Transcript No Slide Title

International Finance
Session 1: Introduction
Dick Sweeney
Introduction
• What’s different about International Finance?
• Multiple currencies, exchange rates: $, £, ¥, €,
baht, rupiah, yuan, krona, krone, …
• International financial markets--everywhere and
nowhere (London, Tokyo, Bahrain—Chp. 4, on reserve)
• Multiple governments, laws, languages, cultural
environments (e.g., U.S., Indonesia—2nd half)
• Exponential complexity
– Not 10 x 2, but 10 2
Introduction (cont.)
•
•
•
•
•
•
•
•
Open exchange rate positions are risky
What’s the risk-return trade off?
Deposit in Euros vs. in USD
St+1/St + ieur,t vs. iusd,t
St+1/St + ieur,t - iusd,t : excess return
E St+1/St + ieur,t - iusd,t: expected excess return
E St+1/St + ieur,t - iusd,t = t (E RM,t - iusd,t)
E St+1/St + ieur,t = iusd,t + t (E RM,t - iusd,t)
Introduction (cont.)
•
•
•
•
•
•
•
•
How to survive the complexity? Ask…
What’s the same? Same tools are used
Net present value
Portfolio analysis (mean-variance analysis)
Asset pricing models (one example: CAPM)
Option theory
Tools are flexible  use them flexibly
Primacy of Intuition  experience
Comparison of Stocks and
Exchange Rates
Stocks
• Prices look like
“random walks”
• Returns are pretty
close to random
• Systematic risk,
Non-systematic risk
Exchange Rates
Prices look like
“random walks”
Returns are pretty
close to random
Systematic risk,
Non-systematic risk
Comparison of Stocks and
Exchange Rates (cont.)
•
•
•
•
Stocks
Returns depend on
betas, risk factors
Average market beta: unity
Typical stock’s beta:
fluctuates around unity
Standard deviation: U.S.
stock market, 4.33% to
5.77% per month
Exchange Rates
Returns depend on
betas, risk factors
Average market beta: zero
Typical exchange rate’s beta:
fluctuates around zero
Standard deviation: USD,
2.9% to 3.5% per month for
most currencies
Exchange-Rate Risk
• How big is FX risk?
– Sigma ()?  3.3% per month?
– Beta ()? 0.0?  0.10?  0.20?
•
•
•
•
Which risk matters for you? for client?
What can you do about risk?
Hedge  eliminate risk
Portfolio choices (diversification)  reduce risk
on average
• Valuation: How to handle FX risk?
What do firms do about risk?
• Derivatives used by: 59% of large firms, 13%
of small firms in U.S.—survey
• FX derivatives: 76% of derivative users
• Which FX derivatives? 75% forwards, 50%
options
• Contractual exposure: 86% forwards, 7%
options
Goals of Course
• Know the basics about FX markets, how
they are organized and work
• Know the basics of FX risk management
• Know how to analyze international capitalbudgeting problems, or valuation problems
• Know how to analyze FX problems
• Know how to choose which tools to use
• Know how to solve FX problems
Topics and Time Allocation: 1
FX Market
Exchange Rate
Behavior
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
How to Hedge
Should you
hedge?
Technical
Analysis
Fundamental
Analysis
International
Portfolio
Decisions
International Finance
Topics and Time Allocation: 2
Real Exchange
Rates
40%
ForeignCurrency Betas
35%
30%
Valuation
Methods
25%
20%
Foreign
Company or
Project
Valuation
Case Studies
15%
10%
5%
0%
International Finance
Role of Concepts
Analytical Techniques
35%
30%
25%
Asset
Pricing
20%
Portfolio
Analysis
15%
10%
Options
5%
0%
International Finance
Net Present
Value
Parity Conditions:
Percent of What You Should Know
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Covered
Interest
Parity
Uncovered
Interest
Parity
Purchasing
Power Parity
International Finance: I
The Euro: A First Look
• Born Jan. 1, 1999--rocky 6 years
• Euro as currency started Jan. 1, 2002
• What can be expected?
– In concrete, quantitative terms in next month?
– In general terms over next several years?
• Look at history of DEM during float
– Large ups and downs
• Euro looks “normal” compared to history
G er m an N o m in al Ex ch an g e Rate
D EM p er U S D
3 .5
3 .0
DEM per USD
N o min al Rate
2 .5
2 .0
1 .5
1 .0
74 76 78 80 82 84 86 88 90 92 94 96 98 00
USD/DEM Appreciation Rate
0.05
0.04
0.03
0.02
0.01
0
-0.01
-0.02
-0.03
Appreciation