk in Pegged Exchange Rate Systems
• Currency Risk in Currency Boards and Monetary Unions
• Trends in Currency Systems
• 5.2 Central Banks
• The Central Bank’s Balance Sheet
• Bank Reserves and Currency in Circulation
• Domestic Credit
• Official Reserves
• Money Creation and Inflation
• The Impossible Trinity or Trilemma
• Foreign Exchange Interventions
• Non-Sterilized Interventions
• Sterilized Interventions
• How Do Central Banks Peg a Currency?
• Pegging the Exchange Rate
• 5.3 Flexible Exchange Rate Systems
• The Effects of Central Bank Interventions
• Direct Effects of Interventions
• Indirect Effects of Interventions
• Empirical Evidence on the Effectiveness of Interventions
• 5.4 Fixed Exchange Rate Systems
• The International Monetary System Before 1971: A Brief History
• The Gold Standard
• Hyperinflation and the Interwar Period
• The Bretton Woods System
• Individual Incentives Versus Aggregate Incentives
• Special Drawing Rights
• Pegged Exchange Rate Systems in Developing Countries
• Illegal Currency Markets
• Why Not Simply Float?
• Currency Boards
• Dollarization
• 5.5 Limited-Flexibility Systems: Target Zones and Crawling Pegs
• Target Zones
• Speculative Attacks
• Defending the Target Zone
• Lead–Lag Operations
• Crawling Pegs
• 5.6 How to See an Emu Fly: The Road to Monetary Integration in Europe
• The European Monetary System
• Intervention Rules
• Realignment Rules
• On ECUs, Euros, and Franken
• The Politics of Naming the Euro
• Was the EMS Successful?
• Day-to-Day Variability Was Down
• Inflation and Interest Differentials Narrowed
• Asymmetric Adjustments
• The Maastricht Treaty and the Euro
• ERM II
• Pros and Cons of a Monetary Union
• Optimum Currency Areas
• Is Europe an Optimum Currency Area?
• 5.7 Summary
• Questions
• Problems
• Bibliography
• Part II International Parity Conditions and Exchange Rate Determination
• 6 Interest Rate Parity
• 6.1 The Theory of Covered Interest Rate Parity
• The Intuition Behind Interest Rate Parity
• Deriving Interest Rate Parity
• A General Expression for Interest Rate Parity
• Interest Rate Parity and Forward Premiums and Discounts
• Interest Rate Parity with Continuously Compounded Interest Rates (Advanced)
• Covered Interest Arbitrage
• A Box Diagram
• 6.2 Covered Interest Rate Parity in Practice
• The External Currency Market
• Transaction Costs in the External Currency Market
• How the External Currency Market Affects Other Capital Markets
• Covered Interest Arbitrage with Transaction Costs (Advanced)
• Does Covered Interest Parity Hold?
• 6.3 Why Deviations from Interest Rate Parity May Seem to Exist
• Default Risks
• Exchange Controls
• Political Risk
• 6.4 Hedging Transaction Risk in the Money Market
• Hedging a Foreign Currency Liability
• Hedging a Foreign Currency Receivable
• 6.5 The Term Structure of Forward Premiums and Discounts
• The Term Structure of Interest Rates
• Spot Interest Rates
• A Review of Bond Pricing
• Yields to Maturity
• Deriving Long-Term Spot Interest Rates
• Long-Term Forward Rates and Premiums
• 6.6 Summary
• Questions
• Problems
• Bibliography
• 7 Speculation and Risk in the Foreign Exchange Market
• 7.1 Speculating in the Foreign Exchange Market
• Uncovered Foreign Money Market Investments
• Speculating with Forward Contracts
• The Break-Even Spot Rate
• Comparing Forward Market and Foreign Money Market Investments
• Currency Speculation and Profits and Losses
• Quantifying Expected Losses and Profits
• Lessons from History: The Variability of Currency Changes and Forward Market Returns
• 7.2 Uncovered Interest Rate Parity and the Unbiasedness Hypothesis
• Uncovered Interest Rate Parity
• The Unbiasedness Hypothesis
• Forecast Errors
• Unbiased Predictors
• The Unbiasedness Hypothesis and Market Efficiency
• 7.3 Risk Premiums in the Foreign Exchange Market
• What Determines Risk Premiums?
