P A R T 0 N E 1
Foundations of International Financial Management 1
BRIEF CONTENTS 1
Foundations of International Financial Management 1
1 Globalization and the Multinational Firm, 2
GLOBALIZATION AND THE MULTINATIONAL FIRM, 2
What's Special about International Finance? 5
Market Imperfections, 6
Foreign Exchange and Political Risks, 6
Expanded Opportunity Set, 8
Goals for International Financial Management, 9
Globalization of the World Economy: Recent Trends, 10
Privatization: The Theme of the Nineties, 13
INTERNATIONAL FINANCE IN PARCTICE BOXES 14
What Is Privatization, Anyway? 14
Multinational Corporations, 16
Multinationals Spur Surge in Investment, 18
Organization of the Text, 18
Summary, 23
Appendix IA: Gains from Trade: The Theory of Comparative Advantage, 28
INTERNATIONAL MONETARY SYSTEM, 31
2 International Monetary System, 31
Bimetallism: Before 1875, 32
Evolution of the International Monetary System, 32
Classical Gold Standard: 1875--1914, 33
Interwar Period: 1915--1944, 35
Bretton Woods System:1945--1972, 36
The Flexible Exchange Rate Regime:1973--Present, 39
The Current Exchange Rate Arrangements, 41
European Monetary System, 44
Europe: Unification for the Favored Few, 48
The New World Order of Finance, 50
The Mexican Peso Crisis, 50
Fixed versus Flexible Exchange Rate Regimes, 52
Summary, 54
Mini Case: The ProSPect of the European Monetary union(EMU), 56
C h a p t e r 3 58
BALANCE OF PAYMENTS, 58
3 Balance of Payments, 58
Balance-of-Payments Accounting, 59
Balance-of-Payments Accounts, 60
The Current Account, 60
The Capital Account, 63
Statistical Discrepancy, 65
Official Reserves Account, 65
The Balance-of-Payments Identity, 66
The Balance-of-Payments Trends in Major Countries. 68
Will the Party Fizzle When the Sake Runs Dry? 70
Summary, 72
Mini Case: Mexico's Balance-of-Payments Problem. 74
C h a p t e r 4 76
THE MARKET FOR FOREIGN EXCHANGE, 76
4 The Market for Foreign Exchange, 76
Function and Structure of the FOREX Market, 77
FX Market ParticiPants, 78
CorresPondent Banking Relationships. 79
Fearless Dealers, 80
The Spot Market, 82
Spot Rate Quotations, 82
The Bid-Ask Spread, 83
SPot FX Trading. 84
Cross Exchange Rate Quotations. 85
Young Traders Run Currency Markets, 86
Alternate Expressions for the Cross-Exchange Rate, 88
The Cross-Rate Trading Desk, 89
Triangular Arbitrage, 90
The Forward Market, 93
Forward Rate Quotations, 94
Long and Short Forward Positions, 95
Forward Cross Exchange Rates, 96
Swap Transactions, 96
Forward Premium, 98
Summary, 99
Mini Case: Shrewsbury Herbal Products, Ltd., 101
C h a p t e r 5 104
INTERNATIONAL PARITY RELATIONSHIP AND FORECASTING 104
FOREIGN EXCHANGE RATES, 104
5 International Parity Relationships and Forecasting Foreign Exchange Rates, 104
Interest Rate Parity, 105
Covered Interest Arbitrage, 107
Interest Rate Parity and Exchange Rate Determination, 110
Reasons for Deviations from Interest Rate Parity 111
Purchasing Power Parity 114
Purchasing Power Parity and Exchange Rate Determination, 115
Equilibrium in Currency Markets? 116
PPP Deviations and the Real Exchange Rate, 117
Evidence on Purchasing Power Parity. 118
The Fisher Effects, 122
Forecasting Exchange Rates, 123
Efficient Market Approach. 124
Fundamental Approach, 125
Technical Approach, 126
Performance of the Forecasters, 127
Summary, 129
World Financial Markets and Institutions 134
P A R T T W 0 134
INTERNATIONAL BANKING AND MONEY MARKET, 136
C h a p t e r 6 136
6 International Banking and Money Market, 136
World Financial Markets and Institutions 136
P A R T T W 0 136
International Banking Services, 137
The World's Largest Banks, 137
