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1、McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-0Chapter Outline32.1 Terminology32.2 Foreign Exchange Markets and Exchange Rates32.3 The Law of One Price and Purchasing Power Parity32.4 Interest Rates and Exchange Rates: Interest Rate Parity32.5 Internationa
2、l Capital Budgeting32.6 International Financial Decisions32.7 Reporting Foreign Operations32.8 Summary and ConclusionsMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-132.1 Terminology American Depository Receipt (ADR): a security issued in the U.S. to repres
3、ent shares of a foreign stock. Cross rate: the exchange rate between two foreign currencies, e.g. the exchange rate between and . Euro (): the single currency of the European Monetary Union which was adopted by 11 Member States on 1 January 1999. These member states are: Belgium, Germany, Spain, Fra
4、nce, Ireland, Italy, Luxemburg, Finland, Austria, Portugal and the Netherlands. Eurobonds: bonds denominated in a particular currency and issued simultaneously in the bond markets of several countries.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-232.1 Ter
5、minology Eurocurrency: money deposited in a financial center outside the home country. Eurodollars are dollar deposits held outside the U.S.; Euroyen are yen denominated deposits held outside Japan. Foreign bonds: bonds issued in another nations capital market by a foreign borrower. Gilts: British a
6、nd Irish government securities. LIBOR: the London Interbank Offer Rate is the rate most international banks charge on another for loans of Eurodollars overnight in the London market.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-332.2 Foreign Exchange Marke
7、ts and Exchange Rates Without a doubt the foreign exchange market is the worlds largest financial market. In this market one countrys currency is traded for anothers. Most of the trading takes place in a few currencies.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights res
8、erved.32-4FOREX Market Participants The FOREX market is a two-tiered market: Interbank Market (Wholesale) About 700 banks worldwide stand ready to make a market in Foreign exchange. Nonbank dealers account for about 20% of the market. There are FX brokers who match buy and sell orders but do not car
9、ry inventory and FX specialists. Client Market (Retail) Market participants include international banks, their customers, nonbank dealers, FOREX brokers, and central banks.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-5Correspondent Banking Relationships L
10、arge commercial banks maintain demand deposit accounts with one another which facilitates the efficient functioning of the forex market. International commercial banks communicate with one another with: SWIFT: The Society for Worldwide Interbank Financial Telecommunications. CHIPS: Clearing House In
11、terbank Payments System ECHO Exchange Clearing House Limited, the first global clearinghouse for settling interbank FOREX transactions.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-6Spot Rate Quotations The spot market is the market for immediate delivery.
12、 (Settlement is due within two days.) Direct quotation the U.S. dollar equivalent e.g. “a Japanese Yen is worth about a penny” Indirect Quotation the price of a U.S. dollar in the foreign currency e.g. “you get 100 yen to the dollar”McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc.
13、All rights reserved.32-7Spot FX trading In the interbank market, the standard size trade is about U.S. $10 million. A bank trading room is a noisy, active place. The stakes are high. The “long term” is about 10 minutes.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights res
14、erved.32-8Cross Rates Suppose that SDM(0) = .50 i.e. $1 = 2 DM in the spot market and that S(0) = 100 i.e. $1 = 100 What must the DM/ cross rate be?50 DM1or .02 )0(5011$21001$,$ since/DMSDMDMDMDMDMMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-9Triangular A
15、rbitrage$Credit Lyonnais S(0) = 1.50Credit AgricoleS/(0) = 85BarclaysS(0) = 120Suppose we observe these banks posting these exchange rates.First calculate the implied cross rates to see if an arbitrage exists.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-1
16、0Triangular Arbitrage$Credit Lyonnais S(0) = 1.50Credit AgricoleS/(0) = 85BarclaysS(0) = 120The implied S(/) cross rate is S(/) = 80Credit Agricole has posted a quote of S(/)=85 so there is an arbitrage opportunity.8011201$1$50. 1So, how can we make money?McGraw-Hill/IrwinCopyright 2002 by The McGra
17、w-Hill Companies, Inc. All rights reserved.32-11Triangular Arbitrage$Credit Lyonnais S(0) = 1.50Credit AgricoleS/(0) = 85BarclaysS(0) =120As easy as 1 2 3:1. Sell our $ for , 2. Sell our for , 3. Sell those for $.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
18、32-12Triangular ArbitrageSell $100,000 for at S(0) = 1.50receive 150,000 Sell our 150,000 for at S/(0) = 85 receive 12,750,000Sell 12,750,000 for $ at S(0) = 120receive $106,250profit per round trip = $ 106,250- $100,000 = $6,250McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All
19、rights reserved.32-13The Forward Market A forward contract is an agreement to buy or sell an asset in the future at prices agreed upon today. If you have ever had to order an out-of-stock textbook, then you have entered into a forward contract.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Compa