• Systematic and Unsystematic Risk
• The CAPM
• Applying the CAPM to Forward Market Returns
• Formal Derivation of CAPM Risk Premiums (Advanced)
• The CAPM in Symbols
• The CAPM and Forward Market Returns
• 7.4 Uncovered Interest Rate Parity and the Unbiasedness Hypothesis in Practice
• Situations Where Premiums Matter
• International Portfolio Management
• The Cost of Hedging
• Exchange Rate Forecasting
• Exchange Rate Determination
• 7.5 Empirical Evidence on the Unbiasedness Hypothesis
• The Quest for a Test
• Incorporating Rational Expectations into the Test
• A Test Using the Sample Means
• Data on Rates of Appreciation and Forward Premiums
• The Test
• High-Interest-Rate Currencies Depreciate
• Regression Tests of the Unbiasedness of Forward Rates
• Interpreting the Forward Bias
• 7.6 Alternative Interpretations of the Test Results
• Market Inefficiency
• Exploiting the Forward Bias and Carry Trades
• Sharpe Ratios and Leverage
• Currency Strategies in Practice
• Risk Premiums
• The Variability of the Risk Premium (Advanced)
• Is It Risk?
• Problems Interpreting the Statistics
• Unstable Coefficients in the Unbiasedness Hypothesis Regressions
• Peso Problems
• The Peso Problem and Carry Trades
• Swedish Interest Rates of 500%
• 7.7 Summary
• Questions
• Problems
• Appendix
• Appendix 7.1 The Siegel Paradox
• Appendix 7.2 The Portfolio Diversification Argument and the CAPM
• Appendix 7.3 A Regression Refresher
• Bibliography
• 8 Purchasing Power Parity and Real Exchange Rates
• 8.1 Price Levels, Price Indexes, and the Purchasing Power of a Currency
• The General Idea of Purchasing Power
• Calculating the Price Level
• Calculating a Price Index
• Internal Purchasing Power
• External Purchasing Power
• 8.2 Absolute Purchasing Power Parity
• The Theory of Absolute Purchasing Power Parity
• Goods Market Arbitrage
• 8.3 The Law of One Price
• The Perfect Market Ideal
• Why Violations of the Law of One Price Occur
• Tariffs and Quotas
• Transaction Costs That Prevent Trade
• Speculation and Contracts
• Non-Competitive Markets
• Sticky Prices
• How Wide Is the Border?
• 8.4 Describing Deviations from PPP
• Overvaluations and Undervaluations of Currencies
• Predictions Based on Overvaluations and Undervaluations
• The MacPPP Standard
• The Implied MacPPP Rates
• Overvaluations and Undervaluations
• Predicting British Heartburn
• The Econometric Evidence
• 8.5 Exchange Rates and Absolute PPPs Using CPI Data
• Interpreting the Charts
• Overvaluations and Undervaluations
• Fixing When PPP Held
• Analyzing the Data
• Dollar–Pound
• Dollar–Euro
• Yen–Dollar
• Canadian Dollar–US Dollar
• Mexican Peso–US Dollar
• 8.6 Explaining the Failure of Absolute PPP
• Changes in Relative Prices
• A Burgers-and-Sushi World
• Non-Traded Goods
• Housing
• Technological Change
• PPP Deviations and the Balance of Payments
• 8.7 Comparing Incomes across Countries
• Comparing Incomes in New York and Tokyo
• The Salary Offers
• A Naïve Calculation
• Incorporating Purchasing Power
• Working with the PPP Rate
• Comparing GDPs Using PPP Exchange Rates
• 8.8 Relative PPP
• A General Expression for Relative PPP
• The Logic of Relative PPP
• A Symbolic Representation of Relative PPP
• Relative PPP with Continuously Compounded Rates of Change (Advanced)
• 8.9 The Real Exchange Rate
• The Definition of the Real Exchange Rate
• Real Appreciations and Real Depreciations
• The Percentage Change in the Real Exchange Rate
• What Leads to Real Appreciations or Depreciations?
