International Financial Management

PREFACE xvii

SELECTED CURRENCIES AND SYMBOLS xix

SYMBOLS AND ACRONYMS xxi

PART 1 THE GLOBAL FINANCIAL MANAGEMENT ENVIRONMENT

1 INTRODUCTION TO INTERNATIONAL FINANCIAL MANAGEMENT 3

1.1 The Rise of the International Company 5

1.2 The Internationalization of Business and Finance 24

1.3 International Financial Management: Theory and Practice 36

1.4 Outline of the Text 42

APPENDIX 1A The Origins and Consequences of International Trade 45

2 EXCHANGE RATE DETERMINATION 51

2.1 Setting the Equilibrium Spot Exchange Rate 52

2.2 Expectations and the Asset Market Model of Exchange Rates 58

2.3 The Fundamentals of Central Bank Intervention 73

2.4 The Equilibrium Approach to Exchange Rates 80

2.5 Summary and Conclusions 83

3 THE INTERNATIONAL MONETARY SYSTEM 87

3.1 Alternative Exchange Rate Systems 88

3.2 A Brief History of the International Monetary System 97

3.3 The European Monetary System and Monetary Union 109

3.4 Emerging Market Currency Crises 129

3.5 Summary and Conclusions 132

4 CURRENCIES: EXPECTATIONS, PARITIES, AND FORECASTING 135

4.1 Arbitrage and the Law of One Price 135

4.2 Purchasing Power Parity 138

4.3 The Fisher Effect 147

4.4 The International Fisher Effect 153

4.5 Interest Rate Parity Theory 157

4.6 The Relationship Between the Forward Rate and the Future Spot Rate 162

4.7 Currency Forecasting 165

4.8 Summary and Conclusions 171

5 THE INTERNATIONAL MONETARY SYSTEM AND THE BALANCE OF PAYMENTS 178

5.1 Balance–of–Payments Categories 179

5.2 The International Flow of Goods, Services, and Capital 184

5.3 Coping with the Current–Account Deficit 193

5.4 Summary and Conclusions 203

6 COUNTRY RISK 208

6.1 Measuring Political Risk 209

6.2 Economic and Political Factors Underlying Country Risk 218

6.3 Country Risk Analysis in International Lending 236

6.4 Summary and Conclusions 243

PART 2 CURRENCY AND DERIVATIVES MARKETS

7 CURRENCY MARKETS 249

7.1 Organization of the Foreign Exchange Market 250

7.2 The Spot Market 257

7.3 The Forward Market 265

7.4 Summary and Conclusions 269

8 CURRENCY DERIVATIVES 272

8.1 Futures Contracts 272

8.2 Currency Options 279

8.3 Reading Currency Futures and Options Prices 295

8.4 Summary and Conclusions 297

APPENDIX 8A Option Pricing Using Black–Scholes 299

APPENDIX 8B Put–Call Option Interest Rate Parity 302

9 INTEREST RATE DERIVATIVES 306

9.1 Interest Rate and Currency Swaps 306

9.2 Interest Rate Forwards and Futures 318

9.3 Structured Notes 322

9.4 Credit Default Swaps 324

9.5 Summary and Conclusions 326

PART 3 MANAGING CURRENCY RISKS

10 TRANSLATION AND TRANSACTION EXPOSURE 331

10.1 Alternative Measures of Foreign Exchange Exposure 332

10.2 Alternative Currency Translation Methods 334

10.3 Transaction Exposure 335

10.4 Designing a Hedging Strategy 337

10.5 Managing Translation Exposure 347

10.6 Managing Transaction Exposure 349

10.7 Summary and Conclusions 364

APPENDIX 10A Currency Translation in Practice 369

11 ECONOMIC EXPOSURE 373

11.1 Foreign Exchange Risk and Economic Exposure 374

11.2 The Economic Consequences of Exchange Rate Changes 379

11.3 Identifying Economic Exposure 383

11.4 Calculating Economic Exposure 386

11.5 An Operational Measure of Exchange Risk 391

11.6 Managing Operating Exposure 393

11.7 Summary and Conclusions 404

PART 4 FINANCING INTERNATIONAL OPERATIONS

12 INTERNATIONAL AND DOMESTIC CAPITAL MARKETS 411

12.1 Corporate Sources and Uses of Funds 412

