International Financial Management, 2nd Edition PDF by Jeff Madura, Ariful Hoque and Chandrasekhar Krishnamurti


International Financial Management, 2nd Edition

By Jeff Madura, Ariful Hoque and Chandrasekhar Krishnamurti

International Financial Management, 2nd Edition


Guide to the text xiv

Guide to the online resources xvii

Preface xviii

About the authors xxi

Acknowledgements xxii


1 Multinational Financial Management: An Overview 2

LO1.1 Managing the MNC 3

1.1a How business disciplines are used to manage the MNC 3

1.1b Agency problems 4

1.1c Management structure of an MNC 6

LO1.2 Why companies pursue international business 7

1.2a Theory of comparative advantage 7

1.2b Imperfect markets theory 8

1.2c Product cycle theory 8

LO1.3 How companies engage in international business 9

1.3a International trade 9

1.3b Licensing 10

1.3c Franchising 10

1.3d Joint ventures 10

1.3e Acquisitions of existing operations 11

1.3f Establishment of new foreign subsidiaries 11

1.3g Summary of methods 11

LO1.4 Valuation model for an MNC 13

1.4a Domestic model 13

1.4b Multinational model 14

1.4c Uncertainty surrounding an MNC’s cash flows 17

1.4d Summary of international effects 21

1.4e How uncertainty affects the MNC’s cost of capital 22

LO1.5 The global financial crisis 23

1.5a Fundamental cause of the GFC 23

1.5b Foreign exchange markets 24

1.5c MNC currency risk management 24

LO1.6 The impact of COVID-19 on multinational companies 25

LO1.7 Organisation of the text 27

Term paper on the international credit crisis 39

2 International Flow Of Funds 40

LO2.1 Balance of payments 41

2.1a Australia’s balance of payments 41

2.1b Current account 43

2.1c Capital account 45

2.1d Financial account 46

LO2.2 Growth in international trade 47

2.2a Events that increased trade volume 47

2.2b Impact of outsourcing on trade 49

2.2c Trade volume among countries 51

2.2d Trend in Australian balance of trade 52

LO2.3 Factors affecting international trade flows 57

2.3a Cost of labour 58

2.3b Inflation 59

2.3c National income 59

2.3d Credit conditions 59

2.3e Government policies 60

2.3f Exchange rates 66

LO2.4 International capital flows 70

2.4a Factors affecting foreign direct investment 71

2.4b Factors affecting international portfolio investment 72

LO2.5 Agencies that facilitate international flows 72

2.5a International Monetary Fund 73

2.5b World Bank 74

2.5c World Trade Organization 74

2.5d International Financial Corporation 75

2.5e International Development Association 75

2.5f Bank for International Settlements 75

2.5g OECD 75

2.5h Regional development agencies 75

3 International Financial Markets 81

LO3.1 Foreign exchange market 82

3.1a History of foreign exchange 82

3.1b Foreign exchange transactions 83

3.1c Foreign exchange quotations 86

3.1d Interpreting foreign exchange quotations 89

LO3.2 Forward market 95

3.2a How MNCs use forward contracts 96

3.2b Bank quotations on forward rates 97

3.2c Premium or discount on the forward rate 97

3.2d Movements in the forward rate over time 99

3.2e Offsetting a forward contract 99

3.2f Using forward contracts for swap transactions 100

3.2g Non-deliverable forward contracts 100

LO3.3 International money market 102

3.3a Origins and development 102

3.3b Money market interest rates among currencies 104

4 Exchange Rate Systems And Central Bank Intervention 112

LO4.1 Exchange rate systems 113

4.1a Fixed exchange rate system 113

4.1b Freely floating exchange rate system 115

4.1c Managed float exchange rate system 116

4.1d Pegged exchange rate system 118

4.1e Dollarisation 123

4.1f Australia’s exchange rate system 124

LO4.2 A single European currency 127

4.2a Monetary policy in the eurozone 127

4.2b Impact on companies in the eurozone 127

4.2c Impact on financial flows in the eurozone 128

4.2d Exposure of countries within the eurozone 128

4.2e Impact of crises within the eurozone 128

4.2f Impact on a country that abandons the euro 131

4.2g Impact of abandoning the euro on eurozone conditions 131

