International Financial Management

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International FinancialManagementCheol S. EunGeorgia Institute of TechnologyBruce G. ResnickWake Forest UniversityMcGrawHillEducation

ContentsPART ONEFoundations of International Financial ManagementrHARTER 1Globalization and theMultinational Firm, 4What's Special about International Finance?, 5Foreign Exchange and Political Risks, 5Market Imperfections, 6Expanded Opportunity Set, 7Goals for International Financial Management, 8Clobalization of the World Economy:Major Trends and Developments, 10Emergence of Globalized Financial Markets, 7 0Emergence ofthe Euro as a Clobal Currency, 77Europe's Sovereign Debt Crisis of2010, 12Trade Liberalization and Economic Integration, 13Privatization, 16Global Financial Crisis of2008-2009, 7 7Multinational Corporations, 19Summary, 21MINI CASE: Nike and Sweatshop Labor, 23APPENDIX 1A: Cain from Trade: The Theoryof Comparative Advantage, 25CJsAPTER 2InternationalMonetary System, 27Evolution ofthe International Monetary System, 27Bimetallism: Before 1875, 28Classical Gold Standard: 1875-1914, 28Interwar Period: 1915-1944, 30Bretton Woods System: 1945-1972, 31The Flexible Exchange RateRegime: 1973-Present, 34The Current Exchange Rate Arrangements, 36European Monetary System, 41The Euro and the European Monetary Union, 43A Brief History ofthe Euro, 43WhatAre the Beneßts of Monetary Union?, 44Costs of Monetary Union, 46Prospects ofthe Euro: Some Critical Ouestions, 47INTERNATIONAL FINANCE IN PRACTICE: MundellWins Nobel Prize in Economics, 48The Mexican Peso Crisis, 50The Asian Currency Crisis, 51Origins ofthe Asian CurrencyCrisis, 52Lessonsfrom the Asian Currency Crisis, 54The Argentine Peso Crisis, 55Fixed versus Flexible Exchange Rate Regimes, 56Summary, 58MINI CASE: GrexitorNot? 60CHARTER 3Balance ofPayments, 62Balance-of-Payments Accounting, 62Balance-of-Payments Accounts, 64The Current Account, 64The Capital Account, 66Statistical Discrepancy, 68Official Reserve Account, 69The Balance-of-Payments Identity, 72Balance-of-Payments Trends in Major Countries, 72INTERNATIONAL FINANCE IN PRACTICE: The Dollar and theDeficit, 74Summary, 77MINI CASE: Mexicos Balance-of-PaymentsProblem, 80APPENDIX 3A: The Relationship BetweenBalance of Payments and National IncomeAccounting, 81xvii

xviiiCONTENTSCHARTER 4CorporateGovernanceAround the World, 82PART TWOGovernance of the Public Corporation:Key Issues, 83The Agency Problem, 84Remedies for the Agency Problem, 86Board of Directors, 87Incentive Contracts, 87INTERNATIONAL FINANCE IN PRACTICEt Whetl BoardsAre All in the Family, 88Concentrated Ownership, 88Accounting Transparency, 90Debt, 90Overseas Stock Listings, 90Market for Corporate Control, 9 7Law and Corporate Governance, 92Consequences of Law, 95Ownership and Control Pattern, 95Private Beneßts of Control, 99Capital Markets and Voluation, 99Corporate Governance Reform, 100Objectives of Reform, 100Political Dynamics, 7 01The Sarbanes-Oxley Act, 101The Cadbury Code of Best Practice, 7 02The Dodd-Frank Act, 103Summary, 104MINI CASE: Parmalat: Europe's Enron, 107The Foreign Exchange Market, Exchange RateDetermination, and Currency DerivativesCHARTER 5The Market forForeignExchange, 112CHARTER 6International ParityRelationships andForecasting ForeignExchange Rates, 140Function and Structure of the FX Market, 113INTERNATIONAL FINANCE IN PRACTICE: The Mouse Takes Overthe Floor, 114FX Market Participants, 17 4Correspondent Banking Relationships, 116The Spot Market, 117Spot Rate Quotations, 117INTERNATIONAL FINANCE IN PRACTicE: Where Money TalksVery Loudly, 118Cross-Exchange Rate Quotations, 122Alternative Expressions for theCross-Exchange Rate, 123The Bid-Ask Spread, 123Spot FX Trading, 124The Cross-Rate Trading Desk, 125Triangular Arbitrage, 127Spot Foreign Exchange MarketMicrostructure, 727The Forward Market, 129Forward Rate Quotations, 729Long and Short Forward Positions, 130Non-Deliverable Forward Contracts, 130Forward Cross-Exchange Rates, 7 30Forward Premium, 132Swap Transactions, 132Exchange-Traded CurrencyFunds, 135Summary, 135MINI CASE: Shrewsbury HerbaiProducts, Ltd., 139Interest Rate Parity, 140Covered Interest Arbitrage, 7 42Interest Rate Parity and Exchange RateDetermination, 145Currency Carry Trade, 146Reasonsfor Deviationsfrom InterestRate Parity, 147Purchasing Power Parity, 149PPP Deviations and the Real Exchange Rate, 151Evidence on Purchasing Power Parity, 151INTERNATIONAL FINANCE IN PRACTICE: McCurrencies, 152Fisher Effects, 156Forecasting Exchange Rates, 158Efficient Market Approach, 159Fundamental Approach, 160Technical Approach, 161Performance of the Forecasters, 162Summary, 166MINI CASE: Turkish Lira and PurchasingPower Parity, 1 71APPENDIX 6A: Purchasing Power Parity andExchange Rate Determination, 172

