International Financial i

Transcription

1 : International Financial i Management Geert Bekaert Columbia University and the National Bureau of Economic Research Robert J. Hodrick Columbia University and the National Bureau of Economic Research PEARSOfsi Pearson Education International

2 CONTENTS Preface PART I xxiii INTRODUCTION TO FOREIGN EXCHANGE MARKETS AND RISKS 1 CHAPTER 1 Globalization and the Multinational Corporation Introduction Globalization and the Growth of International Trade and Capital Flows 2 The Growth of International Trade 2 The Globalization of Financial Markets Multinational Corporations 8 How Multinational Corporations Enter Foreign Markets 10 The Goals of an MNC 10 Corporate Governance Around the World 12 Multinational Corporations and Foreign Direct Investment Other Important International Players 18 International Banks 18 International Institutions 19 Governments 22 Institutional and Individual Investors Globalization and the Multinational Firm: Benefactor or Menace? 23 A Rocky Road to Free Trade 23 Do International Capital Flows Cause Havoc? 24 The Anti-globalist Movement and MNCs 26 Some Final Thoughts on Globalization Overview of the Book 29 Part I: Introduction to Foreign Exchange Markets and Risks 29 Part II: International Parity Conditions and Exchange Rate Determination 29 Part III: International Capital Markets 30 Part IV: International Corporate Finance 30 Part V: Managing Ongoing Operations 30 Part VI: Foreign Currency Derivatives 30 A Final Introduction Summary 32 Bibliography 34 CHAPTER 2 The Foreign Exchange Market The Organization of the Foreign Exchange Market 36 Size of the Market 38 Types of Contracts Traded 39 Foreign Exchange Dealers 39 Foreign Exchange Brokers 39 Computerized Trading Systems 40 IX

3 Other Participants in the Forex Market 40 The Competitive Marketplace Currency Quotes and Prices 41 Exchange Rates 42 Exchange Rate Quotes 42 Vehicle Currencies and Currency Cross-Rates 46 Triangular Arbitrage Inside the Interbank Market I: Bid-Ask Spreads and Bank Profits 51 Bid-Ask Spreads 51 The Magnitude of Bid-Ask Spreads 53 Bid-Ask Spreads All Day Around the World Inside the Interbank Market II: Communications and Fund Transfers 56 Communication Systems 56 Cross-Currency Settlement (or Herstatt) Risk Describing Changes in Exchange Rates 59 Rates of Appreciation and Depreciation 62 Continuously Compounded Rates of Appreciation (Advanced) Summary 64 Questions 64 Problems 65 Bibliography 65 Appendix: Logarithms 66 CHAPTER 3 Forward Markets and Transaction Exchange Risk Transaction Exchange Risk Describing Uncertain Future Exchange Rates 69 Assessing Exchange Rate Uncertainty Using Historical Data 69 The Probability Distribution of Future Exchange Rates Hedging Transaction Exchange Risk 74 Forward Contracts and Hedging 74 The Costs and Benefits of a Forward Hedge 77 Examples of Using Forward Contracts to Hedge Transaction Risk The Forward Foreign Exchange Market 81 Market Organization 81 Forward Contract Maturities and Value Dates 82 Forward Market Bid-Ask Spreads 83 Net Settlement 86 The Foreign Exchange Swap Market Forward Premiums and Discounts 90 Sizes of Forward Premiums or Discounts 91 Forward Premiums and Swap Points Changes in Exchange Rate Volatility (Advanced) 92 Volatility Clustering 93 Other Volatility Models Summary 95 Questions 95 Problems 96 Bibliography 96 Appendix: A Statistics Refresher 97