LO4.3 Reserve Bank of Australia intervention 133

4.3a Reasons for RBA intervention 133

4.3b Direct intervention 135

4.3c Indirect intervention 138

LO4.4 Intervention as a policy tool 140

4.4a Influence of a weak home currency 140

4.4b Influence of a strong home currency 141




5 Exchange Rate Determination 159

LO5.1 Measuring exchange rate movements 160

LO5.2 Exchange rate equilibrium 161

5.2a Demand for a currency 162

5.2b Supply of a currency for sale 163

5.2c Equilibrium 163

5.2d Change in the equilibrium exchange rate 164

LO5.3 Factors that influence exchange rates 166

5.3a Relative inflation rates 166

5.3b Relative interest rates 167

5.3c Relative income levels 169

5.3d Government controls 170

5.3e Expectations 170

5.3f Interaction of factors 172

5.3g Influence of factors across multiple currency markets 173

5.3h Impact of liquidity on exchange rate adjustment 174

LO5.4 Movements in cross exchange rates 175

5.4a Explaining movements in cross exchange rates 176

LO5.5 Capitalising on expected exchange rate movements 176

5.5a Institutional speculation based on expected appreciation 176

5.5b Institutional speculation based on expected depreciation 178

5.5c Speculation by individuals 179

5.5d The ‘carry trade’ 180

LO5.6 Why was the Australian dollar floated? 183

6 Relationshipsamong Inflation, Interest Rates And Exchange Rates 193

LO6.1 Purchasing power parity (PPP) 194

6.1a Interpretations of purchasing power parity 194

6.1b Rationale behind relative PPP theory 195

6.1c Derivation of purchasing power parity 195

6.1d Using PPP to estimate exchange rate effects 196

6.1e Graphic analysis of purchasing power parity 198

6.1f Testing the purchasing power parity theory 200

6.1g Why purchasing power parity does not hold 202

LO6.2 International Fisher effect (IFE) 204

6.2a Fisher effect 204

6.2b Using the IFE to predict exchange rate movements 205

6.2c Implications of the international Fisher effect 206

6.2d Derivation of the international Fisher effect 208

6.2e Graphical analysis of the international Fisher effect 210

LO6.3 Tests of the international Fisher effect 212

6.3a Limitations of the IFE 213

6.3b IFE theory versus reality 214

7 International Arbitrage And Interest Rate Parity 222

LO7.1 International arbitrage 223

7.1a Locational arbitrage 223

7.1b Triangular arbitrage 226

7.1c Arbitrage strategy for five Asian tiger-denominated currencies 229

7.1d Covered interest arbitrage 230

7.1e Comparison of arbitrage effects 234

LO7.2 Interest rate parity (IRP) 236

7.2a Derivation of interest rate parity 236

7.2b Determining the forward premium 237

7.2c Graphic analysis of interest rate parity 239

7.2d How to test whether interest rate parity holds 241

7.2e Interpretation of interest rate parity 241

7.2f Does interest rate parity hold? 242

7.2g Considerations when assessing interest rate parity 242

LO7.3 Variation in forward premiums 243

7.3a Forward premiums across maturities 244

7.3b Changes in forward premiums over time 244

LO7.4 Comparison of the IRP, PPP and IFE 247

8 Forecasting Exchange Rates 260

LO8.1 Why companies forecast exchange rates 261

LO8.2 Forecasting techniques 263

8.2a Technical forecasting 263

8.2b Fundamental forecasting 264

8.2c Market-based forecasting 269

8.2d Mixed forecasting 272

8.2e Guidelines for implementing a forecast 273

LO8.3 Forecast error 274

8.3a Measurement of forecast error 274

8.3b Forecast errors among time horizons 275

8.3c Forecast errors over time periods 275

8.3d Forecast errors among currencies 275

8.3e Forecast bias 276

8.3f Comparison of forecasting methods 279

8.3g Forecasting under market efficiency 280

LO8.4 Using interval forecasts 281

8.4a Methods of forecasting exchange rate volatility 281


Midterm Self-Exam 294


9 Currency Derivatives 303

LO9.1 Currency futures market 304

9.1a Contract specifications 304

9.1b Trading currency futures 305

9.1c Comparing futures to forward contracts 306

9.1d Credit risk of currency futures contracts 307

