PART Ⅰ INTRODUCTION AND OVERVIEW 2
1 Introduction to the Study of International Financial Markets 2
1 Introduction to the Study of International Financial Markets 2
PART Ⅰ INTRODUCTION AND OVERVIEW 2
The Changing Financial Landscape 3
The Expanding Menu of Financial Choices 4
Greater Volatility as a Feature of Financial Markets 5
Box 1．1:Accidents along the International Financial Superhighway 6
Increased Competition within and among Financial Markets 6
Major Themes 8
Prices in International Financial Markets 8
Policy Issues in International Financial Markets 10
Box 1．2: London，Tokyo Said Crucial to Market in U．S．Treasurys 13
Box 1．3: Germany Will Issue Short-Term Bills，Sign of Pressure from Euro-Currency 14
Challenges in the Study of International Financial Markets and the Practice of International Financial Management 14
The Importance of Foreign Exchange in the United States 15
The Importance of Foreign Exchange outside the United States 15
The Study of International Financial Markets:More Demanding 18
The Practice of International Financial Management:More Demanding 18
A Road Map for the Remainder of the Book 18
Summary of Major Topics 18
Typical Chapter Outline 20
2 An Overview of International Monetary Systems and Recent Developments in International Financial Markets 21
2 An Overview of International Monetary Systems and International Financial Markets 21
International Monetary Arrangements in Theory and Practice 22
The International Gold Standard，1879-1913 24
Box 2．1:Rules of the Game:The International Gold Standard，1879-1913 24
The Spirit of the Bretton Woods Agreement，1945 26
Box 2．2:Rules of the Game:The Spirit of the Bretton Woods Agreement in 1945 27
The Fixed-Rate Dollar Standard，1950-1970 28
Box 2．3:Rules of the Game:The Fixed-Rate Dollar Standard，1950-1970 29
The Floating-Rate Dollar Standard，1973-1984 32
The Plaza-Louvre Intervention Accords and the Floating-Rate Dollar Standard，1985-1996 33
Box 2．4:Rules of the Game:The Floating-Rate Dollar Standard，1973-1984 33
Box 2．5:Rules of the Game:The Plaza-Louvre Intervention Accords and the Floating-Rate Dollar Standard，1985-1996 35
The Spirit of the European Monetary System，1979 35
Box 2．6:Rules of the Game:The Spirit of the European Monetary System，1979 38
The European Monetary System as a Greater DM Area，1979-1992 38
Exchange Rate Developments 39
Recent Behavior of Prices in International Financial Markets 39
Box 2．7:Rules of the Game:The European Monetary System as a Greater DM Area，1979-1992 39
Box 2．8:A Primer on Foreign Exchange Market Math and Terminology 41
Interest Rate Developments 49
Summary of Recent Developments 56
Policy Matters-Private Enterprises 57
The Conduct of Business under Pegged and Floating Exchange Rates 57
Greater Exchange Rate Variability under Floating 57
Costs of Exchange Rate Variability 57
Policy Matters-Public Policymakers 58
Exchange Rate Policies in Emerging Markets 58
Problems in the European Monetary System 60
Summary 62
PART Ⅱ FOREIGN EXCHANGE MARKETS 66
3 Market Structure and Institutions 66
PART Ⅱ FOREIGN EXCHANGE MARKETS 66
3 Market Structure and Institutions 66
Importance of Foreign Exchange Market Trading 67
Origins of the Market 67
Volume of Foreign Exchange Trading 68
Foreign Exchange Trading Profits 69
Explaining the Profitability of Foreign Exchange Trading 71
Box 3:1:How to Succeed at Intervention by Really Signaling 73
Foreign Exchange Market Products and Activities 73
Spot and Forward Contracts 73
Foreign Exchange Swaps 74
Types of Trading Activities:Speculation and Arbitrage 75