4 ! CHAPTER 4 The Balance of Payments The Balance of Payments: Concepts and Terminology 102 Major Accounts of the Balance of Payments 102 A Double-Entry Accounting System 104 Current Account Transactions 104 Capital Account Transactions 107 Official Reserves Account Transactions Surpluses and Deficits in the Balance of Payments Accounts 109 An Important Balance of Payments Identity 109 The U.S. Current Account 109 The U.S. Capital and Financial Accounts 111 BOP Deficits and Surpluses and the Official Settlements Account 115 Balance of Payment Statistics Around the World The Dynamics of the BOP 118 The Trade Account and the Investment Income Account 118 Countries as Net Creditors or Net Debtors 119 Data on International Investment Positions Savings, Investment, Income, and the BOP 122 Linking the Current Account to National Income 122 National Savings, Investment, and the Current Account 123 Current Accounts and Government Deficits 123 What Causes Current Account Deficits and Surpluses? 124 Assessing the Openness of International Capital Markets Summary 129 Questions 130 Problems 131 Bibliography 132 Appendix: A Primer on National Income and Product Accounts 133 CHAPTER 5 Exchange Rate Systems Alternative Exchange Rate Arrangements and Currency Risk 136 Exchange Rate Systems Around the World 136 Currency Risks in Alternative Exchange Rate Systems 140 Trends in Currency Systems Central Banks 144 The Central Bank's Balance Sheet 144 Foreign Exchange Interventions 149 How Do Central Banks Peg a Currency? Flexible Exchange Rate Systems 151 The Effects of Central Bank Interventions 152 Empirical Evidence on the Effectiveness of Interventions Fixed Exchange Rate Systems 155 The International Monetary System Before 1971: A Brief History 155 Pegged Exchange Rate Systems in Developing Countries 157 Why Not Simply Float? 160 Currency Boards 161 Dollarization Limited-Flexibility Systems: Target Zones and Crawling Pegs 163 Target Zones 163 Crawling Pegs 166 xi

5 5.6 How to See an Emu Fly: The Road to Monetary Integration in Europe 168 The European Monetary System (EMS) 168 On ECUs, Euros, and Franken 169 Was the EMS Successful? 171 The Maastricht Treaty and the Euro 172 Pros and Cons of a Monetary Union (Advanced) Summary 174 Questions 175 Problems 175 Bibliography 176 PART II INTERNATIONAL PARITY CONDITIONS AND EXCHANGE RATE DETERMINATION 178 r CHAPTER 6 Interest Rate Parity The Theory of Covered Interest Rate Parity 178 The Intuition Behind Interest Rate Parity 180 Deriving Interest Rate Parity 183 Covered Interest Arbitrage Covered Interest Rate Parity in Practice 188 The External Currency Market 188 Covered Interest Arbitrage with Transaction Costs (Advanced) Problems Related to Testing Interest Rate Parity 196 Default Risks 196 Exchange Controls 197 Political Risk Hedging Transaction Risk in the Money Market 201 Hedging a Foreign Currency Liability 201 Hedging a Foreign Currency Receivable The Term Structure of Forward Premiums and Discounts 203 The Term Structure of Interest Rates 203 /' Long-Term Forward Rates and Premiums Summary 209 Questions 210 Problems 211 Bibliography 212 CHAPTER 7 Speculation and Risk in the Foreign Exchange Market Speculating in the Foreign Exchange Market 213 Uncovered Foreign Money Market Investments 213 Speculating with Forward Contracts 215 Currency Speculation and Profits and Losses Uncovered Interest Rate Parity and the Unbiasedness Hypothesis 223 Exchange Rate Forecasts and Market Efficiency 223 Uncovered Interest Rate Parity 224 The Unbiasedness Hypothesis Risk Premiums in the Foreign Exchange Market 227 What Determines Risk Premiums? 228 Formal Derivation of CAPM Risk Premiums (Advanced) 230 xii