9.1e How companies use currency futures 308

9.1f Speculation with currency futures 310

LO9.2 Currency options market 311

9.2a Option exchanges 311

9.2b Over-the-counter market 312

LO9.3 Currency call options 312

9.3a Factors affecting currency call option premiums 313

9.3b How companies use currency call options 313

9.3c Speculating with currency call options 315

LO9.4 Currency put options 318

9.4a Factors affecting currency put option premiums 318

9.4b Hedging with currency put options 318

9.4c Speculating with currency put options 319

9.4d Contingency graph for the purchaser of a call option 321

9.4e Contingency graph for the seller of a call option 322

9.4f Contingency graph for the buyer of a put option 323

9.4g Contingency graph for the seller of a put option 323

9.4h Conditional currency options 323

9.4i Asia-Pacific example: Using currency

options to hedge against currency price movements 325

Appendix 9a: Currency Option Pricing 338

Appendix 9b: Currency Option Combinations 342

10 Currency And Interest Rate Swaps 358

LO10.1 Currency swaps 359

LO10.2 Financing to match the inflow currency 359

10.2a Using currency swaps to execute the matching strategy 361

10.2b Using parallel loans to execute the matching strategy 362

LO10.3 Interest rate swaps 365

LO10.4 Fixed-versus-floating-rate debt decision 366

10.4a Financing costs of fixed-versus-floating-rate loans 367

LO10.5 Hedging interest payments with interest rate swaps 367

10.5a Limitations of interest rate swaps 370

10.5b Other types of interest rate swaps 370

10.5c Standardisation of the swap market 370

11 Measuring Exposure To Exchange Rate Fluctuations 378

LO11.1 Relevance of exchange rate risk 379

11.1a The investor hedge argument 379

11.1b Currency diversification argument 379

11.1c Stakeholder diversification argument 379

11.1d Response from MNCs 380

LO11.2 Transaction exposure 380

11.2a Estimating ‘net’ cash flows in each currency 381

11.2b Exposure of an MNC’s portfolio 382

11.2c Transaction exposure based on value-at-risk 386

LO11.3 Economic exposure 391

11.3a Exposure to local currency appreciation 392

11.3b Exposure to local currency depreciation 393

11.3c Economic exposure of domestic companies 393

11.3d Measuring economic exposure 394

LO11.4 Translation exposure 397

11.4a Determinants of translation exposure 397

11.4b Exposure of an MNC’s stock price to translation effects 399

12 Managing Transaction Exposure 412

LO12.1 Policies for hedging transaction exposure 413

12.1a Hedging most of the exposure 413

12.1b Selective hedging 413

LO12.2 Hedging exposure to payables 414

12.2a Forward or futures hedge on payables 414

12.2b Money market hedge on payables 415

12.2c Call option hedge on payables 415

12.2d Comparison of techniques for hedging payables 418

12.2e Evaluating the hedge decision 421

LO12.3 Hedging exposure to receivables 422

12.3a Forward or futures hedge on receivables 422

12.3b Money market hedge on receivables 423

12.3c Put option hedge on receivables 423

12.3d Comparison of techniques for hedging receivables 426

12.3e Evaluating the hedge decision 430

12.3f Summary of hedging techniques 431

LO12.4 Limitations of hedging 432

12.4a Limitation of hedging an uncertain payment 432

12.4b Limitation of repeated short-term hedging 432

LO12.5 Alternative hedging techniques 435

12.5a Leading and lagging 435

12.5b Cross-hedging 435

12.5c Currency diversification 436

Appendix 12: Non-Traditional Hedging Techniques 451

13 Managing Economic Exposure

And Translation Exposure 456

LO13.1 Managing economic exposure 457

13.1a Assessing economic exposure 458

13.1b Restructuring to reduce economic exposure 460

13.1c Issues involved in the restructuring decision 463

LO13.2 A case of hedging economic exposure 464

13.2a UniQuest Co.’s dilemma 464

13.2b Possible strategies for hedging economic exposure 466

13.2c UniQuest’s hedging strategy 468

13.2d Limitations of UniQuest’s hedging strategy 468

