International Business Chapter 3 International Financial Markets Lecture Outline Foreign Exchange Market History Foreign Exchange

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Chapter 3

International Financial Markets

Lecture Outline

Foreign Exchange Market

History of Foreign Exchange

Foreign Exchange Transactions

Foreign Exchange Quotations

Derivative Contracts in the Foreign Exchange Market

International Money Market

Dollar-denominated Bank Accounts in Europe and Asia

Money Market Interest Rates Among Currencies

Risk of International Money Market Securities

International Credit Market

Syndicated Loans in the Credit Market

International Bond Market

Eurobond Market

Development of Other Bond Markets

Risk of International Bonds

International Stock Markets

Issuance of Stock in Foreign Markets

International Financial Market Crises

Contagion Effects

How Financial Markets Serve MNCs

International Financial Markets ❖2

Chapter Theme

This chapter identifies and discusses the various international financial markets used by MNCs. These

markets facilitate day-to-day operations of MNCs, including foreign exchange transactions, investing in

foreign markets, and borrowing in foreign markets.

Topics to Stimulate Class Discussion

1. Why do international financial markets exist?

2. How do banks serve international financial markets?

POINT/COUNTER-POINT:

Should Firms That Go Public Engage in International Offerings?

POINT: Yes. When a U.S. firm issues stock to the public for the first time in an initial public offering

(IPO), it is naturally concerned about whether it can place all of its shares at a reasonable price. It will be

able to issue its stock at a higher price by attracting more investors. It will increase its demand by

spreading the stock across countries. The higher the price at which it can issue stock, the lower is its cost

of using equity capital. It can also establish a global name by spreading stock across countries.

COUNTER-POINT: No. If a U.S. firm spreads its stock across different countries at the time of the IPO,

there will be less publicly-traded stock in the U.S. Thus, it will not have as much liquidity in the

secondary market. Investors desire stocks that they can easily sell in the secondary market, which means

that they require that the stocks have liquidity. To the extent that a firm reduces its liquidity in the U.S. by

spreading its stock across countries, it may not attract sufficient U.S. demand for the stock in the U.S.

Thus, its efforts to create global name recognition may reduce its name recognition in the U.S.

WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support?

Offer your own opinion on this issue.

ANSWER: The key is that students recognize the tradeoff involved. A firm that engages in a relatively

International Financial Markets ❖3

Answers to End of Chapter Questions

1. Motives for Investing in Foreign Money Markets. Explain why an MNC may invest funds in a

financial market outside its own country.

2. Motives for Providing Credit in Foreign Markets. Explain why some financial institutions prefer

to provide credit in financial markets outside their own country.

3. Exchange Rate Effects on Investing. Explain how the appreciation of the Australian dollar against the

U.S. dollar would affect the return to a U.S. firm that invested in an Australian money market security.

ANSWER: If the Australian dollar appreciates over the investment period, this implies that the U.S.

4. Exchange Rate Effects on Borrowing. Explain how the appreciation of the Japanese yen against the

U.S. dollar would affect the return to a U.S. firm that borrowed Japanese yen and used the proceeds

for a U.S. project.

5. Bank Services. List some of the important characteristics of bank foreign exchange services that

MNCs should consider.

6. Bid/ask Spread. Utah Bank’s bid price for Canadian dollars is $.7938 and its ask price is $.81. What

is the bid/ask percentage spread?

7. Bid/ask Spread. Compute the bid/ask percentage spread for Mexican peso retail transactions in

which the ask rate is $.11 and the bid rate is $.10.

International Financial Markets ❖6

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

ANSWER: Firms may issue stock in foreign markets when they are concerned that their home

market may be unable to absorb the entire issue. In addition, these firms may have foreign currency

inflows in the foreign country that can be used to pay dividends on foreign-issued stock. They may

also desire to enhance their global image. Since the euro can be used in several countries, firms may

need a large amount of euros if they are expanding across Europe.

20. Financing with Stock. Chapman Co. is a privately owned MNC in the U.S. that plans to engage in an

initial public offering (IPO) of stock, so that it can finance its international expansion. Currently, world

stock market conditions are very weak, but they are expected to improve in the future. The U.S. market

tends to be weak in periods when the other stock markets around the world are weak. A financial

manager of Chapman Co. recommends that the firm wait until the world stock markets recover before it

issues stock. Another manager believes that Chapman Co. could issue its stock now even if the price

would be low, since its stock price should rise later once world stock markets recover. Who is correct?

Explain.

Advanced Questions

21. Effects of September 11. Why do you think the terrorist attacks on the U.S. were expected to cause a

decline in U.S. interest rates? Given the expectations for a potential decline in U.S. interest rates and

stock prices, how were capital flows between the U.S. and other countries likely affected?