6 7.4 Uncovered Interest Rate Parity and the Unbiasedness Hypothesis in Practice 231 International Portfolio Management 231 Exchange Rate Forecasting 231 Exchange Rate Determination 232 The Cost of Hedging Empirical Evidence on the Unbiasedness Hypothesis 234 The Quest for a Test 234 A Test Using the Sample Means 236 Regression Tests of the Unbiasedness of Forward Rates Alternative Interpretations of the Test Results 240 Risk Premiums 241 Do Survey Data Reveal Irrational Expectations? 242 Peso Problems Summary 248 Questions 249 Problems 250 Bibliography 251 Appendix 7.1: The Portfolio Diversification Argument and the CAPM 252 Appendix 7.2: A Regression Refresher 255 CHAPTER 8 Purchasing Power Parity and Real Exchange Rates Price Levels and Price Indexes 260 The General Idea of Purchasing Power 260 Calculating the Price Level 260 Calculating a Price Index The Purchasing Power of a Currency 262 Internal Purchasing Power 262 External Purchasing Power Absolute Purchasing Power Parity 263 The Theory of Absolute Purchasing Power Parity 263 Goods Market Arbitrage The Law of One Price 265 The Perfect Market Ideal 265 Why Violations of the Law of One Price Occur 265 How Wide Is the Border? Describing Deviations from PPP 269 Overvaluations and Undervaluations of Currencies 269 Predictions Based on Overvaluations and Undervaluations The MacPPP Standard 271 The Big Mac as a Price Index 271 Comparing Prices Across Countries 271 Some Predictions of Currency Appreciations Exchange Rates and Absolute PPPs Using CPI Data 274 Interpreting the Charts 274 Dollar-Pound Data 2 75 Deutsche Mark-Dollar Data 276 Yen-Dollar Data 276 Canadian Dollar-U.S. Dollar Data 277 French Franc-Deutsche Mark Data 278 Italian Lira-Deutsche Mark Data 278 Mexican Peso-Dollar Data 279 xiii

7 8.8 Explaining the Failure of Absolute PPP 280 Changes in Relative Prices 280 Non-Traded Goods 281 PPP Deviations and the Balance of Payments Comparing Incomes Across Countries 282 Comparing Incomes in New York and Tokyo 282 Comparing GDPs Using PPP Exchange Rates Relative Purchasing Power Parity 285 A General Expression for Relative PPP 286 Relative PPP with Continuously Compounded Rates of Change (Advanced) The Real Exchange Rate 288 The Definition of the Real Exchange Rate 288 Real Appreciations and Real Depreciations 289 Trade-Weighted Real Exchange Rates S Summary 292 Questions 293 Problems 294 Bibliography 294 CHAPTER 9 Measuring and Managing Real Exchange Risk How Real Exchange Rates Affect Real Profitability 296 The Real Profitability of an Exporting Firm Real Exchange Risk and the Profitability of Domestic and Foreign Firms 298 The Real Exchange Rate Risk of a Net Exporter 299 The Real Exchange Risk of a Net Importer 300 The Real Exchange Risk of an Import Competitor 302 Measuring Real Exchange Risk Exposure Sharing the Real Exchange Risk: An Example 305 Safe Air's Situation 305 Metallwerke A. G. 's Proposal 305 The Consultant's Task 306 Basic Data and Analysis 307 Analyzing Contracts When Inflation and Real Exchange Rates Are Changing 309 Designing a Contract That Shares the Real Exchange Risk 312 Would the Redesigned Contract Be Adopted? Pricing-to-Market Strategies 315 Some Examples of Pricing-to-Market Strategies 315 Pricing-to-Market by a Monopolist 316 A Monopolistic Net Importer 319 Empirical Evidence on Pricing-to-Market Evaluating the Performance of a Foreign Subsidiary 322 Three Types of Subsidiaries 322 Initial Operating Profitability 323 Actual Versus Forecasted Operating Results 323 Comparing the Optimal Response with No Response by Managers 325 Who Deserves a Bonus? 326 Assessing the Long-Run Viability of a Subsidiary Strategies for Managing Real Exchange Risk 328 Transitory Versus Permanent Changes in Real Exchange Rates 328 xiv