LO13.3 Hedging foreign exchange exposure to fixed assets 468

LO13.4 Managing translation exposure 470

13.4a Hedging with forward contracts 470

13.4b Limitations of hedging translation exposure 471



14 Foreign Direct Investment 481

LO14.1 Current trends in FDI 482

LO14.2 Motives for foreign direct investment 486

14.2a Revenue-related motives 486

14.2b Cost-related motives 488

14.2c Comparing benefits of FDI among countries 490

14.2d Measuring an MNC’s benefits of FDI 491

14.2e Diversification analysis of international projects 492

14.2f Diversification among countries 494

LO14.3 Host government views of FDI 494

14.3a Incentives to encourage FDI 494

14.3b Barriers to FDI 495

14.3c Government-imposed conditions on engaging in FDI 497

LO14.4 International corporate control 497

14.4a Motives for international acquisitions 498

14.4b Trends in international acquisitions 499

14.4c Barriers to international corporate control 500

14.4d Model for valuing a foreign target 501

14.4e Impact of the SOX Act on the valuation of targets 503

LO14.5 Factors affecting target valuation 503

14.5a Target-specific factors 503

14.5b Country-specific factors 504

LO14.6 Example of the valuation process 505

14.6a International screening process 505

14.6b Estimating the target’s value 506

14.6c Changes in valuation over time 508

LO14.7 Disparity in foreign target valuations 510

14.7a Expected cash flows of the foreign target 510

14.7b Exchange rate effects on remitted earnings 510

14.7c Required return of acquirer 510

LO14.8 Other corporate control decisions 511

14.8a International partial acquisitions 511

14.8b International acquisitions of privatised businesses 511

14.8c International divestitures 512

LO14.9 Control decisions as real options 513

Appendix 14: Benefits Of International Diversification 522

15 Multinational Capital Budgeting 525

LO15.1 Subsidiary versus parent perspective 526

15.1a Tax differentials 526

15.1b Restrictions on remitted earnings 526

15.1c Exchange rate movements 526

15.1d Summary of factors 526

LO15.2 Input for multinational capital budgeting 527

LO15.3 Multinational cost of capital 529

15.3a MNC’s cost of debt 529

15.3b MNC’s cost of equity 529

15.3c Estimating an MNC’s cost of capital 530

15.3d Comparing costs of debt and equity 530

15.3e Cost of capital for MNCs versus domestic companies 531

15.3f Cost-of-equity comparison using the CAPM 533

LO15.4 Cost of capital across countries 535

15.4a Country differences in the cost of debt 535

15.4b Country differences in the cost of equity 537

LO15.5 Multinational capital budgeting example 538

15.5a Background 538

15.5b Analysis 539

LO15.6 Other factors to consider 542

15.6a Exchange rate fluctuations 542

15.6b Inflation 546

15.6c Financing arrangement 546

15.6d Blocked funds 549

15.6e Uncertain salvage value 550

15.6f Impact of project on prevailing cash flows 551

15.6g Host government incentives 552

15.6h Real options 553

LO15.7 Adjusting project assessment for risk 554

15.7a Risk-adjusted discount rate 554

15.7b Sensitivity analysis 554

15.7c Simulation 555

16 Country Risk Analysis And International Corporate Governance 568

LO16.1 Country risk characteristics 569

16.1a Political risk characteristics 569

16.1b Financial risk characteristics 572

LO16.2 Measuring country risk 574

16.2a Techniques for assessing country risk 574

16.2b Deriving a country risk rating 576

16.2c Comparing risk ratings among countries 579

LO16.3 Incorporating risk in capital budgeting 580

16.3a Adjustment of the discount rate 580

16.3b Adjustment of the estimated cash flows 580

16.3c Analysis of existing projects 584

LO16.4 Preventing host government takeovers 585

16.4a Use a short-term horizon 585

16.4b Rely on unique supplies or technology 585

16.4c Hire local labour 585

16.4d Borrow local funds 585

16.4e Purchase insurance 586

16.4f Use project finance 586

LO16.5 Incorporating international tax law 586

16.5a Variation in tax laws among countries 587