Types of InternationaI Banking Offices, 140
Reasons for International Banking, 140
CorresPondent Bank, 141
Representative Offices, 141
Foreign Branches, 141
Subsidiary and Affiliate Banks, 142
Edge Act Banks, 143
Offshore Banking Centers, 143
International Banking Facilities, 144
Capital Adequacy Standards, 144
International Money Market, 146
Eurocurrency Market, 146
Illustrated Mini Case: Eurocurrency Creation, 149
Eurocredits, 151
Forward Rate Agreements, 153
Euronotes, 154
Contents 155
Euro-Medium-Term Notes, 155
Eurocommercial PaPer 155
History, 156
International Debt Crisis, 156
Debt-for-Equity Swaps. 158
LDC Lenders Should Have Listened to David Hume, 158
The Solution: Brady Bonds, 161
The Recent Situation, 162
Summary, 163
Mini Case Detroit Motors' Latin American Expansion, 166
C h a g t e r 7 169
INTERNATIONAL BOND MARKET, 169
7 International Bond Market, 169
The World's Bond Markets: A Statistical Perspective, 170
Foreign Bonds and Eurobonds, 170
Bearer Bonds and Registered Bonds. 172
National Security Regulations. 172
Withholding Taxes, 173
Other Recent Regulatory Changes, 173
Global Bonds. 173
Types of Instruments, 174
Straight Fixed-Rate issues. 174
Floaring-Rate Notes, 174
Equity-Related Bonds, 175
Zero-Coupon Bonds. 175
Dual-Currency Bonds, 176
Currency Distribution, Nationality, and Type of Issuer, 177
Composite Currency Bonds, 177
International Bond Market Credit Ratings, 179
Sara Lee Corp. Offers 3-Year Eurobonds at 6%, 180
Primary Market. 183
Eurobond Market Structure and Practices, 183
Secondary Market, 184
Clearing Procedures, 186
International Bond Market Indexes, 186
Summary, 190
8 International Equity Markets, 194
C h a p t e r 8 194 195
INTERNATIONAL EQUITY MARKETS, 195
A Statistical Perspective, 195
Market Capitalization of Developed Countries, 195
Market CaPitalization of Developing Countries, 195
Measures of Liquidity, 198
Measures of Market Concentration, 200
International Equity Market Benchmarks, 200
Market Structure, Trading Practices, and Costs, 202
Trading in International Equities, 207
Magnitude of International Equity Trading, 211
Cross-Listing of Shares, 211
Yankee Stock Offerings, 214
Eurolist, 214
American Depository Receipts, 215
Factors Affecting International Equity Returns, 217
Macroeconomic Factors, 217
Buying Foreign Stocks From U.S. Brokers Gets Easier, 218
Exchange Rates, 218
Industrial Structure, 219
Summary. 220
FUTURES AND OPTIONS ON FOREIGN EXCHANGE 225
C h a p t e r 9 225
9 Futures and Options on Foreign Exchange, 225
Futures Contracts: Some Preliminaries, 226
Currency Futures Markets, 228
Basic Currency Futures Relationships, 230
Eurodollar Interest Rate Futures Contracts, 231
Options Contracts:Some Preliminaries, 233
Currency Options Markets, 234
Commodities: Why Isn't Currency Turmoil Sparking Future Boom? 236
Currency Futures Options, 237
Basic Option-Pricing Relationships at Expiration, 238
American Option-Pricing Relationships, 241
European Option-Pricing Relationships, 242
A European Option-Pricing Formula, 244
Empirical Tests of Currency Options, 245
Summary, 246
Mini Case. The Options Speculator, 248
C h a p t e r 1 0 251
CURRENCY AND INTEREST RATE SWAPS, 251
10 Currency and Interest Rate Swaps, 251
Some Useful Definitions, 252
Size of the Swap Market, 252
The World Bank's First Currency Swap, 253
Basic Interest Rate Swap, 254
Interest Rate Swaps, 254
The Swap Bank, 254
Currency Swaps, 257
Parallel Loans, 257
Back-to-Back Loans, 259
Institutional Difficulties of Parallel and Back-to-Back Loans, 259
Basic Currency Swap, 260
Swap Market Quotations, 264
Variations of Basic Currency and Interest Rate Swaps. 264