8 Production Management 329 Marketing Management Summary 332 Questions 332 Problems 333 Bibliography 333 CHAPTER 10 Exchange Rate Determination and Forecasting Parity Conditions and Exchange Rate Forecasts 335 The Fisher Hypothesis 336 The International Parity Conditions 339 Real Interest Rates and the Parity Conditions Currency Forecasting Techniques 342 Fundamental Exchange Rate Forecasting 342 t Exchange Rate Forecasting with Technical Analysis 343 Evaluating Forecasts Fundamental Exchange Rate Forecasting 346 The Asset Market Approach to Exchange Rate Determination 346 Sticky Prices and Overshooting 348 The Real Exchange Rate and the Real Interest Rate Differential 350 The Real Exchange Rate and the Current Account 353 The Capital Account and Real Exchange Rates 354 Equilibrium 354 Variables That Affect the Real Exchange Rate-Current Account Equilibrium 355 Forecasting Performance of Fundamental Exchange Rate Models Technical Analysis 357 "Pure" Technical Analysis: Chartism 357 Filter Rules 359 Regression Analysis 362 Evaluating Forecasting Services Predicting Devaluations 366 What Causes a Currency Crisis? 367 Empirical Evidence on the Predictability of Currency Crises Summary 373 Questions 373 Problems 374 Bibliography 375 PART III INTERNATIONAL CAPITAL MARKETS 378 CHAPTER 11 International Debt Financing The Global Sources of Funds for International Firms 378 The Financing Mix Around the World The Characteristics of Debt Instruments 380 Currency of Denomination 380 Maturity 382 The Nature of Interest Rate Payments: Fixed-Rate Versus Floating-Rate Debt 383 The International Character of Debt 385 xv

9 11.3 A Tour of the World's Bond Markets 386 Size and Structure of the World Bond Market 386 The International Bond Market 388 The Types of Debt Instruments in the International Bond Market and Their Prevalence International Banking 395 Banks as MNCs 396 Types of International Banking Offices 398 Small Belgian Bank Carves Out a Niche 400 International Banking Regulation International Bank Loans 403 Eurocredits 403 The Euronote Market 407 The Major Debt Arrangers Comparing the Costs of Debt 409 * The All-in-Cost Principle 409 Minimizing the Cost of Debt Internationally Summary 419 Questions 420 Problems 420 Bibliography 421 CHAPTER 12 International Equity Financing A Tour of International Stock Markets 423 The Size of Stock Markets 423 The Organization and Operation of Stock Markets 426 Turnover and Transaction Costs 430 Emerging Stock Markets International Cross-Listing and Depositary Receipts 438 American Depositary Receipts 440 Global Depositary Receipts The Advantages and Disadvantages of Cross-Listing 445 Why Firms Choose to Cross-list 445 Why Firms Decide Against Cross-listing Strategic Alliances Summary 453 Questions 454 Problems 454 Bibliography 455 CHAPTER 13 International Capital Market Equilibrium Risk and Return of International Investments 457 The Two Risks of Investing Abroad 458 The Volatility of International Investments 459 Expected Returns 461 Sharpe Ratios The Benefits of International Diversification 462 Risk Reduction Through International Diversification 462 The Effect of International Diversification on Sharpe Ratios 466 xvi

10 13.3 Optimal Portfolio Allocations 469 Preferences 469 The Case of One Risky Asset 470 The Mean Standard Deviation Frontier The Capital Asset Pricing Model 475 Assumptions and Origins 475 A Derivation of the CAPM (Advanced) 476 Interpreting the CAPM 477 Domestic Versus World CAPMs The CAPM in Practice 481 A Recipe for the Cost of Equity Capital 482 The Benchmark Problem 482 Beta Estimation 484 The Risk Premium on the Market Integrated Versus Segmented Markets 487 * Investing in Emerging Markets 487 The Cost of Capital in Integrated and Segmented Markets 489 Segmentation and Integration over Time 491 Home Bias and Its Implications Alternative Cost-of-Capital Models 496 The Usefulness of the CAPM 496 The Arbitrage Pricing Theory 497 The Fama-French Factor Model Summary 500- Questions 502 Problems 502 Bibliography 503 CHAPTER 14 Political and Country Risk Political Risk Versus Country Risk 507 Country Risk 507 Political Risk Factors 509 The Debt Crisis Incorporating Political Risk in Capital Budgeting 516 Adjusting Expected Cash Flows for Political Risk 517 Adjusting the Discount Rate Instead of Cash Flows Country and Political Risk Analysis 522 Country Risk Ratings 522 The PRS Group's 1CRG Rating System 525 Country Credit Spreads 529 Computing Political Risk Probabilities Managing Political Risk 542 Structuring an Investment 542 Insurance 543 Project Finance Summary 550 Questions 551 Problems 551 Bibliography 552 xvii