The Relationship between Spot and Forward Contracts 77
Box 3:2:Example of Reuters Screen Page，Citibank Long-Dated Forward Rates February 22，1985 80
The Foreign Exchange Market Setting 83
Comparing the Foreign Exchange Market with Other Markets 83
Tracking a Foreign Exchange Transaction 84
Corporate Foreign Exchange Trading 88
Access to the Interbank Foreign Exchange Market 88
Trends Toward Automated Brokerage，Trading，Clearing，and Settlement 89
Policy Matters-Private Enterprises 90
A Close-Up View on Foreign Exchange Trading 90
Controls over Foreign Exchange Trading 91
Valuing Foreign Exchange Trading Profits 93
Policy Matters-Public Policymakers 93
Summary 94
4 International Parity Conditions:Purchasing Power Parity 98
4 International Parity Conditions:Purchasing Power Parity 98
An Overview of International Parity Conditions in a Perfect Capital Market 99
The Usefulness of Parity Conditions in International Financial Markets 99
Purchasing Power Parity in a Perfect Capital Market 101
The Law of One Price 101
Absolute Purchasing Power Parity 102
Relative Purchasing Power Parity 102
Box 4.1:Absolute PPP Comparisons with Alternative Market Baskets and Alternative Inflation Scenarios 104
The Real Exchange Rate and Pruchasing Power Parity 105
Relaxing the Perfect Capital Market Assumptions 107
Transaction Costs 107
Uncertainty 108
Taxes 108
Empirical Evidence on Prices and Exchange Rates 109
Empirical Methods，or How to Test a Parity Condition 109
Evidence on the Law of One Price 110
Relative PPP:Evidence on Recent Quarterly Data 110
Relative PPP:Evidence from Hyperinflationary Economies 114
Relative PPP:Evidence from Long-Run Data 115
The Role of Parity Conditions for Management Decisions 117
Empirical Tests of PPP:The Final Word 117
Policy Matters—Private Enterprises 117
Purchasing Power Parity and Managerial Decisions 118
Purchasing Power Parity and Product Pricing Decisions 118
Box 4:2:Gray Markets and the Law of One Price 119
Policy Matters—Public Policymakers 122
Summary 123
Appendix4．1:PPP，Continuous Compounding and Logarithmic Returns 124
5 International Parity Conditions:Interest Rate Parity and the Fisher Parities 127
5 International Parity Conditions:Interest Rate Parity and the Fisher Parities 127
Interest Rate Parity:The Relationship between Interest Rates，Spot Rates，and Forward Rates 128
The Usefulness of the Parity Conditions in International Financial Markets:A Reprise 128
Interest Rate Parity in a Perfect Capital Market 129
Relaxing the Perfect Capital Market Assumptions 133
Empirical Evidence on Interest Rate Parity 136
The Fisher Parities 140
The Fisher Effect 140
The International Fisher Effect 141
Box 5:1:Deviations from Uncovered Interest Parity，or How Exchange Rate Changes Can Substantially Raise（or Lower）the Cost（or Return）on Your Funds 142
Relaxing the Perfect Capital Market Assumptions 144
Empirical Evidence on the International Fisher Effect 145
The Forward Rate Unbiased Condition 148
Interpreting a Forward Rate Bias 148
Empirical Evidence on the Forward Rate Unbiased Condition 148
Tests Using the Level of Spot and Forward Exchange Rates 149
Tests Using Forward Premiums and Exchange Rate Changes 149
Policy Matters—Private Enterprises 153
Application 1:Interest Rate Parity and One-Way Arbitrage 153
Application 2:Credit Risk and Forward Contracts—To Buy or to Make? 155
Box 5:2:An Example of One-Way Arbitrage Profits When There Are No Round-Trip Arbitrage Profits 155
Application 4:Are Deviations from the International Fisher Effect Predictable? 156
Application 3:Interest Rate Parity and the Country Risk Premium 156