20、nies, Inc. All rights reserved.32-14Forward Rate Quotations The forward market for FOREX involves agreements to buy and sell foreign currencies in the future at prices agreed upon today. Bank quotes for 1, 3, 6, 9, and 12 month maturities are readily available for forward contracts. Longer-term swap
21、s are available.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-15Forward Rate Quotations Suppose you observe that for Japanese yen, the spot rate is 115.75 = $1.00While the 180-day forward rate is 112.80 = $1.00 Whats up with that?The forex market clearly t
22、hinks that the yen is going to be worth more in six months (the yen is expected to appreciate) because one dollar will buy fewer yen.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-16Long and Short Forward Positions If you have agreed to sell anything (spot
23、or forward), you are “short”. If you have agreed to buy anything (forward or spot), you are “long”. If you have agreed to sell forex forward, you are short. If you have agreed to buy forex forward, you are long.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32
24、-1732.3 The Law of One Price and Purchasing Power Parity The exchange rate between two currencies should equal the ratio of the countries price levels.S(0) = P$ P Relative PPP states that the rate of change in an exchange rate is equal to the differences in the rates of inflation. e = $ - If U.S. in
25、flation is 5% and U.K. inflation is 8%, the pound should depreciate by 3%.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-18Evidence on PPP PPP probably doesnt hold precisely in the real world for a variety of reasons. Haircuts cost 10 times as much in the d
26、eveloped world as in the developing world. Film, on the other hand, is a highly standardized commodity that is actively traded across borders. Shipping costs, as well as tariffs and quotas can lead to deviations from PPP. PPP-determined exchange rates still provide a valuable benchmark.McGraw-Hill/I
27、rwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-1932.4 Interest Rates and Exchange Rates: Interest Rate Parity IRP is an arbitrage condition. If IRP did not hold, then it would be possible for an astute trader to make unlimited amounts of money exploiting the arbitrage o
28、pportunity. Since we dont typically observe persistent arbitrage conditions, we can safely assume that IRP holds.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-20Interest Rate Parity DefinedSuppose you have $100,000 to invest for one year.You can either 1.
29、Invest in the U.S. at i$. 2. Future value = $100,000(1 + ius)2. Trade your dollars for yen at the spot rate, invest in Japan at i and hedge your exchange rate risk by selling the future value of the Japanese investment forward. Future value = $100,000(F/S)(1 + i) Since both of these investments have
30、 the same risk, they must have the same future valueotherwise an arbitrage would exist.(F/S)(1 + i) = (1 + ius) McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-21Interest Rate Parity DefinedFormally, (F/S)(1 + i) = (1 + ius) or if you prefer,SFii$11IRP is so
31、metimes approximated as S(F- S) ) -i(i$McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-22IRP and Covered Interest ArbitrageIf IRP failed to hold, an arbitrage would exist. Its easiest to see this in the form of an example.Consider the following set of foreig
32、n and domestic interest rates and spot and forward exchange rates.Spot exchange rateS(0) = $1.25/360-day forward rateF(360) = $1.20/U.S. discount ratei$= 7.10%British discount rate i =11.56%McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-23IRP and Covered In
33、terest ArbitrageA trader with $1,000 to invest could invest in the U.S., in one year his investment will be worth $1,071 = $1,000(1+ i$) = $1,000(1.071)Alternatively, this trader could exchange $1,000 for 800 at the prevailing spot rate, (note that 800 = $1,000$1.25/) invest 800 at i = 11.56% for on
34、e year to achieve 892.48. Translate 892.48 back into dollars at F(360) = $1.20/, the 892.48 will be exactly $1,071.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-24According to IRP only one 360-day forward rate, F(360), can exist. It must be the case that F
35、(360) = $1.20/Why? If F(360) $1.20/, an astute trader could make money with one of the following strategies:IRP & Exchange Rate DeterminationMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-25Arbitrage Strategy IIf F(360) $1.20/ i. Borrow $1,000 at t = 0 at i
36、$ = 7.1%.ii. Exchange $1,000 for 800 at the prevailing spot rate, (note that 800 = $1,000$1.25/) invest 800 at 11.56% (i) for one year to achieve 892.48iii. Translate 892.48 back into dollars, if F(360) $1.20/ , 892.48 will be more than enough to repay your dollar obligation of $1,071.McGraw-Hill/Ir
37、winCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-26Arbitrage Strategy IIIf F(360) $1.20/ i. Borrow 800 at t = 0 at i= 11.56% .ii. Exchange 800 for $1,000 at the prevailing spot rate, invest $1,000 at 7.1% for one year to achieve $1,071.iii. Translate $1,071 back into pound
38、s, if F(360) $1.20/ , $1,071 will be more than enough to repay your obligation of 892.48.McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-27You are a U.S. importer of British woolens and have just ordered next years inventory. Payment of 100M is due in one ye
39、ar.IRP and Hedging Currency RiskIRP implies that there are two ways that you fix the cash outflowa)Put yourself in a position that delivers 100M in one yeara long forward contract on the pound. You will pay (100M)(1.2/) = $120Mb)Form a forward market hedge as shown below.Spot exchange rateS(0) = $1.
