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[Complete Summary] International Finance
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Well written document summarising the course of International Finance, MBA. You will find everything the teacher explained.
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GDV.INTERNATIONAL
FINANCE
Alessandro Scopelliti 2021-2022
, GDV.
TABLE OF CONTENT (EXERCISES AT THE END)
L0: Introduction to International Finance
L1: Foreign Exchange Markets
1.1 Foreign Exchange Rate Risk
1.2 International Financial Markets
1.2.1 Structure of Forex Market
1.2.2 Transaction Types
1.2.3 Settlement Risk – Herstatt Risk
1.3 Exchange rate quotations
1.3.1 Forex Trading
L2: The Balance of Payments
L3: Exchange Rate Systems
3.1 Foreign Exchange Markets and Central Banks
L4: Uncovered and Covered Interest Rate Parity
4.1 Uncovered Interest Rate Parity
4.2 Covered Interest Rate Parity
4.3 Interest Rate Parity in Practice
L5: Purchasing Power Parity and Real Exchange Rate
5.1 General Concepts of Purchasing Power
5.2 Absolute Purchasing Power Parity
5.3 Relative Purchasing Power Parity
5.4 Parity Conditions and Exchange Rate Forecasts
L6: Exchange Rate Determination and Forecasting
6.1 Currency Forecasting Techniques
6.1.1 Fundamental Exchange Rate Forecasting (fundamental analysis)
6.1.2 Technical Analysis
L7: The Financing Decision in International Fixed-income Markets
7.1 Global Sources of Funds for International Firms
7.2 Characteristics of Debt Instruments
7.3 Tour of the World’s Bond Markets
7.4 International Banking
7.5 International Bank Loans
7.6 Comparing the Cost of Debt
L8: International Equity Financing
8.1 Tour of International Stock Markets
8.2 International Cross-Listing and Depositary Receipts
8.3 Advantages and Disadvantages of Cross-Listing
L9: Foreign Exchange Products
9.1 Forward Contracts
9.2 Currency Options
9.3 Currency Swaps
Total theory pages: 39
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, GDV.
L0: Introduction to International Finance
>> Compulsory book: International Financial Management (Bekaert, G. and Hodrick, R., 2019)<<
Closed-book exam, 3h. Open questions (describe issues, conduct exercises), FOCUS ON
UNDERSTANDING THE ISSUES, and do not learn by heart without being able to explain. The exam is
based on a critically understanding of issues. Each part of the course will have a question. Some can
be numerical; others can be based on intuition (check the book).
L1: Foreign Exchange Markets
1.1 Foreign Exchange Rate Risk
The exchange rate is a relative price that expresses one currency in terms of another currency.
Direct quote: what amount of domestic currency is needed to buy one unit of foreign currency.
Indirect quote: what amount of foreign currency is needed to buy one unit of the domestic currency.
The foreign exchange rate is strictly related to inflation and might be driven by the balance of
imports/exports, the development of debts in a country, etc. Many factors are driving the foreign
exchange rate.
The foreign exchange rate risk matters to companies because companies are subject to contractual
exposure due to nominal exchange rate (price of one currency against another) risk. This nominal
exchange rate risk is the uncertainty about the value of an asset or liability that expires at some future
point in time and is denominated in foreign currency. (e.g., company imports raw materials from India,
costs of goods depend on the value of the Indian rupee relative to the home currency).
In main cases, the goods and services are priced in the currency of the server. However, oil was always
priced in US dollars. In this case, fluctuations in US Dollars impact the oil prices. To hedge this risk,
financial companies can use options, swaps, etc.
Also, some strong events might influence the currency of a country (e.g., Brexit). Of course, this had
strong implications for companies. Many are exposed to these fluctuations of currencies, such as
airline companies (buying fuel which is expressed in dollars). On the other hand, the depreciation of
currencies makes the produced goods of countries cheaper for foreign consumers. However, in the
case of purely domestic retail companies, their depreciation of currency might have negative
implications on the profit.
Regarding the real exchange risk, based on the economic exposure of companies, it depends on the
real pricing of goods. This real exchange risk may depend on the competitiveness of the country.
Central banks can intervene to reduce these fluctuations of currencies by including a cap. For instance,
this threshold helped support the GDP of Switzerland, as companies were less impacted by the
fluctuations. However, creating a cap might trigger inflation and other financial risks. At one point, the
Swiss bank decided to remove the cap, and this had an immediate implication on the foreign markets.
The Swiss Franc appreciated by almost 30% to the Euro, causing losses for investors.
1.2 International Financial Markets
1.2.1 Structure of Forex Market
2
, GDV.
This market is not like the stock market, as it is not as regulated.
The Forex market operates 24/7. It is composed of several elements. The most important is the
interbank market, where major banks are trading currencies. This interbank market is also composed
of the market makers (providing the services allowing other participants to make their transactions).
They might use derivatives to do so. The trades are generally significant amounts.
The local and smaller banks might not have direct access to trade but do it through major banks.
The benefits of a 24/7 market are to react to opportunities whenever they arise, trade when it’s most
convenient, taking advantage of periods of higher volatility when markets overlap. London Forex
market is the most important in the world, even after Brexit. Its turnover increased throughout the
years due to the electronification of the process and the diversity in market participants. However,
the Euro always had a more important value than any other value.
The market participants in the interbank market are giving a two-way quote (bid and ask), they profit
from buying currencies at a bid price and reselling it at a higher price, ask price. The difference
between the bid and ask price is called the spread.
The interbank Forex brokers are intermediaries between interbank market makers. Their transactions
are usually done by phone or call box. Brokers shop around to find takers of someone else’s offers.
However, more and more transactions have been done by electronic interbank Forex brokers.
For instance, a German manufacturer needs to buy the British pound to pay his UK suppliers. He would
first go to the central bank and would pay the asking price (which is higher) and if he has a surplus and
wants to sell back in Euros, he will receive the bid price (which is lower).
However, central banks do not usually act on interbank markets. It is mostly hedge funds, smaller
financial institutions, or high net worth individuals. The Swiss case was specific.
1.2.2 Transaction Types
Spot transaction: purchase of foreign exchange, with delivery and payment to take place, normally,
on the second following business day. The date of settlement is referred to as the value date. Notation
spot exchange rate at time t: St.
Forward transaction: transaction that requires delivery/payment at a future value date of a specified
amount of one currency for a specified amount of another currency. The exchange rate is established
at the time of the agreement, but payment and delivery are not required until maturity. A forward is
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