1. What is international money all about? 1
The foreign exchange markets 1
Eurocurrency markets 3
2. The essence of currency calculations 6
Foreign exchange marketS 6
Inflation, interest and exchange rates 8
Practicalities 14
An overview 14
Appendix: A deductive proof of the four-way equivalence model 15
3. How are foreign exchange rates quoted? 23
The players 23
Methods of quotation 24
Forward contracts and quotations 26
An overview 29
4. What makes exchange rates move? 30
The balance of payments approach 30
The monetary approach 32
Chartism 33
The efficient markets hypothesis 36
An overview 38
5. What is foreign exchange risk? 40
Transaction exposure 41
Translation exposure 41
Economic exposure 46
An overview 49
6. Why worry about foreign exchange risk? 50
Transaction exposure 50
Economic exposure 53
Translation exposure 54
An overview 56
7. Internal techniques of managing foreign exchange exposure 58
Netting 58
Matching 59
Leading and lagging 60
Price variation 62
Invoicing in foreign currency 62
Asset and liability management 66
An overview 67
8. External techniques of managing foreign exchange exposure 68
Forward markets 68
Trading purpose of the forward market 69
Short-term borrowing 75
Discounting foreign currency denominated bills receivable 77
Factoring foreign currency denominated receivables 77
Currency overdrafts 78
Government exchange risk guarantees 79
An overview 79
9. What are currency swaps? 81
Swaps 81
An overview 84
10. What are financial futures on foreign exchange? 88
Financial futures in general 88
Currency contracts 91
An overview 94
11. How do currency options work? 95
How currency option markets work 96
Currency option strategies 100
option pricing models 103
Corporate use of currency options 105
An overview 107
12. Interest rate risk 108
The term structure of interest rates 108
Forward rate agreements 112
Interest rate futures 114
Interest rate swaps 114
Interest rate options 115
An overview 116
13. The value of growth options 117
An example using decision trees 118
Flexibility and value creation 120
The Black and Scholes model 121
Another example with decision trees 122
An overview 125
14. Is the international investment decision different? 126
The international complications 126
An overview 132
15. Is the international financing decision different? 133
The Eurobond market 133
Borrowing internationally 135
The risks of borrowing internationally 137
An overview 138
16. The European Monetary System 139
Principal features of the EMS 139
The Exchange Rate Mechanism 140
European Monetary Union 141
German reunification 142
Black Wednesday 144
The wake of Black Wednesday 145
An overview 147
17. Why hedge anyway? 149
The capital asset Pricing model 149
What does exposure management aim to achieve? 156
The arguments against corporate hedging 156
Employees and managers 158
And shareholders too 158
The value of the firm 159
Financial distress 159
An overview 162
18. Economic exposure revisited 163
Macroeconomic exposure 163
The analysis 164
Hedging 165
Interest rates invariably key 166
Experiments with macroeconomic exposure 167
An overview 167
Questions and answers 168
Numerical questions 168
Bramit Investment Trust plc 170
Answers to numerical questions 172
Suggested answers to the Bramit Investment Trust questions 175
Further reading 180
Index 181