xixCONTENTSCHARTER 7Futures andOptions on ForeignExchange, 173Futures Contracts: Some Preliminaries, 174Currency Futures Markets, 1 76INTERNATIONAL FiNXNCE IN PRACTICE: FX Market VolumesSurge, 177Basic Currency Futures Relationships, 1 78Options Contracts: Some Preliminaries, 181Currency Options Markets, 181Currency Futures Options, 182Basic Option-Pricing Relationships atExpiration, 182American Option-Pricing Relationships, 185European Option-Pricing Relationships, 187Binomial Option-Pricing Model, 189European Option-Pricing Formula, 191Empirical Tests of Currency Options, 192Summary, 193MINI CASE: The Options Speculator, 195PART THREEForeign Exchange Exposure and ManagementCHARTER 8Managementof TransactionExposure, 198Three Types of Exposure, 198Forward Market Hedge, 200Money Market Hedge, 202Options Market Hedge, 203Hedging Foreign Currency Payables, 205Forward Contracts, 206Money Market Instruments, 206Currency OptionsContracts, 207Gross-Hedging Minor CurrencyExposure, 208Hedging Contingent Exposure, 208Hedging Recurrent Exposure with SwapContracts, 209Hedging through Invoice Currency, 210Hedging via Lead and Lag, 210Exposure Wetting, 211Should the Firm Hedge?, 211What Risk Management Products DoFirms Use?, 213Summary, 214MINI CASE: Airbus'Dollar Exposure, 218CASE APPLICATION: Richard May's Options, 218CHARTER 3Managementof EconomicExposure, 225How to Measure Economic Exposure, 226Operating Exposure: Definition, 230Illustration of Operating Exposure, 231Determinants of Operating Exposure, 233Managing Operating Exposure, 235Selecting Low-Cost ProductionSites, 236Flexible Sourcing Policy, 236Diversification ofthe Market, 237R&D Efforts and Product Differentiation, 237Financial Hedging, 238CASE APPLICATION: Exchange Risk Managementat Merck, 238Summary, 240MINI CASE: Economic Exposure of Albion ComputersPLC, 242CHARTER 10Managementof TranslationExposure, 244Translation Methods, 244Current/Noncurrent Method, 244Monetary/Nonmonetary Method, 245Temporal Method, 245Current Rate Method, 245Financial Accounting Standards BoardStatement 8, 246Financial Accounting Standards BoardStatement 52, 246The Mechanics ofthe FASB 52 TranslationProcess, 249Highly Inflationary Economies, 250International Accounting Standards, 250CASE APPLICATION: Consolidation ofAccounts according to FASB 52: The CentraliaCorporation, 250Management of Translation Exposure, 254Translation Exposure versus Transaction Exposure, 254Hedging Translation Exposure, 255Balance Sheet Hedge, 255Derivatives Hedge, 256Translation Exposure versus Operating Exposure, 257Empirical Analysis of the Change fromFASB 8 to FASB 52, 257Summary, 258MINI CASE: Sundance Sporting Goods, Inc., 259