16.5b Corporate income taxes 587

16.5c Withholding taxes 588

16.5d Personal and excise tax rates 589

16.5e Provision for carrybacks and carryforwards 589

16.5f Tax treaties 589

16.5g Tax credits 590

16.5h Taxes on income from intercompany transactions 591

LO16.6 International corporate governance 593

16.6a Governance by board members 596

16.6b Governance by institutional investors 596

16.6c Governance by shareholder activists 597

17 International Equity Markets 606

LO17.1 An overview of global equity markets 607

LO17.2 Background on international stock exchanges 609

17.2a Reduction in transaction costs 609

17.2b Reduction in information costs 611

17.2c Exchange rate risk 611

LO17.3 An overview of market structure and trading in global equity markets 612

17.3a Categorisation of stock market trading systems 613

LO17.4 International stock markets 614

17.4a Issuance of stock in foreign markets 614

17.4b Issuance of foreign stock in the United States 615

17.4c Non-Australian companies listing on Australian Securities Exchange 617

17.4d Investing in foreign stock markets 618

17.4e How market characteristics vary among countries 619

17.4f Integration of stock markets 621

17.4g Integration of international stock markets and credit markets 621

LO17.5 Investing in international equity markets 622

17.5a International stock diversification 622

17.5b Valuation of foreign stocks 623

17.5c Methods used to invest internationally 625

Appendix 17: Investing In A Portfolio Of Currencies 632

18 International Debt Markets 637

LO18.1 The eurocurrency market 638

LO18.2 The eurobond and foreign bond markets 639

LO18.3 Financing with euronotes and eurocommercial paper 641

LO18.4 Debt denomination decision by subsidiaries 642

18.4a Debt decision in host countries with high interest rates 643

18.4b Debt denomination to finance a project 648

LO18.5 Debt maturity decision 651

18.5a Assessment of the yield curve 651

18.5b Financing costs of loans with different maturities 651

LO18.6 Choice between fixed and floating rate debt 653



19 International Banking 663

LO19.1 The evolution of international banking 664

LO19.2 Services offered by international banks 665

LO19.3 Reasons for establishing international banking services 667

LO19.4 Risks in international banking 667

LO19.5 Bank risks and capital requirements 673

19.5a Bank capital requirements: Basel I Accord 673

19.5b Bank capital requirements: Basel II Accord 675

19.5c Bank capital requirements: Basel III Accord 679

LO19.6 Regulatory capital and bank supervision in Australia 683

LO19.7 The basic features of Islamic banking 687

LO19.8 Recent developments 690

19.8a Cryptocurrencies 690

19.8b Peer-to-peer lending 693

19.8c Impact of COVID-19 on international banking 694

20 Trade Financing And Facilitation 700

LO20.1 International activities of Australian banks 701

LO20.2 Activities of foreign banks in Australia 701

LO20.3 Payment methods for international trade 702

20.3a Prepayment 703

20.3b Letters of credit 703

20.3c Drafts 704

20.3d Consignment 704

20.3e Open account 705

20.3f Impact of the credit crisis on payment methods 705

LO20.4 Trade finance methods 705

20.4a Accounts receivable financing 705

20.4b Factoring 706

20.4c Letters of credit (L/Cs) 706

20.4d Banker’s acceptances 711

20.4e Working capital financing 713

20.4f Medium-term capital goods financing (forfaiting) 713

20. 4g Countertrade 715

LO20.5 Agencies that facilitate international trade 716

20.5a Export promotion in Australia 716

20.5b Export-Import Bank of the United States 716

20.5c Private Export Funding Corporation 718

20.5d Overseas Private Investment Corporation 718


Final Self-Exam 726

Glossary 735

Index 742

Appendix A: Answers To Self-Test Questions [Online]

Appendix B: Supplemental Cases [Online]

Appendix C: Using Excel To Conduct Analysis [Online]

Appendix D: International Investing Project [Online]

Appendix E: Discussion In The Boardroom [Online]

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