Risks of Interest Rate and Currency Swaps, 265
Eli Lilly and Company: The Case of the Appreciating Yen, 266
Is the Swap Market Efficient? 266
Concluding Points about Swaps, 267
Summary. 268
Mini Case The Centralia Corporations Currency Swap. 271
11 International Portfolio Investments, 273
C h a p t e r 1 1 275
International Correlation Structure and Risk Diversification, 275
Optimal International Portfolio Selection, 277
Effects of Changes in the Exchange Rate, 284
International Bond Investment, 286
International Mutual Funds: A Performance Evaluation, 287
International Diversification through Country Funds, 289
International Diversification with ADRs, 293
Live Here, Invest Abroad, 294
Why Home Bias in Portfolio Holdings? 296
Stay-at-Home Shareholders, 298
Summary. 300
Mini Case: Solving for the OPtimal International Portfolio, 303
Appendix 11A: International Investment with Exchange Risk Hedging 307
APPendix 11B: Solving for the Optimal Portfolio, 308
C h a p t e r 1 2 312
ANAGEMENT OF ECONOMIC EXPOSURE, 312
12 Management of Economic Exposure, 312
Foreign Exchange Exposure and Management 312
P A R T T H R E E 312
Three Types of Exposure, 313
How to Measure Economic Exposure, 315
U.S. Firms Feel the Pain of Peso's Plunge, 316
Operating Exposure: Definition, 320
Illustration of Operating Exposure, 321
Determinants of OPerating Exposure, 324
Selecting Low-cost Production Sites, 326
Managing Operating Exposure, 326
Flexible Sourcing Policy, 327
The Strong Yen and Toyota's Choice, 327
Financial Hedging, 328
Diversification of the Market, 328
R D Efforts and Product Differentiation, 328
Illustrated Mini Case:Exchange Risk Management at Merck, 329
Step 1: Exchange Forecasting, 329
SteP 2: Assessing Strategic Plan Impact, 330
SteP 3: Deciding Whether to Hedge, 330
SteP 4: Selecting the Hedging Instruments, 330
SteP 5: Constructing a Hedging Program. 330
Summary, 331
Mini Case: Economic Exposure of Albion Computers PLC, 333
13 Management of Transaction Exposure, 335
C h a p t e r 1 3 336
Forward Market Hedge, 336
Money Market Hedge, 339
Options Market Hedge, 340
Hedging Contingent Exposure, 343
Hedging Recurrent Exposure, 344
Hedging through Invoice Currency, 345
Hedging via Lead and Lag, 346
Exposure Netting, 346
Should the Firm Hedge? 347
TO Hedge or Not to Hedge, 348
What Risk Management Products Do Firms Use? 351
Summary, 352
Mini Case: Western Mining's Currency Exposure 353
Management, 355
14 Management of Translation Exposure, 363
MANGEMENT OF TRANSLATION EXPOSURE, 363
Current/Noncurrent Method, 364
Translation Methods, 364
Monetary/Nonmonetary Method, 364
Current Rate Method, 365
Temporal Method, 365
Financial Accounting Standards Board Statement 8, 367
Financial Accounting Standards Board Statement 52, 368
The Mechanics Of the FASB 52 Translation Process, 369
Highly Inflationary Economies, 370
Illustrated Mini Case: Consolidation of Accounts According to FASB 52: The Centralia Corporation, 372
Translation ExPosure versus Transaction ExPosure, 377
Management of Translation Exposure, 377
Balance Sheet Hedge, 378
Hedging Translation ExPosure, 378
Derivatives Hedge, 379
Empirical Analysis of the Change frOm FASB 8 to FASB 52, 380
Translation ExPosure versus Operating ExPosure, 380
Summary, 381
Mini Case: Sundance Sporting Goods. Inc., 383
Financial Management of the Multinational Firm 388
P A R T F 0 U R 388
15 Foreign Direct Investment, 388
C h a p t e r 15 388
FOREIGN DIRECT INVESTMENT, 388
Global Trends in FDI, 389
Why Do Firms Invest Overseas? 394
Trade Barriers, 394
Imperfect Labor Market, 395
Vertical Integration, 396
Intangible Assets, 396
Product Life Cycle, 397
