Part One Foundations of International Financial Management 1. Part Two World Financial Markets and Institutions 124

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1 contents in brief p r e f a c e v Preface xii Part One Foundations of Financial Management 1 1 Globalization and the Multinational Firm, 2 2 Monetary System, 26 3 Balance of Payments, 52 4 The Market for Foreign Exchange, 68 5 Parity Relationships and Forecasting Foreign Exchange Rates, 96 Part Two World Financial Markets and Institutions Banking and Money Market, Bond Market, Equity Markets, Futures and Options on Foreign Exchange, Interest Rate and Currency Swaps, Portfolio Investment, 253 Part Three Foreign Exchange Exposure and Management Management of Economic Exposure, Management of Transaction Exposure, Management of Translation Exposure, 335 Part Four Financial Management of the Multinational Firm Foreign Direct Investment and Cross-Border Acquisitions, Capital Structure and the Cost of Capital, Capital Budgeting, Multinational Cash Management, Exports and Imports, Tax Environment, Corporate Governance around the World, 486 Glossary 510 Index 521 v

2 contents Preface xii Part One Foundations of Financial Management 1 Chapter 1 Globalization and the Multinational Firm What Is Special about Finance? 3 Foreign Exchange and Political Risk 3 Market Imperfections 5 Expanded Opportunity Set Goals for Financial Management Globalization of the World Economy: Recent Trends 7 Emergence of Globalized Financial Markets 7 The Euro 9 Trade Liberalization and Economic Integration 10 Privatization Multinational Corporations Organization of the Text 15 Summary 21 Mini Case: Nike s Decision 23 Appendix 1A: Gains from Trade: The Theory of Comparative Advantage 24 Chapter 2 Monetary System Evolution of the Monetary System Bimetallism: Before Classical Gold Standard: Interwar Period: Bretton Woods System: The Flexible Exchange Rate Regime: 1973 Present The Current Exchange Rate Arrangements European Monetary System The Euro and the European Monetary Union 39 A Brief History of the Euro 40 What Are the Benefits of the Monetary Union? 41 Costs of the Monetary Union 43 Prospects of the Euro: Some Critical Questions Fixed Versus Flexible Exchange Rate Regimes 46 Summary 49 Mini Case: Will the United Kingdom Join the Euro Club? 51 Chapter 3 Balance of Payments Canada s Balance of Payments Balance of Payments Accounts 53 The Current Account 56 The Capital Account 57 External Balance and the Exchange Rate Balance-of-Payments Trends in Major Countries 61 Summary 64 Mini Case: Mexico s Balance-of-Payments Problem 66 Appendix 3A: The Relationship between Balance of Payments and National Income Accounting 67 Chapter 4 The Market for Foreign Exchange Function and Structure of the FOREX Market 69 FX Market Participants 74 Correspondent Banking Relationships The Spot Market 76 Spot Rate Quotations 76 The Bid-Ask Spread 79 Spot FX Trading 80 Cross-Exchange Rate Quotations 80 Alternative Expressions for the Cross-Exchange Rate 81 The Cross-Rate Trading Desk 82 Triangular Arbitrage 83 Spot Foreign Exchange Market Microstructure 84 vi

3 c o n t e n t s vii 4.3 The Forward Market 86 Forward Rate Quotations 86 Forward Cross-Exchange Rates 89 Swap Transactions 89 Forward Premium 91 Summary 92 Mini Case: Shrewsbury Herbal Products, Ltd. 95 Chapter 5 Parity Relationships and Forecasting Foreign Exchange Rates Interest Rate Parity 96 Interest Rate Parity and Exchange Rate Determination 100 Reasons for Deviations from Interest Rate Parity Purchasing Power Parity 103 PPP Deviations and the Real Exchange Rate 106 Real versus Nominal Exchange Rates A Closer Look 107 Evidence on Purchasing Power Parity Fisher Effects Forecasting Exchange Rates 113 Efficient Market Approach 113 Fundamental Approach 114 Technical Approach 115 Performance of the Forecasters 116 Summary 119 Mini Case: Turkish Lira and Purchasing Power Parity 122 PART TWO World Financial Markets and Institutions 124 Chapter 6 Banking and Money Market Banking Services 125 The World s Largest Banks Types of Banking Offices 128 Correspondent Bank 128 Representative Offices 128 Foreign Branches 128 Subsidiary and Affiliate Banks 129 Edge Act Banks 130 Offshore Banking Centres Capital Adequacy Standards Money Market 132 Eurocurrency Market 132 Eurocredits 134 Euronotes 137 Eurocommercial Paper Financial Crises 137 Global Debt Crisis of the 1980s 138 Mexican Peso Crisis 140 Asian Financial Crisis, Argentina s Currency Board Collapse, Japanese Banking: A Crisis? 144 US Sub-Prime Implosion and Credit Crunch, Summary 146 Mini Case: Detroit Motors Latin American Expansion 148 Appendix 6A: Eurocurrency Creation 150 Chapter 7 Bond Market The World s Bond Markets: A Statistical Overview Foreign Bonds and Eurobonds 153 Bearer Bonds and Registered Bonds 154 National Security Regulations 155 Withholding Taxes 156 Other Regulatory Changes 156 Global Bonds Types of Instruments 157 Straight Fixed-Rate Issues 157 Euro-Medium-Term Notes 158 Floating-Rate Notes 158 Equity-Related Bonds 159 Zero-Coupon Bonds 159 Dual-Currency Bonds Bonds and Notes: Currency, Nationality and Type of Issuer Bond Market Credit Ratings Eurobond Market Structure and Practices 168 Primary Market 168 Secondary Market 170 Clearing Procedures Bond Market Indexes 171 Summary 174