Application 5:Are Deviations from the International Fisher Effect Excessive? 157
Application 6:International Fisher Effect and Diversification Possibilities 158
Application 7:International Fisher Effect，Long-Term Bonds，and Exchange Rate Predictions 158
Policy Matters—Public Policymakers 160
Summary 161
Appendix 5．1:Interest Rate Parity，the Fisher Parities，Continuous Compounding，and Logarithmic Returns 162
Appendix 5．2:Transaction Costs and the Neutral Band Surrounding the Traditional Interest Rate Parity Line 163
6 Spot Exchange Rate Determination 167
6 Spot Exchange Rate Determination 167
News and Foreign Exchange Rates:An Introduction 168
Box 6．1:The Reaction of the Spot Exchange Rate to News Announcements on Macroeconomic and Political Events 170
Exchange Rates and News Stories:Three Illustrations 170
News and Foreign Exchange Rates:A Summary 175
Box 6．2:Foreign Exchange Rate Behavior:Major Concepts 176
An Overview of the Flow Approach 177
An Overview of the Stock Approach 177
Flow versus Stock Models of the Exchange Rate 177
Combining Flow and Stock Concepts of the Exchange Rate 179
Asset Models of the Spot Exchange Rate 180
The Monetary Approach 181
The Portfolio Balance Approach 186
Empirical Evidence of Exchange Rate Models 188
In-Sample Results 189
Postsample Results 194
The Role of News 196
Policy Matters—Private Enterprises 199
Policy Matters—Public Policymakers 200
Summary 202
Appendix 6．1 The Implications of Flow and Stock Equilibrium on the Foreign Exchange Rate 203
Appendix 6．2 Demonstration That the Present Exchange Rate Reflects All Future Exogenous Macroeconomic Values 207
Appendix 6．3 The Monetary Model of Exchange Rate Determination with Traded and Nontraded Goods 208
7 Foreign Exchange Market Efficiency 211
7 Foreign Exchange Market Efficiency 211
Theory of Market Efficiency 213
Defining the Equilibrium Benchmark 213
Pictures of Efficient Markets 214
Interpreting Efficient Market Studies 215
Box 7．1:Exchange Rate Levels and Changes Generated Using the Random-Walk（No Drift）Model 216
Defining the Available Information Set 217
Extensions of Efficient Market Theory 219
Empirical Evidence on Exchange Market Efficiency 220
Market Efficiency with Certainty and Risk-Free Investment 221
Market Efficiency with Uncertainty and Risky Investment 222
Box 7．2:Tracking Positions and Profits in a Technical Trading Rule:A Numerical Example 225
Policy Matters—Private Enterprises 236
Policy Matters—Public Policymakers 237
Summary 240
8 Exchange Rate Forecasting 243
8 Exchange Rate Forecasting 243
The Forecasting Approach and the Market Setting 245
Resolving Controversies in Exchange Rate Forecasting 245
Forecast Performance Evaluation:Accurate versus Useful Forecasts 253
Box 8．1:The Difference between Forecasting a Random Walk and an“Almost Random”Walk 254
Box 8．2:Evaluating a Forecasting Track Record Using the Percentage Correct Method 258
Assessing the Economic Value of Currency Forecasts 258
Forecasting Methods:Some Specific Examples 260
Short-Run Forecasts:Trends versus Random Walk 260
Long-Run Forecasts:Reversion to the Mean? 264
Composite Forecasts:Theory and Examples 265
Policy Issues and Special Forecasting Problems 268
“Consumers”of Exchange Rate Forecasts 268
“Producers”of Exchange Rate Forecasts 269
Special Problems in Exchange Rate Forecasting 269
Summary 271
9 The Eurocurrency Market 276
PART Ⅲ OFFSHORE FINANCIAL MARKETS 276
PART Ⅲ OFFSHORE FINANCIAL MARKETS 276
9 The Eurocurrency Market 276
The Origins of Supply and Demand for Offshore Banking 278