Linear Sequence in Manufacturing: Singer and Company, 398
Shareholder Diversification Services. 399
Cross-Border Acquisitions, 401
MCI's New Extension: Merging with British Telecom Gives the American Upstart the Muscle to Attack Local Phone Markets, 404
Political Risk and FDI, 407
Stories Past and Present, 408
Summary, 416
16 International Capital Structure and the Cost of Capital, 420
C h a p t e r 1 6 420
INTERNAIONAL CAPITAL STRUCTURE AND THU COST OF CHPITAL, 420
Cost of Capital, 421
The U.S. Welcomes the Alien Invasion, 422
Cost of CaPital in Segmented versus Integrated Markets, 425
Does the Cost of Capital Differ among Countries? 426
Cross-Border Listings of Stocks, 430
Capital Asset Pricing under Cross-Listings, 432
The Effect of Foreign Equity Ownership Restrictions, 436
Illustrated Mini Case: Nestle, 437
Pricing-to-Market Phenomenon, 437
Asset Pricing under Foreign Ownership Restrictions, 438
The Financial Structure of Subsidiaries, 440
Summary, 443
C h a p t e r 1 7 447
Appendix 16 A: Pricing of Nontradable Assets, 447
17 International Capital Budgeting, 448
INTERNATIONAL CHPITAL BUDGETING, 448
Review of Domestic Capital Budgeting, 449
The Adjusted Present Value Model, 450
Capital Budgeting from the Parent Firm's Perspective, 452
Generality of the APV Model, 455
Estimating the Future Expected Exchange Rate, 456
Illustrated Mini Case: The Centralia Corporation, 456
Sensitivity Analysis, 460
Risk Adjustment in the Capital Budgeting Analysis, 460
Summary, 461
Mini Case: Dorchester, Ltd., 462
MULTINATIONAL CASH MANHGEMENT, 465
18 Multinational Cash Management, 465
C h a p t e r 1 8 465
Illustrated Mini Case: Teltrex's Cash Management System, 466
The Management of International Cash Balances, 466
Netting Systems, 467
Centralized Cash Depository, 469
Bilateral Netting of Internal and External Net Cash Flows 472
Reduction in Precautionary Cash Balances, 473
Cash Management Systems in Practice, 474
Transfer Pricing and Related Issues, 475
Disciplining European Cash: Currency Violation Spurs Proactive Cash Management, 476
Illustrated Mini Case: Mintel Products Transfer Pricing Strategy, 478
Low versus High Markup Policy, 478
Exchange Restrictions, 479
Differential Income Tax Rates, 479
Regulations Affecting Transfer Prices. 480
Import Duties, 481
Tug-of-Taxes: International Enforcers May be Pulling in the Wrong Direction, 482
Unbundling Fund Transfers, 484
Miscellaneous Factors, 485
Blocked Funds, 486
Summary, 487
Mini Case I: Efficient Funds Flow at Eastern Trading Company, 489
Mini Case 2: Eastern Trading Company's Optimal Transfer Pricing Strategy, 489
Mini Case 3: Eastern Trading Company's New MBA, 490
19 Exports and Imports, 492
EXPORTS AND IMPORTS, 492
C h a p t e r 1 9 492
A Typical Foreign Trade Transaction, 493
Forfaiting, 496
The ExPort-Import Bank and Affiliated Organizations, 497
Government Assistance in Exporting, 497
Countertrade, 498
Forms of Countertrade, 499
Some Generalizations about Countertrade, 500
Summary, 501
C h a p t e r 2 0 505
20 International Tax Environment, 505
INTERNATIONAL TAX ENVIRONMENT, 505
The Objectives of Taxation, 506
Tax Neutrality, 506
Income Tax, 507
Types of Taxation, 507
Tax Equity, 507
Withholding Tax, 509
Value-Added Tax, 511
The Rise and Rise of VAT 512
National Tax Environments, 512
Worldwide Taxation, 513
Foreign Tax Credits, 514
Territorial Taxation, 514
Branch and Subsidiary Income, 515
Organizational Structures for Reducing Tax Liabilities. 515
Payments to and from Foreign Affiliates, 517
Tax Havens, 518
Foreign Sales Corporation, 519
Controlled Foreign Corporation, 519
U.S. Possessions Corporations, 520
Summary, 521
GLOSSARY, 524
INDEX, 532