International Finance

Question 1

What is a foreign exchange rate?

Answer 1

the rate at which one currency can be exchanged for another one. Exchange rates can be quoted either directly (units of foreign in terms of domestic) or indirectly (units of domestic expressed in terms of foreign)

Question 2

what are devaluations and revaluations?

Answer 2

devaluations and revaluations are INTENTIONAL manipulations of domestic currency by central banks. This practice is used to to raise exports by reducing the home goods relative price for foreigners (devaluations) or raise imports by strengthening home currency (revaluations)

Question 3

what is the primary objective of exchange rates management?

Answer 3

keeping them stable and predictable

Question 4

what is the forex market?

Answer 4

the market in which currencies are exchanged. it is a global network of banks, brokers, and forex dealers connected by electronic communications systems.

Question 5

how do firms utilize the foreign exchange market?

Answer 5

1. currency conversion
2. currency holding
3. currency arbitrage
4. currency speculation
5. currency hedging

Question 6

what is the difference between hedging and speculating in the forex market?

Answer 6

hedging: use of currency derivatives to reduce risk of currency movements that could lead to losses

speculating: trade in currencies and derivatives to earn profits

Question 7

how to hedge against forex risk?

Answer 7

1. forwards: say you have predicted a certain demand of x currenct for the future, you can lock in the trade by entering a forward right now. They are commonyl created for 30, 90, 180 days.
2. currency swap: pay fix receive floating
3. options: the OPTION to exchange a specified amount of currency on a specified date at a specified rate. You need to pay a premium for having the right to choose wether to exercise it or not.
4. futures: different from the foward because the contract has standardized terms and is traded on an exchange. prices are also marked to market (settled on a daily basis)

Question 8

which are the two market views on FX forecasting?

Answer 8

1. efficient market view:
   if the market is efficient and prices reflect all available info, then forward rates should be unbiased predictors of future spot rates. Companies should thus NOT WASTE MONEY ON FORECASTING SERVICES
2. it may be worthwile for international businesses to invest in forecasting services. However, track record of forecasting services is not good.

Question 9

Which two forecasting techniques are you aware of?

Answer 9

Fundamental analysis: using statistical models based on economic indicators to forecast exchange rates

Technical analysis: using charts of past trends

Question 10

what are some challenges in forex forecasting?

Answer 10

unexpected events

human error

regulatory changes

policy intervention

Question 11

why do managers need to understand international monetary systems?

Answer 11

speculative buying and selling can create a volatile situation that companies beed to protect themselves against

exchange rates change the direction of investments

Question 12

what was the gold standard and why did it collapse?

Answer 12

• a system pegging the dollar to gold
• the system reduced exchange rate risk, imposed** STRICT monetary policies **and helped achieveing balance of trade equilibrium
• the system collapsed as countries started printing excessive amounts of paper currency to finance WW1 expenditures
• people lost confidence in the system and demand for gold increased (making it more expensive for countries to print money)
• nations started engaging in competitive devaluations

Question 13

what was the bretton wood agreement? why did it collapse?

Answer 13

an agreement among nations to create a new international monetary system, aimed to balance strict discipline while still giving the flexibility to manage monetary difficulties

this time:
dollar pegged to gold, other currencies pegged to dollar.

during this time, both the WORLD bank and the IMF were born.

the US were experiencing a trade deficit and a budget deficit due to the vietnam war. huge increases in welfare programs to finance the vietnam war were finance by printing money.

governments lost confidence in us discipline and started to convert usd for gold, this was followed by a major sell off of usd

Question 14

what was the jamaica agreement?

Answer 14

after the collapse of bretton woods, IMF members got together.

floating rates were declared acceptable: countries could either go for fixed floating systems or free floating systems.

gold was finally abandoned as reserve asset

Question 15

what is the role of the IMF?

Answer 15

the IMF was originally established to help maintain the exchange rate system that was set at bretton woods. now it deals with:

1. currency crisis
   from either speculative attacks or government’s mismanagement
2. banking crisis
3. government debt crisis

SOMETIMES THEY ALL HAPPEN SIMULTANEOUSLY: asia, argentina (mostly developing countries)

Question 16

What is a back to back loan?

Answer 16

a loan in which a parent company deposits money with a host country bank, hten lends the moeny to a subsidiary located in the host country.

Question 17

what are eurobonds?

Answer 17

bonds issued outside the country in whose currency it is denominated and sold for investors outside the country inwhose currency it is denominated

Question 18

foreign bonds

Answer 18

bonds sold outside the borrower’s country and denominated in the currency of the country in which it is sold (yankee bonds, samurai bonds…)

Question 19

what is transfer pricing?

Answer 19

transfer price is the price at which goods and services are transferred between entities within the firm.

firms apply transfer prices in four main ways:
1. reduce taxes (moving earnings to low tax countries)

2. move found out of a country where they expect significant devaluations
3. move funds from subsidiaries to parents if they fear dividends restrictions by governments
4. reduce import duties

!!!!!!!
governments may think that they are being cheated out of legitimate income and that firms are trying to navigate capital controls. for this reason the IRS requires that firms use arms-length prices- or the prices that would be used in a market setting between unrelated firms.

Question 20

what are some critics regarding the IMF?

Answer 20

• its one size fits all approach of tight monetary policy and fiscal policy
• increase in moral hazard, as it provides a safety net for most countries

Question 21

SE asia currency crisis of 1997

Answer 21

• investment boom and huge increase in exports
• excess capacity, overestimations of demand growth
• most companies borrowed in USD and had difficulties repaying debt
• many investors started borrowing from SE regional banks and dumping the currencies

the IMF provided billions in loans packages to SE asian countries

Question 22

which are the three sources of financial resources?

Answer 22

debt

equity

internal funding

Question 23

What is the difference between american depository receipt and global depository receipts? what are their purpose?

Answer 23

these instruments facilitate equity financing for international businesses:

ADRs are Certificates that trade in the United States and represent ownership in shares of a non-U.S. company

GDRs similar to ADRs but are issued by non-U.S. companies and traded in markets outside the U.S., primarily London and Luxembourg

Question 24

what have been some major driving forces in the development of international capital markets?

Answer 24

1. advances in information technology make it easier and faster to trade.
2. government deregulation makes it easier to trade.
3. financial instruments make it easier to securitize previously hard to trade secutirities.

Question 25

what are the two segments of internal funding?

Answer 25

1. internal debt lent by parents of the subsidiaries (back to back lending for international businesses)
2. revenue from operations

Question 26

what does “fronting loans”?

Answer 26

loans made intragroup through a financial intermediary, for example:

subsidiary borrow from a bank in italy, pays interest which is tax deductible. the money borrowed flow to another subsidiary in a tax haven, which deposits them at the same bank but does not pay taxes on the interest received

Question 26

What is the difference between centralized deposit and multilateral netting? what are some of the pros and cons you can think of?

Answer 26

centralized deposit: holding cash balances at centralized locations.
pros:

pooling cash reserves centrally allows firms to deposit larger amounts and earn higher rates of interest

allows a greater variety of investment opportunities

cons: government restrictions on cross-border capital flows

what if money for subsidiaries are needed fast?

multilateral netting: holding cash balances at each subsidiary and netting debt/credit

less transactions, less transaction costs

reducing forex