International Financial Management, 2nd Edition
By Jeff Madura, Ariful Hoque and Chandrasekhar Krishnamurti
Contents:
Guide to the text xiv
Guide to the online resources xvii
Preface xviii
About the authors xxi
Acknowledgements xxii
PART 1 THE INTERNATIONAL FINANCIAL ENVIRONMENT 1
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
APPENDIX 4: GOVERNMENT INTERVENTION DURING THE ASIAN CRISIS 148
PART 1 INTEGRATIVE PROBLEM: THE INTERNATIONAL FINANCIAL ENVIRONMENT 157
PART 2 EXCHANGE RATE BEHAVIOUR 158
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
PART 2 INTEGRATIVE PROBLEM: EXCHANGE RATE BEHAVIOUR 293
Midterm Self-Exam 294
PART 3 EXCHANGE RATE RISK MANAGEMENT 302
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
PART 3 INTEGRATIVE PROBLEM: EXCHANGE RISK MANAGEMENT 479
PART 4 MANAGEMENT OF LONG-TERM INTERNATIONAL INVESTMENTS AND FINANCING 480
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
PART 4 INTEGRATIVE PROBLEM: LONG-TERM ASSET AND LIABILITY MANAGEMENT 660
PART 5 INTERNATIONAL BANKING AND TRADE FINANCING 662
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
PART 5 INTEGRATIVE PROBLEM: SHORT-TERM ASSET AND LIABILITY MANAGEMENT 724
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]