IBUS 302:
International Finance
Topic 1–Introduction
Lawrence Schrenk, Instructor
Introduction
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

IBUS 302: International Finance
Lawrence P. Schrenk, Instructor
Course Page
http://auapps.american.edu/~schrenk/IBUS302/IBUS302.htm
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Syllabus (Next Class)
Learning Objectives
1.
2.
3.
Decide whether this is this the appropriate
course for you.
Understand the importance of international
finance.
Explain the features unique to international
finance. ▪
The Contract
Why Study International
Finance? Your Career


“The number of CEOs with international
experience rose in 2004 to 33 percent from
30 percent in 2003 and 21 percent in 2002.
Among the top 100 CEOs, 41 percent have
spent time abroad.” source
“The Global CEO: Overseas Experience is
Becoming a Must on Top Executives'
Resumes.” source
A Simple Example



Your firm plans to sell $1 million in products to a
firm in England, the pound is currently valued at
$2.00, and payment will be made in 3 months–so
your buyer is expecting to pay £500,000 in 3
months.
Where is the exposure to foreign exchange risk? ▪
The risk is that the rate of exchange will change
between now and the date of payment. ▪
Who will Bear the Risk?
There are three possibilities:

1.
2.
3.

You bear it by accepting a payment of £500,000
in 3 months.
The buyer could bear it by agreeing to pay
$1,000,000 in 3 months.
You could hedge the risk by entering a contract to
receive $1,000,000 for £500,000 in 3 months. ▪
What are the implications of each choice? ▪
Overview
1.
2.
3.
Similarities
Differences
Trends
Overview: Similarities

The basics principles of finance apply to
international finance: ▪
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The NPV and IRR Rules
Stockholder Wealth Maximization
The Benefits of Diversification
Etc. ▪
The Differences
1.
2.
3.
4.
Political Risk
Increased Opportunity Set
Market Imperfections
Foreign Exchange Risk
1. Political Risk

Description: The possibility that sovereign
governments makes unexpected changes in:
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
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
The movement of goods, capital, and people
across their borders,
The regulatory framework,
Tax rates and codes,
Etc.
Political Risk: Measures
1. Somalia
2. Sudan
3. Zimbabwe
4. Chad
5. Iraq
6. Dem. Rep. of the
7. Afghanistan
8. Côte d'Ivoire
9. Pakistan
10. Central Africn
The Failed States Index:
Most Vulnerable Countries 2008
11. Guinea
20. Sri Lanka
12. Bangladesh
21. Yemen
13. Burma
22. Niger
14. Haiti
23. Nepal
15. North Korea
24. Burundi
16. Uganda
25. Timor-Leste
17. Ethiopia
26. Republic of the
18. Lebanon
27. Kenya
19. Nigeria
28. Uzbekistan
Political Risk: Management

Difficulties ▪
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
Idiosyncratic
Measurability
Prediction
Hedging ▪
2. Increased Opportunity Set


Description: Possibility of additional
investments, markets, sources of capital, etc.
Possible Benefits
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


Investments: Higher Return, More Diversification
Markets: Greater Selling Potential
Capital: Lower Cost of Capital
Human Capital: More Resources
International Correlation
U.S. Can U.K. Ger Fra
U.S.
Can
U.K.
Ger
Fra
Swit
Jap
Aus
Hon
g
0.64 0.61 0.36 0.44
0.50 0.32 0.33
0.55 0.54
0.78
Swit Jap Aus Hon
g
0.51 0.26 0.26 0.38
0.43 0.33 0.49 0.52
0.69 0.52 0.48 0.49
0.64 0.36 0.20 0.31
0.61 0.41 0.25 0.32
0.50 0.25 0.31
Sing
0.51
0.51
0.59
0.44
0.34
0.46
0.25 0.34 0.47
0.29 0.37
0.65
– Meric, Ilhan and Gulser Meric. “Correlation Between the World's Stock Markets Before and After the
1987 Crash.” Journal of Investing 7.3 (Fall 1998): 67 f.
3. Market Imperfections

Description: Any condition that restricts the
free flow of trade, capital, investment, profits,
etc.
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Political: Corruption
Legal/Regulatory: Discriminatory Taxes
Social Culture: Attitudes to Inflation
Business Culture: Alternate Goals
4. Foreign Exchange Risk