• Trade-Weighted Real Exchange Rates
• 8.10 Summary
• Questions
• Problems
• Bibliography
• 9 Measuring and Managing Real Exchange Risk
• 9.1 How Real Exchange Rates Affect Real Profitability
• The Real Profitability of an Exporting Firm
• Calculating a Firm’s Nominal Profit
• A Firm’s Real Export Revenue
• 9.2 Real Exchange Risk at Exporters, Importers, and Domestic Firms
• The Real Exchange Rate Risk of a Net Exporter
• A Competitive Dilemma
• The Real Exchange Risk of a Net Importer
• The Real Exchange Risk of an Import Competitor
• Measuring Real Exchange Risk Exposure
• The Present Value of a Firm’s Profits
• 9.3 Sharing the Real Exchange Risk: An Example
• Safe Air Evaluates an International Supply Contract
• The Indexing Formula
• The Consultant’s Task
• Basic Data and Analysis
• Profitability Under a Simple Contract with Constant Prices
• Sharing the Exchange Rate Risk with Constant Prices
• Analyzing Contracts When Inflation and Real Exchange Rates Are Changing
• Safe Air’s Real Cost per Tank
• Metallwerke’s Real Revenue per Tank
• Designing a Contract That Shares the Real Exchange Risk
• Understanding the Contract
• Would the Redesigned Contract Be Adopted?
• Relative Bargaining Strength
• 9.4 Pricing-To-Market Strategies
• Pricing-to-Market by a Monopolist
• A Monopolistic Exporter
• A Monopolistic Net Importer
• Empirical Evidence on Pricing-to-Market
• 9.5 Evaluating the Performance of a Foreign Subsidiary
• Three Types of Subsidiaries
• The Net Importer
• The Net Exporter
• The Neutral Firm
• Initial Operating Profitability
• Actual Versus Forecasted Operating Results
• RiceNoodle’s Results
• Results at ThaiComp and WeRToys
• Comparing the Optimal Response with No Response by Managers
• Comparisons with No Operating Responses
• Comparisons with Optimal Responses
• Who Deserves a Bonus?
• Assessing the Long-Run Viability of a Subsidiary
• 9.6 Strategies for Managing Real Exchange Risk
• Transitory Versus Permanent Changes in Real Exchange Rates
• Production Management
• Production Scheduling
• Input Sourcing
• Plant Location Decisions
• Marketing Management
• Pricing Policies
• The Frequency of Price Adjustments
• Market Entry Decisions
• Brand Loyalty
• 9.7 Summary
• Questions
• Problems
• Bibliography
• 10 Exchange Rate Determination and Forecasting
• 10.1 Parity Conditions and Exchange Rate Forecasts
• The Fisher Hypothesis
• Interest Rates and Inflation
• Real Rates of Return
• The Ex Ante Real Interest Rate
• The International Parity Conditions
• CIRP
• UIRP or Unbiasedness
• PPP
• Real Interest Rates and the Parity Conditions
• Real Interest Rate Parity
• Testing Real Interest Rate Parity
• 10.2 Currency Forecasting Techniques
• Fundamental Exchange Rate Forecasting
• Exchange Rate Forecasting with Technical Analysis
• Why Technical Analysis Might Work
• Evaluating Forecasts
• Accuracy
• Being on the Right Side of the Forward Rate
• Profitability
• 10.3 Fundamental Exchange Rate Forecasting
• Forecasting Performance of Fundamental Exchange Rate Models
• Forecasting Models and Benchmarks
• The Asset Market Approach to Exchange Rate Determination
• UIRP and the Exchange Rate
• The Exchange Rate as an Asset Price
• The Monetary Approach
• Sticky Prices and Overshooting
• Why the Random Walk Works
• News and Exchange Rates
• The Real Exchange Rate, the Real Interest Rate Differential, and the Current Account
• Converting UIRP to Real Terms
• Mean Reversion
• Empirical Evidence
• The Real Exchange Rate and the BOP
• The Trade Balance and Real Exchange Rates
• The Capital Account and Real Exchange Rates
• Equilibrium
• PPP-Based Forecasts
• 10.4 Technical Analysis
• Pure Technical Analysis: Chartism
• Potentially Spurious Patterns
• Trading on a Random Walk
• Does Charting Work?
• Filter Rules
• x% Rules
• Moving-Average Crossover Rules
• Filter Rule Profitability
• Regression Analysis
• Nonlinear Models
• Evaluating Forecasting Services
• 10.5 Predicting Devaluations
• What Causes a Currency Crisis?
• Macroeconomic Conditions
• Self-Fulfilling Expectations
• Contagion
• Empirical Evidence on the Predictability of Currency Crises
• The Rocky 1990s: Currency Crises Galore
• 1991–1993: Currency Turmoil in Europe
• 1994–1995: The Mexican Crisis and the Tequila Effect
• 1997: The Southeast Asian Crisis
• 10.6 Summary
• Questions
• Problems
• Bibliography
• Part III International Capital Markets
• 11 International Debt Financing
• 11.1 The Global Sources of Funds for International Firms
• The Financing Mix Around the World
• 11.2 The Characteristics of Debt Instruments
• Currency of Denomination
• Centralized Versus Decentralized Debt Denomination
• Is Issuing Debt in Low-Interest Rate Countries a Good Idea?
