Case Problem 2 The Fruits of Free Trade Under the World Trade Organization

The essential difference between free trade and protection is this Under a system of free trade excellence of the product is the only means by which it can secure a market, while under protection an inferior article can dominate the market through the aid of legislation. The necessary effect of free trade is, therefore, to encourage efficiency in production, while the necessary effect of protection is to encourage skill in corruption. Prosperity is an abundance of commodities. The merit of any...

Currency Futures and Options

Do you know how many days it took for a son to lose 150 million in foreign-exchange trading that it had taken his father decades to accumulate The answer is just 60 days. The following story illustrates how volatile the currency derivatives market was in the 1990s. Dad, I lost a lot of money, Zahid Ashraf, a 44-year-old from the United Arab Emirates, confessed to his ailing father, Mohammad. Maybe no matter, the father said, recalling the conversation in court testimony. Mohammad Ashraf, who...

O 194 Cultural Values and Capital Structure

Can cultural values be used to predict capital structure across countries Differences in institutional backgrounds provide only a partial answer to the question of why countries have differences in capital structure (Chui et al. 2002). Researchers from different disciplines have investigated the effects of culture on various business practices, such as the study of management functions, organization design, business performance, compensation practices, cross-border acquisition performance, and...

Case Questions

1 Use the data in table 20.4 to estimate the market value of Computer Engineering in the following three ways 1 price-earnings ratio, 2 market value book value, and 3 the dividend growth model. 2 List and discuss the options available to Thomas Nickerson. 3 Discuss the two major sections of the FCPA - antibribery and accounting. 4 List and discuss the pros and cons concerning corporate codes of conduct. 5 If you were Sam Miller, what would you do about the situation in these South American...

Tables

2.1 Production alternatives of wheat and cameras 31 2.2 Gains to both nations from specialization and trade 31 2.3 The cost of protectionism 37 3.1 The US balance of payments billions of US dollars 60 3.2 The US dollar as a fraction of government reserves around the world 62 3.3 Major-country balances on current account billions of US dollars 64 3.4 Major-country balances on financial account billions of US dollars 64 3.5 World merchandise trade 65 3.6 The international investment position of...

Case Problem 11 The Rise and Fall of the US Stock Market

The USA and Japan have long been like an old married couple. The USA likes to borrow and spend, while Japan likes to save and invest. And for almost 20 years, this odd relationship has endured, but not without strain. By the late 1990s, however, a new question came to the forefront whether the world's biggest saver would continue to provide relatively cheap capital to the world's biggest spender. It is no secret that the US economic expansion of the 1990s had been sustained with borrowed money...

Translation Exposure Management

Main Features of Accounting Exposure Translation exposure has these main features 1 Because accounting exposure, commonly known as translation exposure, is based on book values only, it does not reflect the true economic value a company has at risk. By the same token, the gains and losses of foreign-exchange trading as measured by this concept bear no relationship to the real impact exchange rate changes have on the value of the firm itself. They are purely of a paper nature. 2...

Fundamental analysis

Fundamental analysis is a currency forecasting technique that uses fundamental relationships between economic variables and exchange rates. The economic variables used in fundamental analysis include inflation rates, national income growth, changes in money supply, and other macroeconomic variables. Because fundamental analysis has become more sophisticated in recent years, it now depends on computer-based econometric models to forecast exchange rates. Model builders believe that changes in...

Currency forecasting and market efficiency

Banks and independent consultants offer many currency-forecasting services. Some MNCs have in-house forecasting capabilities. Yet, no one should pay for currency-forecasting services if foreign-exchange markets are perfectly efficient. The efficient market hypothesis holds that 1 spot rates reflect all current information and adjust quickly to new information 2 it is impossible for any market analyst to consistently beat the market and 3 all currencies are fairly priced. Foreign-exchange...

Case Problem 5 The Big Mac Hamburger Standard February 2003

The theory of purchasing power parity PPP is one of the oldest theories in international economics. The theory states that, in the long run, the exchange rates between two currencies should move toward the rate that would equalize the prices of an identical basket of goods and services in the two countries. As a theoretical proposition, it serves as a solid foundation for thinking about the conditions under which prices in international markets adjust to attain long-term equilibrium. As a...

Sources and uses of funds

The balance of payments is a sources-and-uses-of-funds statement reflecting changes in assets, liabilities, and net worth during a specified period. Transactions between domestic and foreign residents are entered in the balance of payments either as debits or credits. In other words, balance-of-payments statistics are gathered on a single-entry basis. In dealing with the rest of the world, a country earns foreign exchange on some transactions and expends foreign exchange on others. Transactions...

