Lecture 1 - Introduction
Eiteman, Stonehill, & Moffett
Chapter One
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ESM Lecture 1 - Introduction
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International Finance
 Examines risk factors particular to
operating internationally
 Exchange rates
 Two units of account moving in different
ways
 Political risk
 Dependent on business rules changing
 Macro
 Risks from large changes in political climate
 Micro
 Risks from marginal changes to political
climate
Risk Factors – Exchange rates
 Trend
 Slope of trend line of time-series regression
 Positive- currency depreciating
 Volatility
 Standard error of estimate of time-series
regression
 Low value - low risk
 Affect on real exchange rates
 Violation of purchasing power parity
condition
 Something real is changing
Foreign Exchange Exposure
 Domestic prices relatively stable
 prices last year increase by
approximately 1.9%
 but standard error of estimate around
the trend line nearly zero
 Exchange rate relatively volatile
 no appreciable trend
 standard deviation of cd price of usd
relatively high
Risk & Return
 measuring risk
 standard deviation (total risk)
 correlation
 beta (non-diversifiable risk)
 expected return
 any risk assumed by the corporation or
investor is compensated by a higher
expected return
 foreign exchange exposure
Political Risk - Macro
 Exists as a function of potential
change in rules (laws pertaining to
business)
 Expropriation
 Quick compensation at fair market value
 War
 Yugoslavia
 Middle East
Political Risk - Micro
 Those in power make the rules
 redistribution of wealth and income
 Monetary policy
 Exchange rate policy
 Fiscal policy
 Corruption
 Soft corruption - political contributions
 Hard corruption - bribes
Corporate Governance (dispersed)
 Inside governance
 Stockholders
 Concerned about value maximization
 Board of directors
 Subset of stockholders
 Hire managers
 Strategic decision making
 Managers
 Tactical decisions making (strategic)
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Outside governance influences
 Equity markets ( concern Value)
 Analysis and trading (information)
 Stock price moves on information
 Up means excess demand at current price
 Down means excess supply at current price
 Debt markets (concern risk)
 Analysis and trading (information)
 Debt prices move on
 Inflationary pressures, exchange rate
movements, central bank mutterings
 Risk
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Outside governance influences
 Hired guns
 Accountants
 Lawyers
 Regulators
 Stakeholders - Agency problems




Customers/management
Management/labor
Stock holders/management
Government/management
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Goals of corporate governance
 Protect shareholder rights
 Majority and minority
 Protect stakeholder rights
 Customers deserve good products and
reasonable prices
 Firms should be good citizens
 Disclosure and transparency
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Market efficiency
 Many buyers, many sellers
 No market power, thick markets
 Low or no transactions costs (taxes)
 Transactions costs and taxes distort
 Perfect information
 Eliminates agency
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Efficient markets??
 U.S., Canadian, British
 Market failures
 Enron, etc.
 Failure of corporate governance structure
 Sarbanes Oxley




CEO, CFO sign off on financial statements
Audit, compensation committees external
Corporate officers cannot take loans from firm
Test their own financial controls against fraud
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Operating Internationally
 Cultural differences
 Corporate governance
 Legal environment
 Regulatory environment
 Different currencies
 Exchange rate risk
 Hedging behavior
 Forwards, futures, options, swaps
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Corporate governance concentration
 Family owned conglomerates
 South America, Asia, France
 Families own a diversified portfolio of
real assets
 Bank ownership of equity stakes
 Germany, Korea
 Government ownership of equity
stakes
 Canada, China, Russia
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Corporate governance concentration
 Concentration of power
 Markets for equities and debt are thin
 Few buyers, few sellers
 Stock price manipulation
 Lack of transparency
 Highly asymmetric information
 Government often complicit with firms
 Goods and service markets manipulated
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Exchange rates
 Price of one currency in terms of another
 Spot markets
 Markets for delivery of exchange today
 Forward markets
 Markets for delivery of exchange in the future
 Devaluation, revaluation
 Fixed exchange rates official changes in parity
 Depreciation, appreciation of the exchange
rate
 Natural market movement of exchange rates in
freely floating markets
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Exchange rate
 Simple ratio
 Canadian dollar (cd) price usd
e cd , usd 
11371
.
cd
1 usd
 usd price of cd
e usd , cd 
July 17, 2016
0.8794 usd
1 cd
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Exchange Rate
 Complex concept
 Equilibrium price at which supply equals demand
 Demand for USD (by Canadians)
 Canadians buying American
 Importing goods
 Buying U.S. securities
 Supply of USD (by Canadians)
 Canadians selling to Americans
 Exporting goods
 Attracting U.S. based investors
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Exchange rate
e cd , usd 

e D usd , S usd

n
D usd 

i1
Pi , usd  Q i , us
n
S usc 
July 17, 2016
e usd , cd   Pi , cd  Q i , canadian
i1
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International Finance
 Examines risk factors particular to
operating internationally
 Exchange rates
 Two units of account moving in different ways
 Political risk
 Dependent on business rules changing
 Macro
 Risks from large changes in political climate
 Micro

July 17, 2016
Risks from marginal changes to political climate
ESM Chapter 1 - Introduction
21
Risk Factors – Exchange rates
 Trend
 Slope of trend line of time-series regression
 Positive- currency depreciating
 Volatility
 Standard error of estimate of time-series
regression
 Low value - low risk
 Affect on real exchange rates
 Violation of purchasing power parity condition
 Something real is changing
July 17, 2016
ESM Chapter 1 - Introduction
22
Political Risk - Macro
 Exists as a function of potential
change in rules (laws pertaining to
business)
 Expropriation
 Quick compensation at fair market value
 War
 Yugoslavia
 Middle East
July 17, 2016
ESM Chapter 1 - Introduction
23
Political Risk - Micro
 Those in power make the rules
 redistribution of wealth and income
 Monetary policy
 Exchange rate policy
 Fiscal policy
 Corruption
 Soft corruption - political contributions
 Hard corruption - bribes
July 17, 2016
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24