Historical Overview 278
Onshore Banking Regulations Boost the Offshore Market 279
The Offshore Markets Endure 280
Box 9．1:Creating Eurodollars 280
Growth of the Eurocurrency Market 282
Pricing of Eurocurrency Deposits and Loans 284
Pricing in the Case of One Currency and Two Financial Centers 285
Box 9．2:Costs of Collecting Deposits and Servicing Loans 286
Can Offshore and Onshore Markets Coexist? 287
The Impact of Capital Controls and Taxes 289
Market Share and Pricing in Competing Offshore Centers 291
The General Case with Many Currencies and Many Financial Centers 292
Policy Matters—Private Enterprises 293
Concems of Depositors 293
Box 9．3:Risk in Cross-Border Transactions:The Wells Fargo-Citibank Case 296
Concems of Borrowers 297
Policy Matters—Public Policymakers 299
Offshore Markets and Macroeconomic Stability 300
Could the Offshore Markets Expand Indefinitely? 301
Approaches to Regulating Offshore Markets 302
Box 9．4:Japanese Banking Woes:The Daiwa Banking Scandal and the“Japan Premium” 303
Competing for Markets:U．S．Policy Initiatives 304
Offshore Markets:European Policy Concerns 307
Summary 308
10 The Eurobond Market 311
10 The Eurobond Market 311
Historical Overview and Dimensions of the Eurobond Market 312
A First Stimulus to the Eurobond Market:The IET 313
A Second Round of Stimulus to the Eurobond Market 313
The Eurobond Market Endures 313
Regulatory and Institutional Characteristics of the Market 317
Regulatory Bodies and Disclosure Practices 317
Queuing，Currency of Denomination，and Speed of Offering 319
Issuing Costs，Ratings，and Exchange Listings 319
Summing Up:The Pros and Cons of Onshore and Offshore Markets 320
Issuing Practices and Competitive Conditions in the Eurobond Market 321
A Brief Sketch of Eurobond Underwriting 322
Tensions and Incentives within a Eurobond Syndicate 323
Box 10．1:“Excessive Competition”in the Eurobond Market 324
The Gray Market 326
Box 10．2:Examples of Gray Market Prices in the Eurobond Market 327
Evidence of Competition among Eurobond Lead Managers 327
Another Innovation:Global Bonds 331
Pricing Eurobonds 331
Eurobonds and Secrecy 332
Market Segmentation and the Pricing of Eurobonds 332
Eurodollar Bond Prices:Some Examples 333
Onshore-Offshore Arbitrage Opportunities 334
Eurodollar Bond Prices:A General Model 336
Policy Matters—Private Enterprises 337
Onshore-Offshore Arbitrage Once Again:Exxon Capital Corporation 338
Using the Eurobond Market to Enhance the Value of the Firm 339
Box 10．3:Recent Cases of Scarcity Value in the Eurobond Market 341
Policy Matters—Public Policymakers 341
The U．S．Competitive Response 341
European Union and the Eurobond Market 343
Summary 346
PART Ⅳ DERIVATIVE SECURITY MARKETS:FUTURES，OPTIONS，AND SWAPS 350
11 Currency and Interest Rate Futures 350
PART Ⅳ DERIVATIVE SECURITY MARKETS:FUTURES，OPTIONS，AND SWAPS 350
11 Currency and Interest Rate Futures 350
Distinctions between Futures and Forwards:Institutions and Terminology 352
Dispersed versus Centralized Trading 353
Customized versus Standardized Transactions 353
Variable Counterparty Risks versus the Clearinghouse 354
Cash Settlement and Delivery versus Marking-to-Market Convention 355
Box 11．1:Rogue Trading Sinks Baring Brothers—But Not the Futures Market 356
Description of Futures Contracts 359
Contract Specifications 361
Payoff Profiles for Futures and Forward Contracts 366
Box 11．2:Hedging the Interest Rate Risk in Planned Investment and Planned Borrowing 370
Futures Pricing and Forward Pricing 372
Forward Pricing and the Cost-of-Carry Model 372