• Debt Portfolios
• Maturity
• The Nature of Interest Rate Payments: Fixed-Rate Versus Floating-Rate Debt
• When to Use Floating Rate Debt
• The Expectations Hypothesis
• Tradability of Debt
• Intermediated and Direct Debt
• Private Placements
• The International Character of Debt
• 11.3 A Tour of the World’s Bond Markets
• Size and Structure of the World Bond Market
• Domestic Bond Markets
• The International Bond Market
• The Foreign Bond Market
• The Eurobond Market
• The Primary Market for Eurobonds
• The Secondary Market for Eurobonds
• Global Bonds
• Dragon Bonds
• The Blurring of the Distinctions in the International Bond Market
• The Types of Debt Instruments in the International Bond Market
• Straight Fixed-Rate Issues
• Floating-Rate Notes
• Equity-Related Bonds
• Currency of Denomination
• 11.4 International Banking
• Banks as MNCs
• Types of International Banking Offices
• Correspondent Banks
• Representative Offices
• Foreign Branches
• Subsidiary and Affiliate Banks
• Offshore Banking Centers
• Edge Act Banks
• International Banking Facilities
• International Banking Regulation
• International Capital Adequacy: The 1988 Basel Accord
• A New Capital-Adequacy Framework or Basel II
• Basel III and the Crisis
• 11.5 International Bank Loans
• Eurocredits
• Types of Eurocredits
• Syndicates
• Fees and Borrowing Costs
• History and Size of Eurocredits
• The Secondary Market
• The Euronote Market
• Euronotes
• Euro-Medium-Term Notes
• The Major Debt Arrangers
• 11.6 Comparing the Costs of Debt
• The All-in-Cost Principle
• Components of the AIC
• Credit Ratings
• Rating Schemes
• Minimizing the Cost of Debt Internationally
• Why Source Debt Internationally?
• Credit Spreads Across Countries
• Empirical Evidence
• 11.7 Summary
• Questions
• Problems
• Bibliography
• 12 International Equity Financing
• 12.1 A Tour of International Stock Markets
• The Size of Stock Markets
• Emerging Stock Markets
• Stock Markets and the Economy
• The Organization and Operation of Stock Markets
• Legal Organization
• The Globalization of Exchanges
• Trading Practices
• Automation and Electronic Trading
• Examples of Trading Practices on Major Exchanges
• Turnover and Transaction Costs
• 12.2 International Cross-Listing and Depositary Receipts
• American Depositary Receipts
• Types of ADRs
• Global Depositary Receipts
• Size and Growth of the Depositary Receipt Market
• Global Registered Shares
• 12.3 The Advantages and Disadvantages of Cross-Listing
• Why Firms Choose to Cross-list
• Liquidity
• Wider Shareholder Base
• Market Integration
• Corporate Governance Signal
• Capital Needs and Growth Opportunities
• Other Benefits of Cross-listing
• Why Firms Decide Against Cross-Listing
• 12.4 Strategic Alliances
• 12.5 Summary
• Questions
• Problems
• Bibliography
• 13 International Capital Market Equilibrium
• 13.1 Risk and Return of International Investments
• The Two Risks of Investing Abroad
• The Volatility of International Investments
• The Volatility of Currency and Equity Returns
• Adding Up Volatility
• Expected Returns
• Average Returns
• Currency Components of Returns
• Sharpe Ratios
• 13.2 The Benefits of International Diversification
• Risk Reduction Through International Diversification
• Idiosyncratic Variance Changes over Time
• International Return Correlations
• What Drives Correlations of Returns?
• Asymmetric Correlations?
• The Effect of International Diversification on Sharpe Ratios
• Portfolio Risk and Return
• When Does International Diversification Improve the Sharpe Ratio?