Questions

1 Why have currency swaps replaced parallel loans 2 Explain both interest rate swaps and currency swaps. Which instrument has a greater credit risk an interest rate swap or a currency swap 3 How can a typical mortgage company use an interest rate swap to escape the interest rate risk 4 How can multinational companies utilize a currency swap to reduce borrowing costs 5 If you expect short-term interest rates to rise more than the yield curve should suggest, would you rather pay a fixed long-term...

Eurodollar instruments

The two major types of instrument used in the Eurodollar market are Eurodollar deposits and Eurodollar loans. Eurodollar deposits Eurodollar deposits are either fixed-time deposits or negotiable certificates of deposit. Most Eurodollar deposits are in the form of time deposits. Time deposits are funds being placed in a bank for a fixed maturity at a specified interest rate. In contrast to the US practice, Eurobanks do not maintain checking accounts demand deposits for their customers. While the...

The September 1992 currency crisis in Europe

The Maastricht Treaty, named after the provincial Dutch town that hosted the EEC summit in mid-December 1991, signaled to many a no-turning-back on the road to European unity. However, Europe's plans for economic union experienced a setback in September 1992, because turbulent trading amid the chaos surrounding an apparent breakdown of the European Monetary System EMS racked world currency markets. Although the roots of the currency crisis lay in Germany's high interest rates, the UK took...

Info

Figure 10.1 Exchange rates for the Brazilian real and the US dollar 2001, the number one spot in the industry. Fiscal 2002 was one of the toughest years to date in the PC industry. Because of the softening of the global economy and the events of September 11, demand for PCs was down sharply. Dell responded with an aggressive price strategy and reduced costs through workforce reductions and facility consolidations. Although global industry shipments fell in 2002 by 5 percent, Dell's unit...

Exchange Rate Forecasting

Opening Case 8 Mundell Wins Nobel Prize in Economics One major finding by Robert A. Mundell, who won the Nobel Prize in economics in 1999, has become conventional wisdom when money can move freely across borders, policy-makers must choose between exchange rate stability and an independent monetary policy. They cannot have both. Professor Mundell remains a fan of the gold standard and fixed exchange rates at a time when they are out of favor with most economists. You have fixed rates between New...

Key reasons for forward exchange transactions

Actual exchange market participants are banks, companies, individuals, governments, and other financial institutions. However, these participants are called arbitrageurs, traders, hedgers, or speculators, depending on the purpose of their participation in the exchange market. Arbitrageurs seek to earn riskless profits by taking advantage of differences in interest rates among countries. Traders use forward contracts to eliminate possible exchange losses on export or import orders denominated in...

Case Problem 13 Arms Dealers Get Creative with Offsets

In December 2002, Lockheed Martin, with its F-16 Fighting Falcon, beat French and Anglo-Swedish rivals to land a 3.6 billion deal from Poland, which is Eastern Europe's largest defense order. Do you know how Lockheed won the contract The answer is simple. Lockheed's offset offer was larger than that of their two rivals. Lockheed put together over 100 projects it valued at 9.8 billion, compared with 7.8 billion from its Anglo-Swedish rival and 3.9 billion from its French rival. In recent years,...

Basic objectives of documentation

Documentation in foreign trade is supposed to assure that the exporter will receive the payment and the importer will receive the merchandise. More specifically, a number of documents in foreign trade are used to eliminate noncompletion risk, to reduce foreign-exchange risk, and to finance trade transactions. Noncompletion risk The risk of noncompletion is greater in foreign trade than in domestic trade. This is why exporters want to keep title to the goods until they are paid and importers are...

Countertrade

Countertrade refers to world trade arrangements that are variations on the idea of a barter. Modern countertrade covers various international trade arrangements in which the sale of goods and services by an exporter is linked to an import purchase of other goods and services. It became popular in the 1960s and 1970s as a way for communist countries to finance their international trade without money. In recent years, countertrade has gained new stature in international trade. World trade...

References

Scholes, The Pricing of Options and Corporate Liabilities, Journal of Political Economy, May June 1973, pp. 637-59. Chicago Board of Trade, Commodity Trading Manual, Chicago Board of Trade of the City of Chicago, 1989. Chicago Mercantile Exchange, Using Currency Futures and Options, 1987. Giddy, I. H., Foreign Exchange Options, Journal of Futures Markets, Summer 1983, pp. 145-65. Giddy, I. H., The Foreign Exchange Option as a Hedging Tool, in Joel M. Stern and Donald H. Chew,...