Futures Pricing and the Marking-to-Market Convention 373
The Term Structure of Forward Rates 374
A Risk Premium in Forwards? 377
Policy Matters—Private Enterprises 379
Deciding on Futures versus Forwards 379
New Futures Contracts and Trading Arrangements 380
Policy Matters—Public Policymakers 382
Futures Prices and Cash Market Volatility 382
Transaction Costs and Transaction Taxes 383
Summary 384
Appendix 11．1 Synthetic Interest Rate Futures 386
12 Currency and Interest Rate Options 391
12 Currency and Interest Rate Options 391
First Principles:Terminology and Institutions 393
Types of Contracts 393
Location of Trading 395
Contract Specifications 397
Option Pricing:An Introduction 403
Spot Currency Options:Prices at Maturity 403
Interest Rate Futures Options:Prices at Maturity 406
Option Prices Prior to Maturity 406
Box 12．1:Practical Applications of Currency and Interest Rate Options 408
Option Pricing:Formal Models 413
Pricing Spot Currency Options 414
Pricing Currency and Interest Rate Futures Options 423
Box 12．2:A Link between Put Prices，Call Prices，and Market Sentiment 424
Empirical Evidence on Option Prices 426
Arbitrage Boundary Conditions 426
Pricing Efficiency and Pricing Biases 426
Policy Matters—Private Enterprises 428
Can Option Pricing and Trading Be Made an Exact Science? 428
Is Volatility Constant or Does Volatility Vary? 431
Other Shortcomings of Option Pricing Models 433
Box 12．3:What Does Implied Volatility Predict? 434
Policy Matters—Public Policymakers 435
Options Markets and Price Volatility in Underlying Markets 435
Capital Requirements for Option Traders 435
Summary 436
Appendix 12．1 Determination of the Replicating Portfolio in the Two-Period Binomial Model 437
Appendix 12．2 Boundary Conditions，Early Exercise，and Option Prices 438
Appendix 12．3 Introduction to Exotic Options 440
13 Currency and Interest Rate Swaps 446
13 Currency and Interest Rate Swaps 446
The Role of Capital Controls 447
Origins and Underpinnings of the Swap Market 447
Factors Favoring the Rise of Swaps 449
Swaps Outstanding，the Volume of Transactions，and Gross Exposure 449
The Basic Cash Flows of a Swap Transaction 452
Currency Swap 452
Interest Rate Swap 454
Box 13．1:A Summary of the IBM/World Bank Currency Swap 455
Box 13．2:Comparing Genuine Fixed-Rate and Synthetic Fixed-Rate Financing:A Detailed Example 458
Risks in Swaps 460
Swap Risks for the Hedger 460
Swap Risks for the Speculator 460
Box 13．3:Interest Rate Volatility and the Potential for Gain and Loss in an Interest Rate Swap Contract 462
Measuring the Risks of Swaps 463
Using Simulation to Estimate the Risks of Swaps 464
The Pricing of Swaps 468
Price Quoting Conventions in the Swap Market 469
The Fundamental Determinants of Swap Prices 471
Policy Matters—Private Enterprises 472
Applications of Swaps:Capturing Arbitrage Opportunities，Reducing Risks，Enhancing Sales 472
Pricing Interest Rate Swaps:The Source of Gains 473
Applications of Swaps:Magnifying Risk and Return 474
Formation of AAA-Rated Subsidiaries 476
Policy Matters—Public Policymakers 476
A Large-Scale Default Hits the Swap Market 476
BIS Capital Requirements for Swap Transactions 477
Netting Agreements and the Risk Exposure of Swap Transactions 478
Summary 480
Appendix 13．1 Valuing the Cash Flows in an Interest Rate Swap 481
PART Ⅴ INTERNATIONAL ASSET PORTFOUOS 488
14 Bond Portfolios 488
PART Ⅴ INTERNATIONAL ASSET PORTFOUOS 488
14 Bond Portfolios 488
Dimensions of National Bond Markets 492
Bonds Outstanding by Market Location 492
Bonds Outstanding by Market Segment 493
Return and Risk in National Bond Markets 494