• Investment Hurdle Rates
• 13.3 Optimal Portfolio Allocation
• Preferences
• The Case of One Risky Asset
• The Optimal Portfolio
• The Mean–Standard Deviation Frontier
• Two-Fund Separation (Advanced)
• The Efficient Frontier
• The Mean-Variance-Efficient (MVE) Portfolio
• 13.4 The Capital Asset Pricing Model
• Assumptions and Origins
• A Derivation of the CAPM (Advanced)
• Interpreting the CAPM
• The CAPM Equilibrium
• The Risk Premium on the Market
• Individual Expected Returns and the Role of Beta
• Domestic Versus World CAPMs
• The Role of Exchange Rates
• International CAPMs (Advanced)
• 13.5 The CAPM in Practice
• A Recipe for the Cost of Equity Capital
• The Benchmark Problem
• The Market Portfolio
• World Market Proxies
• Getting the Benchmark Wrong
• Beta Estimation
• The Risk Premium on the Market
• Historical Estimates
• Caveats
• The Need for Sensitivity Analysis
• 13.6 Integrated Versus Segmented Markets
• Investing in Emerging Markets
• The Cost of Capital in Integrated and Segmented Markets
• Equity Market Liberalizations
• Segmentation and Integration over Time
• A Model of Time-Varying Market Integration
• The Practical Implications of Segmentation and Time-Varying Integration
• Home Bias and Its Implications
• Implications for Pricing
• Time-Varying Correlations
• 13.7 Alternative Cost-of-Capital Models
• The Usefulness of the CAPM
• The Consequences of Using the Wrong Model
• Factor Models and the Fama–French Model
• The Value and the Small Firm Effects
• The Fama–French Three-Factor Model (Advanced)
• 13.8 Summary
• Questions
• Problems
• Appendix 13.1 The Mathematics of International Diversification
• Risk Reduction
• Improving the Sharpe Ratio
• Bibliography
• 14 Country and Political Risk
• 14.1 Country Risk Versus Political Risk
• Country Risk
• Financial and Economic Risk Factors
• Political Risk Factors
• Expropriation or Nationalization
• Contract Repudiation
• Taxes and Regulation
• Exchange Controls
• Corruption and Legal Inefficiency
• Ethnic Violence, Political Unrest, and Terrorism
• Home-Country Restrictions
• The Debt Crisis
• Origins of the Debt Crisis
• Managing the Debt Crisis
• The Brady Plan
• 14.2 Incorporating Political Risk in Capital Budgeting
• Adjusting Expected Cash Flows for Political Risk
• General Formulas
• Adjusting the Discount Rate Instead of Cash Flows
• Discount Rates for Emerging Markets and Political Risk
• 14.3 Country and Political Risk Analysis
• Country Risk Ratings
• Political Risk Analysis
• Some Examples of Ratings Systems
• The PRS Group’s ICRG Rating System
• Financial and Economic Risk Factors
• The Political Risk Components
• Overall Ratings
• Country Credit Spreads
• Sovereign Credit Ratings
• Why Is Sovereign Credit Risk Different?
• Historical Background: Brady Bonds
• Analyzing a Brady Bond
• Country Spreads and Political Risk Probabilities
• Default Probabilities with Positive Recovery Values
• Case Study: The Mexican Peso Crisis and Country Risk
• Computing Political Risk Probabilities
• Using Country Spreads to Compute Political Risk Probabilities
• Using Political Risk Ratings
• 14.4 Managing Political Risk
• Structuring an Investment
• Insurance
• Political Risk Insurance for US Companies
• Political Risk Insurance in Emerging and Transitioning Economies
• Public Versus Private Insurance
• Project Finance
• 14.5 Summary
• Questions
• Problems
• Bibliography
• Part IV International Corporate Finance
• 15 International Capital Budgeting
• 15.1 An Overview of Adjusted Net Present Value
• Step 1: Discount the Cash Flows of the All-Equity Firm
• Step 2: Add the Value of the Financial Side Effects
• Step 3: Value Any Real Options
• 15.2 Deriving the NPV of Free Cash Flow
• Incremental Profit
• Deriving Free Cash Flow
• Revenues and Costs
• EBIT and NOPLAT
• Free Cash Flow
• Discounting Free Cash Flows
• Calculating the Terminal Value of a Project
• 15.3 Financial Side Effects
• The Costs of Issuing Securities
• Tax Shields for Certain Securities
• The Proper Discount Rate
• Costs of Financial Distress
• Direct Costs of Financial Distress
• Indirect Costs of Financial Distress
• The Equilibrium Amount of Debt
• Subsidized Financing
• 15.4 Real Options
• Problems with the Discounted Cash Flow Approach
• 15.5 Parent Versus Subsidiary Cash Flows
• A Three-Step Approach to Determining the Value of a Foreign Subsidiary
• 15.6 The Case of International Wood Products
• IWPI-Spain’s Free Cash Flows
• Forecasting Total Revenue