11 PART IV INTERNATIONAL CORPORATE FINANCE 555 CHAPTER 15 International Capital Budgeting An Overview of Adjusted Net Present Value 555 Step 1: Discount the Cash Flows of the All-Equity Firm 556 Step 2: Add the Value of the Financial Side Effects 556 Step 3: Value the Growth Options Deriving the NPV of Free Cash Flow 557 Incremental Profits 558 Revenues 559 Costs 559 Earnings Before Interest and Taxes (EBIT) 559 Net Operating Profit Less Adjusted Taxes (NOPLAT) 559 Gross Cash Flow 560 l>free Cash Flow 560 Discounting Free Cash Flows Financial Side Effects 562 The Costs of Issuing Securities 562 Tax Shields for Certain Securities 562 The Proper Discount Rate 563 Costs of Financial Distress 564 The Equilibrium Amount of Debt 564 Subsidized Financing Growth Options 566 Problems with the Discounted Cash Flow Approach Parent Versus Subsidiary Cash Flows 568 A Three-Step Approach to Determining the Value of a Foreign Subsidiary The Case of International Wood Products 569 IWPI-Spain 's Free Cash Flows 570 The Parent Company's Perspective 576 Valuing the Financial Side Effects 580 The Full ANPV of IWPI-Spain 582 The Cannibalization of Export Sales Summary 584 Questions 585 Problems 586 Bibliography 587 Appendix: Deriving the Value of a Perpetuity 587 CHAPTER 16 Additional Topics in International Capital Budgeting Alternative Approaches to Capital Budgeting 590 The ANPV Approach 590 Two Valuation Alternatives to ANPV 590 The WACC Approach to Capital Budgeting 590 The Flow-to-Equity Method of Capital Budgeting 596 The Pros and Cons of Alternative Capital Budgeting Methods Forecasting Cash Flows of Foreign Projects 598 The Choice of Currency 598 Reconciling the Two Methods for Discounting Foreign Cash Flows 598 xviii

12 16.3 Case Study: CMTC's Australian Project 600 The Australian Investment Proposal 600 Gathering the Economic Data 601 Discounted Cash Flows 603 Case Solution 603 The Expected Real Appreciation of the U.S. Dollar Terminal Value When ROI Equals r WACC 611 Terminal Value with Perpetual Growth 611 Equilibrium Rate of Return on Investment Tax Shields on Foreign Currency Borrowing 614 The Tax Implications of Borrowing in a Foreign Currency 614 Foreign Currency Borrowing by Banana Computers Conflicts Between Bondholders and Stockholders 619 The Incentive to Take Risks 619 The Underinvestment Problem 620 Other Managerial Problems Caused by Financial Distress International Differences in Accounting Standards Summary 623 Questions 623 Problems 624 Bibliography 624 CHAPTER 17 Risk Management and the Foreign Currency Hedging Decision To Hedge or Not To Hedge 625 Hedging in an Entrepreneurial Venture 626 Hedging in a Modern Corporation 626 The Hedging-Is-Irrelevant Logic of Modigliani and Miller Arguments Against Hedging 628 Hedging Is Costly 628 Hedging Equity Risk Is Difficult, if Not Impossible 629 Hedging Can Create Bad Incentives Arguments for Hedging 634 Hedging Can Reduce the Firm's Expected Taxes 634 Hedging Can Lower the Costs of Financial Distress 639 Hedging Can Improve the Firm's Future Investment Decisions 640 Hedging Can Change the Assessment of a Firm's Managers Merck's Hedging Rationale 642 Developing Natural Operating Hedges 643 Merck's Five-Step Procedure Hedging Trends 645 Information from Surveys 645 Empirical Analysis of Why Firms Hedge 646 To Hedge or Not to Hedge: Understanding Your Competitors Summary 647 Questions 647 Problems 648 Bibliography 649 xix