Calculating Unhedged Returns in USS Terms 495
Calculating Currency-Hedged Returns in USS Terns 496
Box 14．1:Calculation of Prices and Returns for a Five-Year German Bund on an Unhedged Investment 498
Empirical Evidence on Return and Risk in Global Bond Markets 499
Box 14．2:Calculation of Prices and Returns for a Five-Year German Bund on a Currency-Hedged Investment 500
Returns on Unhedged Bonds 501
Returns on Currency-Hedged Bonds 501
The Efficient Frontier and Gains to International Bond Portfolios 503
Policy Matters—Private Investors and Institutions 504
Currency-Hedged Bonds:Is There a Free Lunch? 504
Active versus Passive Currency-Hedging Strategies 506
Problems in Implementing an International Bond Portfolio 511
Box 14．3:Have Global Bond Funds Delivered? 512
Box 14．4:To Hedge or Not To Hedge—A Global Bond Portfolio 514
Policy Matters—Public Policymakers 515
The Transition to European Monetary Union 515
Brady Bonds and Emerging Market Debt Issues 515
Summary 517
Appendix 14．1 Global Asset Allocation 518
15 Equity Portfolios 522
15 Equity Portfolios 522
Size and Institutional Features of Global Equity Markets 525
Market Capitalization Measures 525
Institutional Aspects of Global Equity Markets 526
Box 15．1:How Large Is the Japanese Stock Market? 527
International Investment Vehicles 531
Direct Purchase of Foreign Shares 531
American Depositary Receipts 531
Box 15．2:The Russian（ADRs）Are Coming...The Russian（ADRs）Are Coming! 533
Closed-End and Open-End Mutual Funds 534
Box 15．3:ADRs:US$ Securities with Substantial Foreign Exchange Risk 535
Risk and Return in International Equity Markets 538
Calculating the Unhedged Returns on Foreign Equity in US$ Terms 538
Portfolio Risk in Domestic and International Stocks 540
Pricing Determinants 544
Empirical Evidence on Pricing 547
Policy Matters—Private Investors 550
Factors Favoring Overweighting Foreign Markets in Portfolios 551
Factors Favoring Overweighting Home Markets in Portfolios 551
Is Investment in MNCs a Close Substitute for International Investment? 552
Can Investors Count on International Diversification Gains in the Future? 553
Are Emerging Markets Integrated with World Capital Markets? 554
Policy Matters—Public Policymakers 556
Equity Market Trading Arrangements 556
Diversity in Accounting Principles and Disclosure Practices 558
Summary 560
PART Ⅵ INTERNATIONAL ASSET PORTFOUOS AND FINANCIAL RISK MANAGEMENT 566
16 Measuring and Managing the Risk in International Financial Positions 566
PART Ⅵ INTERNATIONAL ASSET PORTFOUOS AND FINANCIAL RISK MANAGEMENT 566
16 Measuring and Managing the Risk in International Financial Positions 566
The Market Value of the Firm and Channels of Risk 568
The Corporate Treasurer s Financial Risk Management Problem 568
Accounting Measures of Foreign Exchange Exposure 572
Exposure of the Balance Sheet:Translation Exposure 573
Exposure of the Income Statement:Transaction Exposure 575
U．S．Accounting Conventions:Reporting Accounting Gains and Losses 575
Economic Logic of Accounting Conventions 577
Economic Measures of Foreign Exchange Exposure 578
The Regression Approach:The Basic Model 578
The Regression Approach:An Application 579
The Regression Approach:Three Extensions 581
The Scenario Approach 581
The Scenario Approach:Some Extensions 583
Empirical Evidence on Firm Profits，Share Prices，and Exchange Rates 585
Arguments for Hedging Risks at the Corporate Level 586
PART Ⅶ REGULATORY ISSUES 608
17 Giving Direction to International Financial Markets:Regulation and Intervention in the Competitive Marketplace 608