40、25/360-day forward rateF(360) = $1.20/U.S. discount ratei$= 7.10%British discount rate i =11.56%McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-28IRP and a Forward Market Hedge To form a forward market hedge:Borrow $112.05 million in the U.S. (in one year yo
41、u will owe $120 million).Translate $112.05 million into pounds at the spot rate S(0) = $1.25/ to receive 89.64 million.Invest 89.64 million in the UK at i = 11.56% for one year.In one year your investment will have grown to 100 millionexactly enough to pay your supplier.McGraw-Hill/IrwinCopyright 20
42、02 by The McGraw-Hill Companies, Inc. All rights reserved.32-29Forward Market Hedge Where do the numbers come from? We owe our supplier 100 million in one yearso we know that we need to have an investment with a future value of 100 million. Since i = 11.56% we need to invest 89.64 million at the sta
43、rt of the year.How many dollars will it take to acquire 89.64 million at the start of the year if S(0) = $1.25/?1.1156 100 89.641.25 $1.0089.64$112.05 McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-30Reasons for Deviations from IRP Transactions Costs The in
44、terest rate available to an arbitrageur for borrowing, ib,may exceed the rate he can lend at, il. There may be bid-ask spreads to overcome, Fb/Sa F/S Thus(Fb/Sa)(1 + il) (1 + i b) 0 Capital Controls Governments sometimes restrict import and export of money through taxes or outright bans.McGraw-Hill/
45、IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-31Equilibrium Exchange Rate RelationshipsS(F - S)E(e) )-i(i$ - IRPPPPFEFRPPPIFEFPMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-32A recipe for international decision makers:1. Est
46、imate future cash flows in foreign currency.2. Convert to U.S. dollars at the predicted exchange rate.3. Calculate APV using the U.S. cost of capital.32.5 International Capital BudgetingMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-33Consider this European
47、 investment opportunity:International Capital Budgeting: Example%15$iIs this a good investment from the perspective of the U.S. shareholders?P = 3% P$ = 6%S(0) = $.55265 600 200500 300 0 1 year 2 years3 yearsMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-34
48、International Capital Budgeting: Example 600 200500 300 0 1 year 2 years3 yearsCF0 = (600) S(0) =(600)($.5526/) = $331.6$331.6McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-35International Capital Budgeting: Example 600 200500 300 0 1 year 2 years3 yearsCF1
49、 = (200)ES(1) ES(1) can be found by appealing to the interest rate differential: ES(1) = (1.06/1.03) S(0) = (1.06/1.03)($.5526/) = $.5687/so CF1 = (200)($.5687/) = $113.7$331.6$113.70McGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.32-36International Capital Bud
50、geting: Example 600 200500 300 0 1 year 2 years3 yearsSimilarly,CF2 = (1.06)2/(1.03)2 S(0) (500) = $292.6CF3 = (1.06)3/(1.03)3 S(0) (300) = $180.7$331.6$113.70$292.60$180.7030.107$)15. 1 (70.180$)15. 1 (60.292$)15. 1 (70.113$60.336$32APVMcGraw-Hill/IrwinCopyright 2002 by The McGraw-Hill Companies, I