13 PARTV MANAGING ONGOING OPERATIONS 650 CHAPTER 18 Financing International Trade The Fundamental Problem with International Trade International Trade Documents 652 Bills of Lading 653 Commercial Invoices 654 Packing Lists 654 Insurance 654 Consular Invoice 655 Certificate of Analysis Methods of Payment 655 Cash in Advance 655 Documentary Credits 656 Documentary Collections 661 & Sales on Open Account 662 International Financing on the Internet Financing Exports 663 Bank Line of Credit 663 Banker's Acceptances 664 Buyer Credit 665 Selling Accounts Receivable 665 Limited-Recourse Financing: Forfaiting 665 Export Factoring 666 Government Sources of Export Financing and Credit Insurance Countertrade 670 Transactions Without Money 671 Countertrade Involving Money or Credit Summary 673 Questions 674 Bibliography 675 CHAPTER 19 Managing Net Working Capital The Purpose of Net Working Capital 676 Inventories as Assets 677 Other Current Assets 677 Short-Term Liabilities International Cash Management 678 Constraints on International Cash Management 678 Cash Management with a Centralized Pool Cash Transfers from Affiliates to Parents 685 International Dividend Cash Flows 685 International Royalty and Management-Fee Cash Flows 686 Transfer Pricing and Cash Flows 687 Strategies for Dealing with Blocked Funds Managing Accounts Receivable 695 Currency of Denomination 695 Leading and Lagging Payments 698 Credit Terms Inventory Management 700 Optimal Inventory Theory 700 xx

14 19.6 Summary 703 Questions 704 Problems 705 Bibliography 706 PART VI FOREIGN CURRENCY DERIVATIVES 707 CHAPTER 20 Foreign Currency Futures and Options The Basics of Futures Contracts 707 Futures Versus Forwards 707 The Pricing of Futures Contracts Hedging Transaction Risk with Futures 714 Hedging at Nancy Foods 714 Potential Problems with a Futures Hedge 716 * 20.3 Basics of Foreign Currency Option Contracts 719 Basic Option Terminology 719 Options Trading The Use of Options in Risk Management 725 A Bidding Situation at Bagwell Construction 725 Using Options to Hedge Transaction Risk 726 Hedging with Options as Buying Insurance 731 Speculating with Options 735 Options Valuation Combinations of Options and Exotic Options 743 Range Forwards and Cylinder Options 744 Other Exotic Options Summary 747 Questions 748 Problems 749 Bibliography 750 CHAPTER 21 Interest Rate and Foreign Currency Swaps Introduction to Swaps 751 Currency Swaps Versus Interest Rate Swaps 752 The Size of the Swap Markets Interest Rate Swaps 754 Interest Rate Risk 755 The Nature of Interest Rate Swap Contracts 756 The Profitability of Interest Rate Swaps 757 Dealing with Credit Risks: Requiring Collateral and Marking to Market Foreign Currency Swaps 758 The Mechanics of Modern Currency Swaps 760 Comparative Borrowing Advantages in Matched Currency Swaps 762 Swapping Bond Proceeds and Coupon Rates with Quoted Swap Rates 768 Currency Swaps as a Package of Forward Contracts 772 The Value of a Currency Swap 773 The Rationale for Currency Swaps Parallel Loans and Back-to-Back Loans 775 Parallel Loans 776 Back-to-Back Loans 778 xxi

15 21.5 Summary 779 Questions 779 Problems 780 Bibliography 781 Glossary 783 Index 797 xxii