O 113 The Asian Currency Market

In 1968, an Asian version of the Eurodollar came into existence with the acceptance of dollar-denominated deposits by commercial banks in Singapore. Singapore was an ideal location for the birth of the Asian currency market. It had an excellent communication network, important banks, and a stable government. Because the US dollar accounts for most of the foreign-currency transactions in Singapore, the term Asian dollar market can be used to represent the Asian currency market. The Asian...

How to assess country risk

Country risk is the possibility that borrowers in a country will not honor past obligations. Bank managers must develop a systematic approach for evaluating country risk. Approaches now depend on the type of borrower, such as the host government, an industrial firm, or a private bank. The same variables apply to all three types of clients, although the relative weight assigned to each variable may differ considerably. Country risk may be assessed by various debt ratios, the general...

Measuring a percentage change in spot rates

MNCs frequently measure the percentage change in the exchange rate between two specific points in time for example, the current spot rate and the forecasted spot rate 1 year ahead. For example, if the Australian dollar appreciates from 0.6400 to 0.6800 over a 1-year period, US MNCs are likely to raise questions such as What is the percentage increase in the dollar value of the Australian dollar What is the percent increase in the dollar value of Australian dollar-denominated accounts receivable...

Ase P roblem 10 Dell Mercosur

At the end of 2002, Todd Pickett, CFO of Dell Mercosur, was faced with conflicting predictions of the value of the Brazilian currency, the real, and what to do to hedge Dell's operation in Brazil. Although Pickett was concerned about Dell's exposure in the other Mercosur countries, especially Argentina, Brazil was clearly the largest concern. The year 2002 began with the shocks resulting from the Argentine financial crisis that started at the end of 2001, and it ended with the election in...

Geographical arbitrage

In principle, the exchange rate for a given currency should be the same in every geographical market. However, geographical arbitrage could arise when local demand-and-supply conditions might create temporary discrepancies among various markets. Arbitrage specialists would buy the currency in a market where its price is lower and then sell the currency where its price is higher. If the exchange rate differential is larger than the transaction cost, an arbitrage profit would be made. Two-point...

Exposure management strategy

Most large MNCs manage their foreign-exchange risk by using a pre-established exposure management strategy. For example, Merck uses the following five steps for currency exposure management 1 projecting exchange rate volatility, 2 assessing the impact of the 5-year strategic plan, 3 deciding on hedging the exposure, 4 selecting the appropriate financial instruments, and 5 constructing a hedging program for details, see Case Problem 6 Merck's Use of Currency Options . To protect assets...

Explain Corporate Motives For Forecasting Exchange Rates

1 Describe corporate motives for currency forecasting. 2 If foreign-exchange markets are perfectly efficient, why should no one pay for the services of currency forecasting firms 3 Most empirical studies have found that foreign-exchange markets are at least weak-form efficient. Does this mean that investors can earn extra profits by using technical analysis 4 Explain fundamental analysis as a technique for forecasting exchange rates. 5 Explain technical analysis as a technique for forecasting...

Case Problem 9 Western Minings Economic Exposure Management

Western Mining Company WMC is an Australia-based minerals producer with business interests in 19 countries. It is the world's third largest nickel producer, owns 40 percent of the world's largest alumina producer Alcoa World Alumina and Chemicals , and is a major producer of copper, uranium, gold, fertilizer, and talc. WMC builds its business on large, low-cost, and long-life assets that are globally competitive. Most commodities produced by Australian mining companies, including WMC, are...

How to read currency futures quotes

The Wall Street Journal and other major newspapers carry currency futures quotations, though they do not list the newest or least active contracts. To explain how to read currency futures quotes, we will focus on the Australian dollar futures traded on the CME. Table 6.2 presents the Australian dollar futures prices reported in The Wall Street Journal on July 1, 2004. Because there is a one-day time lag between the transactions of foreign exchange and the report of these transactions, we...

The relative importance of different exchange exposures

Table 9.2 shows the relative importance of different exchange exposures from two perspectives the amount of attention given to each exposure and hedging preference for each exposure. A survey of 125 US MNCs by Malindretos and Tsanacas 1995 revealed that transaction exposure was the overwhelming choice of chief financial officers CFOs in terms of the attention that it must receive, with 64 percent ranking it as the most important one. Twenty-six percent of these CFOs picked economic exposure as...

O 93 Economic Exposure Management

Companies can easily hedge translation and transaction exposures, because these risks are based on projected foreign-currency cash flows. However, it is very difficult, if not impossible, for companies to hedge economic exposure for several reasons. The scope of economic exposure is broad, because it can change a company's competitiveness across many markets and products. A company always faces economic risks from competition. When based in foreign currencies, the risks are long term, hard to...