XXCONTENTSPART FOURCHARTER nInternationalBanking and MoneyMarket, 264CHARTER 12International BondMarket, 304CHARTER 13International EquityMarkets, 323World Financial Markets and InstitutionsInternational Banking Services, 264The World's Largest Banks, 265Reasons for International Banking, 266Types of International Banking Offices, 266Correspondent Bank, 267Representative Offices, 267Foreign Branches, 267Subsidiäry and Affiliate Banks, 268Edge Act Banks, 268Ojfshore Banking Centers, 268International Banking Facilities, 269Capital Adequacy Standards, 269International Money Market, 272Eurocurrency Market, 272ICE UBOR, 274Eurocredits, 274INTERNATIONAL FINANCE IN PRACTICE: The Rotten Heartof Finance, 276Forward Rate Agreements, 276Euronotes, 279Eurocommercial Paper, 279Eurodollar Interest Rate Futures Contracts, 279International Debt Crisis, 281History, 281Debt-for-Equity Swaps, 282The Solution: Brady Bonds, 284The Asian Crisis, 284Global Financial Crisis, 285The Credit Crunch, 285Impact ofthe Financial Crisis, 289Economic Stimulus, 291The Aftermath, 293Summary, 294MINI CASE: Detroit Motors' Latin AmericanExpansion, 299APPENDIX 11A: Eurocurrency Creation, 301The World's Bond Markets: A StatisticalPerspective, 304Foreign Bonds and Eurobonds, 305Bearer Bonds and Registered Bonds, 305National Security Regulations, 306Withholding Taxes, 306Security Regulations that Ease Bond Issuance, 306Global Bonds, 307Types of Instruments, 307INTERNATIONAL FINANCE IN PRACTICE: SOX andBonds, 308Straight Fixed-Rate Issues, 308Euro-Medium-Term Notes, 308Floating-Rate Notes, 309Equity-Related Bonds, 309Dual-Currency Bonds, 309Currency Distribution, Nationality, andType of Issuer, 310International Bond Market Credit Ratings, 311INTERNATIONAL FINANCE IN PRACTICE: Heineken RefreshesEuromarket with Spectacular Unrated Bonds, 312Eurobond Market Structure and Practices, 314Primary Market, 314Secondary Market, 314Clearing Procedures, 316International Bond Market Indexes, 318Summary, 320MINI CASE: Sara Lee Corporation's Eurobonds, 321A Statistical Perspective, 323Market Capitalization, 323Measure of Liquidity, 326Market Structure, Trading Practices, and Costs, 326Market Consolidations and Mergers, 330Trading in International Equities, 330Cross-Listing ofShares, 331Yankee Stock Offerings, 333American Depository Receipts, 334Global Registered Shares, 337Empirical Findings on Cross-Listing and ADRs, 338International Equity Market Benchmarks, 339iShares MSCI, 340Factors Affecting International EquityReturns, 340Macroeconomic Factors, 340INTERNATIONAL FINANCE IN PRACTICE: Foreign Interest inSouth Africa Takes Off, 342Exchange Rates, 342Industrial Structure, 342Summary, 343MINI CASE: San Pico's New Stock Exchange, 345

xxiCONTENTSCHARTER 14Interest Rate andCurrency Swaps, 347Types of Swaps, 347INTERNATIONAL FINANCE IN PRACTICE: The World Bank's FirstCurrency Swap, 348Size ofthe Swap Market, 348The Swap Bank, 349Swap Market Quotations, 349INTERNATIONAL FINANCE IN PRACTICE: Double-Crossed 350Interest Rate Swaps, 351Basic Interest Rate Swap, 351Pricing the Basic Interest Rate Swap, 353Currency Swaps, 354Basic Currency Swap, 354Equivalency of Currency Swap Debt ServiceObligations, 355Pricing the Basic Currency Swap, 356A Basic Currency Swap Reconsidered, 357Variations of Basic Interest Rate andCurrency Swaps, 358Risks of Interest Rate and Currency Swaps, 359Is the Swap Market Efficient?, 359Summary, 360MINI CASE: The Centralia Corporation's CurrencySwap, 364CHARTER 15International PortfolioInvestment, 365International Correlation Structure and RiskDiversification, 366Optimal International Portfolio Selection, 368Effects of Changes in the Exchange Rate, 375International Bond Investment, 377International Mutual Funds: A PerformanceEvaluation, 378International Diversification through CountryFunds, 380International Diversification with ADRs, 383International Diversification with Exchange-TradedFunds, 384International Diversification withHedge Funds, 385Why Home Bias in Portfolio Holdings?, 386International Diversification with Small-CapStocks, 387Summary, 389MINI CASE: Solving for the Optimal InternationalPortfolio, 394APPENDIX 1 5A: International Investment withExchange Risk Hedging, 397APPENDIX 15B: Solving for the OptimalPortfolio, 399PART FiVEFinancial Management of the Multinational FirmCHARTER IGForeign DirectInvestment andCross-BorderAcquisitions, 404Global Trends in FDI, 405Why Do Firms Invest Overseas?, 408Trade Barriers, 409Imperfect Labor Market, 409IntangibleAssets, 410Vertical Integration, 411INTERNATIONAL FINANCE IN PRACTICE: Linear Sequence inManufacturing: Singer & Company, 412Product Life Cycle, 412Shareholder Diversification Services, 413Cross-Border Mergers andAcquisitions, 413Political Risk and FDI, 418Summary, 425MINI CASE: Enron versus BombayPoliticians, 427CHARTER 17International CapitalStructure and theCost of Capital, 431Cost of Capital, 431Cost of Capital in Segmented versus IntegratedMarkets, 434Does the Cost of Capital Differ amongCountries?, 435CASE APPLICATION: Novo Industri, 437Cross-Border Listings of Stocks, 439Capital Asset Pricing under Cross-Listings, 444The Effect of Foreign Equity OwnershipRestrictions, 446Pricing-to-Market Phenomenon, 446CASE APPLICATION: Nestle, 447Asset Pricing under Foreign OwnershipRestrictions, 448The Financial Structure of Subsidiaries, 451Summary, 452APPENDIX 1 7A: Pricing of Nontradable Assets:Numerical Simulations, 457