• Forecasting Net Working Capital, Capital Expenditures, and Depreciation
• Forecasting Total Costs
• Forecasting Net Operating Profit Less Adjusted Taxes (NOPLAT)
• Forecasting IWPI-Spain’s Free Cash Flow
• The Net Present Value of IWPI-Spain
• Deriving the Terminal Value
• The Parent Company’s Perspective
• Forecasting the Dividends Received by IWPI-US
• Calculating the US Foreign Tax Credit
• Calculating the US Income Tax Liability for IWPI-US
• Calculating the Net Present Value of After-Tax Dividends Received by IWPI-US
• Forecasting the Royalty and Overhead Allocation Fees
• Forecasting the Profits Earned from Intermediate Goods
• Valuing the Financial Side Effects
• Interest Tax Shields
• Interest Subsidies
• The Full ANPV of IWPI-Spain
• Cannibalization of Export Sales
• 15.7 Summary
• Questions
• Problems
• Appendix 15.1 Deriving the Value of a Perpetuity
• Bibliography
• 16 Additional Topics in International Capital Budgeting
• 16.1 Alternative Approaches to Capital Budgeting
• The ANPV Approach
• Two Valuation Alternatives to ANPV
• The WACC Approach to Capital Budgeting
• WACC Without Taxes
• WACC with Taxes
• Why rWACC Must Be Less Than rA
• Why Use WACC?
• Deriving rA from rD and rE
• Pros and Cons of Using WACC
• The Flow-to-Equity Method of Capital Budgeting
• The Equivalence of FTE to Other Approaches
• The Pros and Cons of Alternative Capital Budgeting Methods
• 16.2 Forecasting Cash Flows of Foreign Projects
• The Choice of Currency
• Reconciling the Two Methods for Discounting Foreign Cash Flows
• 16.3 Case Study: CMTC’s Australian Project
• The Australian Investment Proposal
• Gathering the Economic Data
• Expected One-Year Real Interest Rates
• Book Value and Depreciation
• Discounted Cash Flows
• Case Solution
• Initial Cash Flows
• The After-Tax Cost Savings of the Project
• Depreciation Tax Shields
• The Total Expected After-Tax Cash Flows in Australian Dollars
• Forecast Future Spot Rates
• The US Dollar Discount Rates
• The Net Present Value of the Project in US Dollars
• How Incorrect Discounting Leads to Problems
• The Net Present Value of the Project in Australian Dollars
• An Incorrect Approach – Again
• The Expected Real Depreciation of the Australian Dollar
• 16.4 Terminal Value When Return on Investment Equals the Weighted Average Cost of Capital
• Equilibrium Rate of Return on Investment
• The Return on Investment and the Plowback Ratio
• The Terminal Value Calculation
• Terminal Value with Perpetual Growth and with Expected Inflation
• 16.5 Tax Shields on Foreign Currency Borrowing
• The Tax Implications of Borrowing in a Foreign Currency
• Foreign Currency Borrowing by Banana Computers
• Banana’s Borrowing Possibilities
• The Dollar Loan
• The Euro and Yen Loans
• Comparing the Foreign Currency Loans
• 16.6 Conflicts between Bondholders and Stockholders
• The Incentive to Take Risks
• The Low-Variance Project
• The High-Variance Project
• The Underinvestment Problem
• A Firm Without a New Project
• A Firm with a New Project
• Underinvestment in Emerging Market Crises
• Other Managerial Problems Caused by Financial Distress
• 16.7 International Differences in Accounting Standards
• Empirical Effects of IFRS Adoption
• 16.8 Summary
• Questions
• Problems
• Bibliography
• 17 Risk Management and the Foreign Currency Hedging Decision
• 17.1 To Hedge or Not to Hedge
• Hedging in an Entrepreneurial Venture
• Hedging in a Modern Corporation
• The Hedging-Is-Irrelevant Logic of Modigliani and Miller
• 17.2 Arguments against Hedging
• Hedging Is Costly
• A True Hedging Cost: The Bid–Ask Spread
• The Employee Cost
• Hedging Equity Risk Is Difficult, if Not Impossible
• The Weehawken Widget Project
• Changes in the Project’s Value over Time
• The Project’s Value with One Year of Hedged Cash Flows
• The Project’s Value with Two Years of Hedged Cash Flows
• The Project’s Value with an Infinite Sequence of Hedged Cash Flows
• The Project’s Value with an Equity Hedge
• Reality Is More Complicated
• Hedging Can Create Bad Incentives
• 17.3 Arguments for Hedging
• Hedging Can Reduce the Firm’s Expected Taxes
• General Principles
• Hedging Can Lower the Costs of Financial Distress
• Hedging Can Improve the Firm’s Future Investment Decisions
• The Basic Logic of the Argument
• Asymmetric Information Is the Problem
• Hedging Can Change the Assessment of a Firm’s Managers
• 17.4 The Hedging Rationale of Real Firms
• Merck’s Hedging Rationale
• Merck’s Five-Step Procedure
• Analysis of Hedging at HDG Inc.