12.2 Domestic Capital Markets as International Financial Centers 419

12.3 Development Banks 429

12.4 Project Finance 433

12.5 Summary and Conclusions 435

13 INTERNATIONAL FINANCIAL MARKETS 438

13.1 The Eurocurrency Market 438

13.2 Eurobonds 445

13.3 Note Issuance Facilities and Euronotes 451

13.4 Euro–Commercial Paper 455

13.5 The Asia currency Market 456

13.6 Summary and Conclusions 457

14 THE INTERNATIONAL COST OF CAPITAL 459

14.1 The Cost of Equity Capital 460

14.2 The Weighted Average Cost of Capital for Foreign Projects 461

14.3 Discount Rates for Foreign Investments 462

14.4 The Cost of Debt Capital 471

14.5 Establishing a Worldwide Capital Structure 473

14.6 Valuing Low–Cost Financing Opportunities 479

14.7 Summary and Conclusions 484

PART 5 INTERNATIONAL CAPITAL BUDGETING

15 INTERNATIONAL PORTFOLIO INVESTMENT 491

15.1 The Risks and Benefits of International Equity Investing 491

15.2 International Bond Investing 509

15.3 Optimal International Asset Allocation 509

15.4 Measuring the Total Return from Foreign Portfolio Investing 510

15.5 Measuring Exchange Risk on Foreign Securities 512

15.6 Summary and Conclusions 513

16 STRATEGIES FOR FOREIGN DIRECT INVESTMENT 517

16.1 Theory of the Multinational Corporation 518

16.2 The Strategy of Multinational Enterprise 520

16.3 Designing a Global Expansion Strategy 527

16.4 Summary and Conclusions 530

17 INTERNATIONAL CAPITAL BUDGETING 534

17.1 Basics of Capital Budgeting 535

17.2 Issues in Foreign Investment Analysis 540

17.3 Foreign Project Appraisal: The Case of International Machine Tools 544

17.4 Political Risk Analysis 552

17.5 Growth Options and Project Evaluation 554

17.6 Summary and Conclusions 556

APPENDIX 17A Managing Political Risk 559

PART 6 INTERNATIONAL MANAGEMENT OF WORKING CAPITAL

18 INTERNATIONAL TRADE MANAGEMENT 567

18.1 Payment Terms in International Trade 568

18.2 Documents in International Trade 577

18.3 Financing Techniques in International Trade 579

18.4 Government Sources of Export Financing and Credit Insurance 582

18.5 Countertrade 586

18.6 Summary and Conclusions 589

19 MANAGING WORKING CAPITAL 592

19.1 International Cash Management 593

19.2 Accounts Receivable Management 606

19.3 Inventory Management 607

19.4 Short–Term Financing 608

19.5 Summary and Conclusions 616

20 FINANCIAL MANAGEMENT FOR THE GLOBAL ENTERPRISE 620

20.1 The Value of the Multinational Financial System 621

20.2 Intercompany Fund–Flow Mechanisms: Costs and Benefits 624

20.3 Designing a Global Remittance Policy 640

20.4 Summary and Conclusions 642

GLOSSARY 645

INDEX 679

Alan C. Shapiro is the holder of the Ivadelle and Theodore Johnson Professorship in Banking and Finance and Professor of Finance and Business Economics at the University of Southern California. He has also been a Visiting Professor at Yale University, UCLA, the Stockholm School of Economics, University of British Columbia, and the U.S. Naval Academy. His specialties are corporate and international financial management.

Peter Moles is Senior Lecturer in Finance at the University of Edinburgh. He has 14 years’ experience in the City in international capital markets, corporate finance, money markets, the Eurobond market and risk management. His research interests are in capital structure; derivatives and risk management; and how management decisions are made and the difficulties associated with managing complex problems. Peter Moles is the co–author of Corporate Finance, published by John Wiley & Sons Ltd.