4 viii c o n t e n t s Chapter 8 Equity Markets A Statistical Perspective 177 Market Capitalization of Emerging Markets 179 Measures of Liquidity 182 Primary and Secondary Markets Equity Market Benchmarks 183 ishares MSCI Trading in Equities 184 Cross-Listing of Shares 184 Canadian Cross-Listed Shares 189 The European Stock Market 192 Depository Receipts 193 Global Registered Shares Factors Affecting Equity Returns 197 Macroeconomic Factors 198 Exchange Rates 198 Industrial Structure 198 Summary 199 Mini Case: regional review asia-pacific 200 Chapter 9 Futures and Options on Foreign Exchange Futures Contracts: Some Preliminaries Currency Futures Markets Basic Currency Futures Relationships 206 Speculating and Hedging with Currency Futures: Managerial Perspectives Eurodollar Interest Rate Futures Contracts Currency Options: Some Preliminaries Market Structure Currency Futures Options Currency Option-Pricing Relationships at Expiry 218 Hedging With Currency Options 221 Comparing the Forward, Futures and Options Hedges 222 Currency Options Pricing: What a Manager Should Know 224 Summary 225 Mini Case: The Options Speculator 229 Appendix 9A: Foreign Currency Option Pricing Model 230 Chapter 10 Interest Rate and Currency Swaps Types of Swaps Size of the Swap Market The Swap Bank Interest Rate Swap Illustration Another Interest Rate Swap Illustration Highlighting the Quality Spread Differential and Costs 236 Unwinding an Interest Rate Swap Interest Rate Swap Quotations Currency Swaps Equivalency of Currency Swap Debt Service 243 Pricing the Currency Swap Finally, A Little More Realism on Currency Swaps Variations of Basic Currency and interest Rate Swaps Risks of Interest Rate and Currency Swaps Is the Swap Market Efficient? Concluding Points about Swaps 247 Summary 248 Mini Case: The centralia Corporation s Currency Swap 252 Chapter 11 Portfolio Investment Portfolio Arithmetic Perspectives 254 Portfolio Diversification Optimal Portfolio Selection 257 Portfolio Design The Simple Case of Diversification An Extensive Illustration Mutual Funds: Access to the World Diversification through Country Funds Diversification with ADRs Diversification with WEBS Diversification with Hedge Funds Why Home Bias in Portfolio Holdings? 276 Summary 277 Mini Case: Solving for the Optimal Portfolio 281 Appendix 11A: Investment with Exchange Risk Hedging 283 Appendix 11B: Solving for the Optimal Portfolio 285

5 c o n t e n t s ix PART THREE Foreign Exchange Exposure and Management 287 Chapter 12 Management of Economic Exposure Three Types of Exposure How to Measure Economic Exposure Operating Exposure: Definition Illustration of Operating Exposure Determinants of Operating Exposure 299 Pass-through Canadian Evidence Managing Operating Exposure 302 Selecting Low-Cost Production Sites 302 Flexible Sourcing Policy 303 Diversification of the Market 303 R&D Efforts and Product Differentiation 304 Financial Hedging 304 How Canadian Firms Deal with Economic Exposure 304 Managerial and Strategic Perspectives on Economic Exposure 305 Illustrated Mini Case: Exchange Rate Management at Merck 307 Summary 309 Mini Case: Economic Exposure of Calais Computers PLC 311 Chapter 13 Management of Transaction Exposure Forward Hedge Money Market Hedge Options Hedge Cross-Hedging Minor Currency Exposure Hedging Contingent Exposure Hedging Recurrent Exposure with Swap Contracts Hedging through Invoice Currency Hedging via Lead and Lag Exposure Netting Should the Firm Hedge? What Risk Management Products Do Firms Use? 328 Summary 330 Mini Case: barrick s real option on tires 333 Chapter 14 Management of Translation Exposure Translation Methods 337 Foreign Operations 337 Two Approaches to Translation: Current Rate Method and the Temporal Approach 337 Temporal Method 339 Which Method in Canada: Current Rate or Temporal 339 Illustrated Mini Case: Consolidation of Accounts According to the CICA Handbook Section 1650: The Maple Corporation Management of Translation Exposure 345 Hedging Translation Exposure 346 Balance Sheet Hedge 347 Derivatives Hedge 347 Translation Exposure versus Operating Exposure Analysis of a Change in Accounting for Translation Gains and Losses 349 Summary 349 Mini Case: Sundance Sporting Goods, Inc. 350 PART FOUR Financial Management of the Multinational Firm 353 Chapter 15 Foreign Direct Investment and Cross-Border Acquisitions Global Trends in FDI Why Do Firms Invest Overseas? 360 Trade Barriers 361 Imperfect Labour Market 361 Intangible Assets 362 Vertical Integration 364 Product Life Cycle 364 Shareholder Diversification Services Cross-Border Mergers and Acquisitions Political Risk and FDI 374 Summary 382 Mini Case 1: Inward and outwards (FDI) Enhancing the competitiveness of countries 384 Mini Case 2: enron versus bombay politicians 385