• Oversight, Control, and Operations
• HDG’s Motivations for Risk Management
• 17.5 Hedging Trends
• Information from Surveys
• The Wharton/CIBC Survey
• Empirical Analysis of Why Firms Hedge
• Financial Effects of Hedging
• To Hedge or Not to Hedge: Understanding Your Competitors
• 17.6 Summary
• Questions
• Problems
• Bibliography
• Part V Managing Ongoing Operations
• 18 Financing International Trade
• 18.1 The Fundamental Problem with International Trade
• 18.2 International Trade Documents
• Purchase Order
• Bills of Lading
• Straight Bill of Lading
• Order Bill of Lading
• On-Board Versus Received-for-Shipment Bills of Lading
• Clean Versus Foul Bills of Lading
• Commercial Invoices
• Packing Lists
• Insurance
• Open Insurance Policies
• Consular Invoice
• Certificates of Analysis
• 18.3 Methods of Payment
• Cash in Advance
• Documentary Credits
• Drafts
• Advantages of Documentary Credits to Exporters
• Advantages of Documentary Credits to Importers
• Attributes of Documentary Credits
• Summary of the Creation and Use of a D/C and a B/A
• Documentary Collections
• Advantages of Documentary Collections
• Disadvantages of Documentary Collections
• Sales on Open Account
• 18.4 Financing Exports
• Bank Line of Credit
• Banker’s Acceptances
• Eligible Versus Ineligible Banker’s Acceptances
• Buyer Credit
• Selling Accounts Receivable
• Limited-Recourse Financing: Forfaiting
• The Mechanics of Forfaiting
• Export Factoring
• Methods of Payment
• Government Sources of Export Financing and Credit Insurance
• Ex-Im Bank
• PEFCO
• Export Credit Insurance
• 18.5 Countertrade
• Transactions Without Money
• Barter and Clearing Arrangements
• Switch Trading
• Countertrade Involving Money or Credit
• Buybacks
• Counterpurchases
• Offsets
• 18.6 Summary
• Questions
• Bibliography
• 19 Managing Net Working Capital
• 19.1 The Purpose of Net Working Capital
• Inventories as Assets
• Other Current Assets
• Short-Term Liabilities
• 19.2 International Cash Management
• Constraints on International Cash Management
• Cash Management with a Centralized Pool
• Short-Term Cash Planning
• Managing Surpluses and Deficits
• Forecasts of Cash Flows
• Multilateral Netting Systems
• Using a Centralized Cash Management System to Reduce Precautionary Cash Demands
• Limits to Centralization
• 19.3 Cash Transfers from Affiliates to Parents
• International Dividend Cash Flows
• Tax Planning
• Dealing with Political Risk
• Dealing with Foreign Exchange Risk
• Other Factors Affecting Dividend Policy
• International Royalty and Management-Fee Cash Flows
• Repatriation in a Joint Venture
• Tax Advantages of Royalties and Fees
• Transfer Pricing and Cash Flows
• Shifting Income and Tax Burdens Between Countries
• The Effect of a Low Transfer Price
• The Effect of a High Transfer Price
• Transfer Pricing Regulations
• How Transfer Prices Affect Managers’ Incentives
• Using Transfer Prices to Offset Tariffs
• A General Transfer Pricing Policy with Tariffs
• Using Transfer Pricing to Deal with Foreign Exchange Quotas
• Transfer Pricing in Joint Ventures
• Strategies for Dealing with Blocked Funds
• Fronting Loans
• Reinvesting Working Capital Locally
• Altering the Terms of Trade
• 19.4 Managing Accounts Receivable
• Currency of Denomination
• Leading and Lagging Payments
• Credit Terms
• 19.5 Inventory Management
• Optimal Inventory Theory
• Devaluation or Depreciation Risk
• 19.6 Summary
• Questions
• Problems
• Bibliography
• Part VI Foreign Currency Derivatives
• 20 Foreign Currency Futures and Options