The Mexican peso crisis of December 1994

In December 1994, Mexico faced a balance-of-payments crisis. Investors lost confidence in Mexico's ability to maintain the exchange rate of the peso within its trading band. Intense pressure on the peso in foreign-exchange markets threatened to exhaust Mexico's international reserves. On December 20, the Mexican government announced its decision to devalue the peso against the dollar by 14 percent. This decision, however, touched off a panic situation to sell pesos. As a result, on December 22,...

The international Fisher effect

The international Fisher effect states that the future spot rate should move in an amount equal to, but in the opposite direction from, the difference in interest rates between two countries. A future spot rate of a currency with a higher interest rate would depreciate in the long run a future spot rate of a currency with a lower interest rate would appreciate in the long run. For example, if the interest rate over the next year is 4 percent in the USA and 10 percent in Switzerland, the franc...

Caseroblem 6 Mercks Use of Currency Options

The effect of foreign-currency fluctuations on a company depends on a company's business structure, its industry profile, and its competitive environment. This case recounts how Merck assessed its foreign-exchange exposure and decided to hedge those exposures. In 2001, Merck celebrated its 110th anniversary in discovering, developing, producing, and distributing human and animal health pharmaceutical products. Today, the company does business in more than 100 countries around the world. Thus,...

About the Authors

Kim, a professor of international finance, is the program coordinator of finance and international business at the University of Detroit Mercy. Professor Kim has authored or coauthored 14 finance textbooks and 60-plus refereed journal publications. According to an article by Allen Morrison and Andrew Inkpen Journal of International Business Studies, First Quarter, 1991 , Professor Kim was among the top 25 international business researchers in the 1980s. He was a Fulbright Scholar in...

Basic terms

Currency options give the holder the right to buy or sell a foreign currency at a set price on or before a specified date. There are two types of options calls and puts. A currency call option gives the buyer the right, but not the obligation, to buy a particular foreign currency at a specified price at any time during the life of the option. A currency put option gives the buyer the right, but not the obligation, to sell a particular foreign currency at a specified price at any time during the...

How to read currency option quotes

To explain how to read currency option quotes, we will focus on the Swiss franc option traded on the Philadelphia Stock Exchange. Table 6.6 reflects typical quotes in The Wall Street Journal for options on the Swiss franc. Although the table does not show them, there are two sets of figures for each of most currencies. One set consists of quotes for European-style options and another set of quotes for American-style options. A European-style option can be exercised only at the time of...

Case Problem 4 The Mexican Peso Crisis of December 1994

Mexico Peso Crisis

Before the December 1994 devaluation, the Mexican government had essentially pegged the peso to the US dollar through its exchange rate stabilization program. Mexico permitted its exchange rate to fluctuate within a band of 2 percent. However, in December 1994 Mexico faced a balance-of-payments crisis. Investors lost confidence in Mexico's ability to maintain the exchange rate of the peso within its trading band, in part because of Mexico's large current-account deficit, which had reached...

The July 1993 currency crisis in Europe

On July 1, 1993, wave after wave of currency selling by investors forced European governments to all but abandon their system of managing exchange rates. The economics ministers of the EU rushed off to the EU headquarters in Brussels that weekend, scrambling to save the EMS. This crisis had been triggered by the German central bank's decision not to lower its discount rate. The ministers debated all manner of possible solutions, including devaluing most of the curren cies, or even removing the...

Motives for World Trade and Foreign Investment

Opening Case 2 The Effect of Foreign Investment on Exports In 1989, Mexico significantly liberalized its foreign investment regulations to allow 100 percent foreign ownership. The North American Free Trade Agreement of 1994 extends the areas of permissible foreign direct investment FDI and protects foreign investors with a dispute settlement mechanism. In addition, Mexico has recently taken a series of additional actions to increase FDI in Mexico. As a consequence, the US FDI in Mexico has...

Company Goals And Functions Of Financial Management

Words, management should strive to increase the corporate wealth for the benefit of all constituents. There are a number of compelling reasons for management to focus on stockholder wealth maximization. First, because stockholders are the owners of the company, management has a fiduciary obligation to act in their best interests. Second, stockholders provide the risk capital that protects the welfare of other constituents. Third, stockholder wealth maximization a high stock price provides the...

Preface and Acknowledgments

The sixth edition of Global Corporate Finance is suitable for both undergraduate- and graduate-level courses in international finance, no matter where in the world it is taught, because it does not adopt any specific national viewpoint. Moreover, it is self-contained, and it combines theory and applications. The earlier editions of Global Corporate Finance have been adopted by teachers in over 200 colleges, universities, and management development programs worldwide, particularly because the...