Chapter 1 and Introduction
Finance 4328 – Moore
International Financial Management
FINANCE 4328 - Moore
Welcome
Agenda
Administrative Material
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

Introduction and Roll Call
Course Syllabus
Index Cards with student details
Course Overview and Chapter 1 Material
To provide a foundation in international finance and an understanding of
the basic problems faced by multinational corporations and international
investors
– Exchange Rate Determination
– Exchange Rate Risk Measurement
– Exchange Rate Risk Management
Organization of the course


FX Market
 Start with an overview of the systems of exchange rates - fixed
versus floating
 Review the details of the foreign exchange market
 Parity conditions - Interest rate parity and Purchasing power
parity
 Instruments available on the FX markets – forwards, options,
futures, swaps
Multinational corporations and their exposure to foreign currency risk
 Nature of risks
 Measurement of risks
 Management of risks
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Chapter 1 and Introduction
Finance 4328 – Moore
Foundation Questions (Basic Issues)
• Exchange Rate Determination
–
–
What is an exchange rate?
How does the exchange rate change?
• Exchange Rate Risk Measurement
–
Why do we care about changing exchange rates?
• Exchange Rate Risk Management
–
What can we do to manage our exchange rate risk?
• Multinational Finance
–
–
How does the above affect capital budgeting?
How does the above affect individual investment decisions?
What is the goal of the corporation?
Maximize Shareholder Wealth or Stock Price.
How does the corporation achieve this goal?
Special Complications Arising In International Finance
1) Exchange Rate Risk.
2) Country or Political Risk.
3) Cultural Differences.
What type of firm is affected by the international environment.
1) Large MNC’s
2) Small importers and exporters
3) What about purely domestic firms?
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Chapter 1 and Introduction
Finance 4328 – Moore
Important concepts from financial theory.
1) Arbitrage.
2) Market Efficiency.
– Weak
– Semi-Strong
– Strong
3) Capital Asset Pricing Model and Systematic Risk.
What is the basis for international trade?
Comparative advantage. (Think of Outsourcing Examples)
“What is prudence in the conduct of every private family can scarce be folly in that of a
great kingdom. If a foreign country can supply us with a commodity cheaper than we
ourselves can make it, better buy it of them with some part of the produce of our own
industry employed in a way in which we have some advantage.”
– Adam Smith (1776)
Japan/US example
 Suppose that, in the U.S., one worker can produce 1 ton of food or 1
ton of steel per year. There are 100 million workers.
 In Japan, one worker can produce 2 tons of food or 4 tons of steel.
There are 50 million workers.
Note that in this example Japan is more efficient than the U.S. in producing either good.
Japan has an absolute advantage.
So, the U.S. "can't compete"!?
Relative price of opportunity cost per ton of output
US
Japan
Food
1 unit food for food
2
Steel
1 unit steel for food
.5
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Chapter 1 and Introduction
Finance 4328 – Moore
Without Trade
Pattern of Employment
US
Japan
Food
50
25
Steel
50
25
Output, Millions of Tons
US
Japan
Food
50 = 50*1
50 = 25*2
Steel
50 = 50*1
100 = 25*4
With Trade
Pattern of Employment
US
Japan
Food
90
10
Steel
10
40
Output, Millions of Tons
US
Japan
Food
90 = 90*1
20 = 10*2
Steel
10 = 10*1
160 = 40*4
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Chapter 1 and Introduction
Finance 4328 – Moore
Exchange rate is 1.5 tons of steel/food

Japan trades 60 tons of steel for food
Pattern of Employment
US
Japan
Food
90 – 40 = 60
20+40 = 60
Steel
10 + 60 = 70
160 – 60 = 100
 Do other possible exchange rates exist which make both partners
better off?
 How does trade increase total welfare?
Gains to trade

If each country exports its cheaper to produce good to the other
country, then it will lead to increased prices for each country's good
and this results in pure exchange gain.

In this example we assumed constant returns to scale, if we assume
increasing returns to scale then we would get an even better result.
Why hasn't International Trade reached the comparative
advantage model?

Countries are not specialists

At least two factors of productions moves freely and directly between
countries (capital and technology)

Trade is determined partly by controlled pricing in a few markets

Comparative advantages change over time

Other assumptions don't hold ( above)
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Chapter 1 and Introduction
Finance 4328 – Moore
The Growth and prosperity of MNC's

The imperfections in the assumptions of the theory of comparative are
the driving forces behind the prosperity of the MNC.

MNC's strive to take advantage of these imperfections in the
theoretical perfect world of free trade and the factors of production.

Each violation of the assumptions leads to an opportunity for the
growth or start of a multinational firm.

The MNC takes advantage of these imperfections to maximize both
shareholder and total corporate wealth.
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