• 20.1 The Basics of Futures Contracts
• Futures Versus Forwards
• Exchange Trading
• Standardized Amounts
• Fixed Maturities
• Credit Risk
• Margins
• Marking to Market
• The Pricing of Futures Contracts
• Comparing Payoffs
• Why Futures Can Differ from Forwards
• Futures Quotes
• 20.2 Hedging Transaction Risk with Futures
• Hedging at Nancy Foods
• The Hedging Decision
• A Numeric Example
• Potential Problems with a Futures Hedge
• Basis Risk
• 20.3 Basics of Foreign Currency Option Contracts
• Basic Option Terminology
• European Versus American Options
• Strike Prices and Intrinsic Value
• Options Trading
• Currency Options on the NASDAQ OMX PHLX
• Currency Options at the CME Group
• Exchange-Listed Currency Warrants
• 20.4 The Use of Options in Risk Management
• A Bidding Situation at Bagwell Construction
• The Transaction Risk
• The Problem with a Forward Hedge
• The Options Solution
• Using Options to Hedge Transaction Risk
• Hedging with Options as Buying Insurance
• Hedging Foreign Currency Risk with Forwards and Options
• Options as Insurance Contracts
• Changing the Quality of the Insurance Policy
• Speculating with Options
• Speculating on Foreign Currency Receivables
• Speculating on Foreign Currency Liabilities
• Options Valuation
• The Intrinsic Value of an Option
• The Time Value of an Option
• Increasing the Exercise Price
• An Increase in the Variance
• Increasing the Time to Expiration
• Put–Call Parity for Foreign Currency Options
• 20.5 Combinations of Options and Exotic Options
• Range Forwards and Cylinder Options
• Synthesizing Cylinder Options
• Other Exotic Options
• Average-Rate Options
• Barrier Options
• Lookback Options
• Digital Options
• 20.6 Summary
• Questions
• Problems
• Appendix 20.1 Foreign Currency Option Pricing (Advanced)
• A Two-State Example of Arbitrage Pricing
• The Binomial Option Pricing Model
• The Continuous Time Case
• Comparative Statics for the Call Option Price
• The Delta of an Option
• Delta Hedging
• The Gamma of an Option
• The Elasticity of an Option
• The Vega of an Option
• The Rhos of an Option
• The Theta of an Option
• Implied Volatility
• Summary
• Additional Questions
• Problems
• Bibliography
• 21 Interest Rate and Foreign Currency Swaps
• 21.1 Introduction to Swaps
• Parallel Loans and Back-to-Back Loans
• Parallel Loans
• Back-to-Back Loans
• Basic Aspects of Currency Swaps and Interest Rate Swaps
• The Size of the Swap Markets
• Credit Default Swaps and the Financial Crisis
• 21.2 Interest Rate Swaps
• Why Use Interest Rate Swaps?
• Fixed Versus Floating-Rate Debt
• Changed Circumstances
• Views on the Future
• Minimizing the Cost of Debt
• Manipulating Earnings
• The Nature of Interest Rate Swap Contracts
• Notional Principal
• Bid–Ask Prices for Interest Rate Swaps
• Profits and Risks for Swap Dealers
• Dealing with Credit Risks
• 21.3 Foreign Currency Swaps
• The Mechanics of Modern Currency Swaps
• Comparative Borrowing Advantages in Matched Currency Swaps
• The Goodweek–Bridgerock Situation
• Absolute Versus Comparative Advantage
• Using a Financial Intermediary in a Currency Swap
• The Sources of the Gains from a Swap
• Swapping Bond Proceeds and Coupon Rates with Quoted Swap Rates
• The Transactions of Goodweek
• The Transactions of Bridgerock
• The Transactions of Bank Carribus
• Currency Swaps as a Package of Forward Contracts
• Euro Bond Issues with Forward Hedging
• The Value of a Currency Swap
• The Rationale for Currency Swaps
• Why Swaps and Not Forwards?
• 21.4 Summary
• Questions
• Problems
• Bibliography
• Glossary
• Index