xxiiCONTENTSReview of Domestic Capital Budgeting, 459The Adjusted Present Value Model, 460Capital Budgeting from the Parent Firm'sPerspective, 462Ceneralityof the APV Model, 464Estimating the Future Expected Exchange Rate, 465CASE APPLICATION: The Centralia Corporation, 465Risk Adjustment in the Capital BudgetingAnalysis, 469Sensitivity Analysis, 470Purchasing Power Parity Assumption, 470Real Options, 470Summary, 472MINI CASE 1 : Dorchester, Ltd., 474MINI CASE 2: Strik-it-Rich Gold MiningCompany, 475CHARTER 19Multinational CashManagement, 477The Management of International CashBalances, 477CASE APPLICATION: Teltrex's Cash ManagementSystem, 477Bilateral Wetting of Internal and External Net CashFlows, 482Reduction in Precautionary Cash Balances, 483Cash Management Systems in Practice, 485Summary, 486MINI CASE 1 : Efficient Funds Flow at EasternTrading Company, 487MINI CASE 2: Eastern Trading Company's NewMBA, 487CHARTER 20International TradeFinance, 488A Typical Foreign Trade Transaction, 488Forfaiting, 491Government Assistance in Exporting, 491INTERNATIONAL FINANCE IN PRACTICE: First Islamic ForfaitingFund Set Up, 492The Export-Import Bank and AffiliatedOrganization, 492Countertrade, 493Forms of Countertrade, 493INTERNATIONAL FINANCE IN PRACTICE: Armed Forces Tops inCountertrade List, 495Some Ceneralizations about Countertrade, 495Summary, 496MINI CASE: American Machine Tools, Inc., 498The Objectives of Taxation, 499Tax Neutrality, 499Tax Equity, 500Types of Taxation, 500Inco me Tax, 500Withholding Tax, 502Value-Added Tax, 502National Tax Environments, 504Worldwide Taxation, 504Territorial Taxation, 504Foreign Tax Credits, 505Organizational Structures, 505Branch and Subsidiary Income, 505Tax Hävens, 506Controlled Foreign Corporation, 507Tax Inversion, 507INTERNATIONAL FINANCE IN PRACTICE: On or Off?It's a Matter of Degree, 508Transfer Pricing and Related Issues, 509CASE APPLICATION: Mintel Products Transfer PricingStrategy, 509INTERNATIONAL FINANCE IN PRACTICE: Transfer Pricing: AnImportant International Tax Issue, 512Miscellaneous Factors, 514INTERNATIONAL FINANCE IN PRACTICE: Wake Up and Smell theCoffee, 515Advance Pricing Agreement, 516ßlocked Funds, 516Summary, 517MINI CASE 1: Sigma Corp.'s LocationDecision, 519MINI CASE 2: Eastern Trading Company's OptimalTransfer Pricing Strategy, 520CHARTER 18International CapitalBudgeting, 458CHARTER 21International TaxEnvironment andTransfer Pricing, 499Glossary, 521Index, 528

Financial Management Cheol S. Eun Georgia Institute of Technology Bruce G. Resnick Wake Forest University Mc Graw Hill Education . Contents PART ONE rHARTER 1 Globalization and the Multinational Firm, 4 Foundations of International Financial Management What's Special about International Finance?, 5 . PART FiVE Financial Management of the .

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