6 x c o n t e n t s Chapter 16 Capital Structure and the Cost of Capital Cost of Capital Cost of Capital in Segmented versus Integrated Markets Adjusting the Cost of Equity to Account for Country-Specific Risk 391 An Illustration with Date Does the Cost of Capital Differ Among Countries? 393 Illustrated Mini Case: Novo Industri Cross-Border Listings of Shares Capital Asset Pricing under Cross- Listings The Effect of Foreign Equity Ownership Restrictions 404 Pricing-to-Market Phenomenon 404 Illustrated Mini Case: Nestlé 405 Asset Pricing under Foreign Ownership Restrictions The Financial Structure of Subsidiaries 408 Summary 410 Appendix 16A: Pricing of Nontradable Assets: Numerical Simulations 413 Chapter 17 Capital Budgeting Review of Capital Budgeting Adjusted Present Value Capital Budgeting from the Parent Firm s Perspective 417 Generality of the APV Model 419 Estimating the Future Expected Exchange Rate 420 Illustrated Mini Case: Research In Motion/ Europe Risk Adjustment in Capital Budgeting Sensitivity Analysis Real Options 425 Summary 427 Mini Case 1: Dorchester 428 Mini Case 2: Timmins Gold Mining Company 429 Chapter 18 Multinational Cash Management Management of Cash Balances 431 Illustrated Mini Case: Teltrex s Cash Management System Reduction in Precautionary Cash Balances Bilateral Netting of Internal and External Net Cash Flows Transfer Pricing and Related Issues 439 Illustrated Mini Case: Mintel Products Transfer Pricing Strategy 441 Miscellaneous Factors Blocked Funds 446 Summary 448 Mini Case 1: Efficient Funds Flow at Eastern Trading Company 449 Mini Case 2: Eastern Trading Company s Optimal Transfer Pricing Strategy 450 Mini Case 3: Eastern Trading Company s New MBA 450 Chapter 19 Exports and Imports A Typical Foreign Trade Transaction Export Finance 457 Buyer Credits and Lines of Credit 457 Supplier Credit and Forfaiting 458 Forfait Finance An Example 459 Leasing Government Financial Support of Exports 460 Governing Agreements and CIRR Rates Intra-firm Trade Countertrade 464 Forms of Countertrade 464 Some Generalizations about Countertrade 465 Summary 466 Mini Case: Manitoba Machine Tools, Inc. 467 Chapter 20 Tax Environment The Objectives of Taxation 469 Tax Neutrality 469 National Treatment 470 The Canadian versus the American Way of Taxing Multinational Enterprise 470 Taxes and Transfer Pricing Types of Taxation 472 Income Tax 472 Withholding Tax 472 Value-Added Tax 474

7 c o n t e n t s xi 20.3 National Tax Environments 476 Worldwide Taxation 476 Territorial Taxation 476 Foreign Tax Credits Organizational Structures for Reducing Tax Liabilities 477 Branch and Subsidiary Income 477 Payments to and from Foreign Affiliates 479 Tax Havens 480 Controlled Foreign Corporation 482 Summary 483 Mini Case 1: Sigma Corp. s Location Decision 485 Mini Case 2: Transfer Pricing Cases Before the Courts 485 Chapter 21 Corporate Governance around the World Governance of the Public Corporation: Key Issues The Agency Problem Remedies for the Agency Problem 492 Board of Directors 490 Incentive Contracts 491 Concentrated Ownership 492 Debt 493 Overseas Shares Listings 494 Market for Corporate Control Law and Corporate Governance Consequences of Law 498 Ownership and Control Pattern 498 Private Benefits of Control 502 Capital Markets and Valuation Corporate Governance Reform 503 Objectives of Reform 503 Political Dynamics 504 The Cadbury Code of Best Practice 505 Summary 506 Mini Case: Parmalat: Europe s Enron 507 Glossary 510 Index 521