Description: The possibility that the value of
an investment, cash flow, return might
change due to changes in exchange rates for
currencies.
Some Historical Data
Dollar/Pound Exchange Rate
Napoleonic
Wars and
War of 1812
1791-2007
Great Depression
American Civil War
WW I
WW II
$10.00
$8.00
$6.00
$4.00
$2.00
Date
1999
1986
1973
1960
1947
1934
1921
1908
1895
1882
1869
1856
1843
1830
1817
1804
$0.00
1791
Exchange Rate
$12.00
The Trends
1.
2.
3.
4.
Global Financial Markets
The Euro (€)
Liberalization and
Integration
Privatization
1. Global Financial Markets



Description: Inter-country integrated capital
and financial markets with minimal trade
barriers. ▪
Financial Innovation
Technology–Computers + Internet


Electronic Trading
24/7 Trading ▪
11/2/1987
9/2/1987
7/2/1987
5/2/1987
3/2/1987
1/2/1987
11/2/1986
9/2/1986
7/2/1986
5/2/1986
3/2/1986
1/2/1986
11/2/1985
9/2/1985
7/2/1985
5/2/1985
3/2/1985
1/2/1985
The ‘Big Bang’
FTSE 100
1985-1987
3000
The 'Big Bang'
2500
2000
1500
1000
500
0
The ‘Big Bang’
22 (of 33)
2. The Euro (€)
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
Integration ▪
European Central Bank (ECB)

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Unified Monetary Policy
Macroeconomic Stability
National Inflexibility
Currency Risk
Transaction Costs ▪
The Eurozone

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Austria
Belgium
Cyprus
Finland
France
Germany
Greece
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Ireland
Italy
Luxembourg
Malta
The Netherlands
Portugal
Slovenia
Spain
Benefits and Costs of the Euro

Benefits

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
Reduce Transaction Costs
Eliminate FX Uncertainty
Costs

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No National Monetary Policy
No National FX Control
Asymmetric Shocks
3. Liberalization and
Integration
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Increased Trade ▪
Reduced Tariffs
Competitive Advantage (Appendix)
Organizations


General Agreements on Tariffs and Trade (GATT)
World Trade Organization (WTO) ▪
0
Cana
da
Chin
a
Czec
h Re
publi
c
Germ
any
Hung
ary
Kuwa
it
Mexi
co
Neth
erlan
Russ
ds
ian F
eder
ation
Thail
and
Unite
d K in
gdom
Unite
d S ta
te s
Braz
il
Arge
ntina
$ millions
Exports
Merchandise Exports
1,200,000
1,000,000
800,000
600,000
400,000
200,000
1995
2006
Ch
i
W
or
ld
na
Re
pu
bl
ic
G
er
m
an
Hu y
ng
ar
y
Ku
wa
it
M
ex
ico
Ru Ne
t
he
ss
rla
ia
n
Fe nd s
de
ra
tio
n
T
Un
ha
ila
ite
nd
d
Ki
Un ngd
om
ite
d
St
at
es
Cz
ec
h
a
Br
az
i
Ca l
na
da
Ar
ge
nt
in
% Change
Exports
Change in Merchandise Exports
1995-2006
600%
500%
400%
300%
200%
100%
0%
Tariffs
EU Average Applied Import Tariff Rates
12
8
6
Ores and metals
Manufactured goods
Chemical products
4
2
Machinery, etc.
0
Other manufactured
goods
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
Tariff Rate
10
4. Privatization

Description: The transfer of ownership and
control of a corporation from the state to
private agents. ▪



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
Various Degrees of Privatization
Governmental Revenues
Foreign Ownership
Multiple Processes
Corruption ▪
Privatization Trends
Privatization Trends

Dramatic rise in the number of privatizing
countries, from 13 in 1988 to 43 in 1995.
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


Latin America 49% (Average Value $68 million)
East Asia 25% (Average Value $110 million)
Europe and Central Asia 17% (Average Value
$11 million)
Other 12%
–Mary M. Shirley. “Trends in Privatization.” Economic Reform Today 1
(1998): 8-10.
Privatization Trends