22. International Financial Markets. Walmart established two retail outlets in the city of Shanzen,

China, which has a population of 3.7 million. These massive outlets sell imported goods in addition to

products produced locally. As Walmart generates earnings beyond what it needs in Shanzen, it may

remit those earnings back to the United States. Walmart is likely to build additional outlets in

Shanzen or in other Chinese cities in the future.

a. Explain how the Walmart outlets in China would use the spot market in foreign exchange.

b. Explain how Walmart might utilize the international money market when it is establishing other

Walmart stores in Asia.

International Financial Markets ❖7

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Thus, the Eurocurrency market serves as a deposit or lending source for Walmart and other MNCs on

a short-term basis.

c. Explain how Walmart could use the international bond market to finance the establishment of

new outlets in foreign markets.

23. Interest Rates. Why do interest rates vary among countries? Why are interest rates usually similar

for those European countries that use the euro as their currency? Offer a reason why the government

interest rate of one country could be slightly higher than the government interest rate of another

country, even though the euro is the currency used in both countries.

24. Interpreting Exchange Rate Quotations. Today you notice the following exchange rate quotations:

*$1 is equal to 3.00 Argentine pesos

*1 Argentine peso = 0.50 Canadian dollars

*You need to purchase 100,000 Canadian dollars with U.S. dollars. How many U.S. dollars will you

need for your purchase?

25. Pricing ADRs. Today, the stock price of Genevo Company (based in Switzerland) is priced at SF80

per share. The spot rate of the Swiss franc (SF) is $.70. During the next year, you expect that the

stock price of Genevo Company will decline by 3%. You also expect that the Swiss franc will

depreciate against the U.S. dollar by 8% during the next year. You own American depository receipts

(ADRs) that represent Genevo stock. Each share that you own represents one share of the stock traded

on the Swiss stock exchange. What is the estimated value of the ADR per share in one year?

26. Explaining Variation in Bid/Ask Spreads. Go to the currency converter at

http://finance.yahoo.com/currency and determine the bid/ask spread for the euro. Then determine the

bid/ask spread for a currency in a less developed country. Why do you think is the main reason for the

difference in the bid/ask spreads between these two currencies?

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

27. Direct Versus Indirect Exchange Rates. Assume that during this semester, the euro appreciated

against the dollar. Did the direct exchange rate of the euro increase or decrease? Did the indirect

exchange rate of the euro increase or decrease?

28. Transparency and Stock Trading Activity. Explain the relationship between transparency of firms

and investor participation (or trading activity) among stock markets. Based on this relationship, how

can governments of countries increase the amount of trading activity (and therefore liquidity) of their

stock markets?

29. How Governance Affects Stock Market Liquidity. Identify some of the key factors that can allow

for stronger governance and thereby increasing participation and trading activity in a stock market.

30. International Impact of the Credit Crisis. Explain how the international integration of financial

markets caused the credit crisis of 2008-2009 to spread across many countries.

ANSWER: Since financial markets are integrated, they allow institutional investors in one country to

31. Issuing Stock in Foreign Markets. Bloomington Co. is a large U.S.-based MNC with large

subsidiaries in Germany. It has issued stock in Germany to establish its business. As an alternative3

financing medchanism, it could have issued stock in the U.S. and then used the proceeds to support

the growth in Europe. What is a possible advantage of issuing the stock in Germany to finance

German operations? Also, why might the German investors prefer to purchase the stock that was

issued in Germany rather than purchase the stock of Bloomington on a U.S. stock exchange?

International Financial Markets ❖9

32. Interest Rates Among Countries. As of today, the interest rate in Countries X, Y, and Z, are similar.

In the next month, Country X is expected to have a weak economy, while Countries Y and Z are

expected to experience a 6% increase in their economic growth. However, conditions this month will

also increase the credit risk of borrowers in Country Z in the next month because of political

concerns, while the credit risk of Countries X and Y remain unchanged. During the next month,

which country should have the highest interest rate? Which country should have the lowest interest

rate?

33. Greece Bailout Negotiations. In July 2015, Greece was negotiating to obtain its third bailout from

several European governments over a five-year period. Greece argued that austerity measures should

not be imposed. Offer some reasoning for this argument.

The European governments insisted on very strict austerity measures as a condition for providing

loans. Offer some reasoning for the very strict austerity measures.

ANSWER: Austerity measures such as reduced government spending on pensions and higher taxes

might help reduce the budget deficit, but results in less disposable income for the citizens of Greece.

CRITICAL THINKING

Impact of Shareholder Rights and Accounting Laws Select a country outside the U.S. and conduct an

online search of the country’s shareholder rights or accounting laws. Write a short essay in which you

briefly describe the shareholder rights or accounting laws of that country. Would you consider investing in

stocks of firms in that country based on your review of this country? Do you believe that the shareholder

rights and accounting laws have encouraged the development of the stock market in this country? Explain.

ANSWER

This question allows students to learn how shareholder rights and accounting transparency can differ among

Solution to Continuing Case Problem: Blades, Inc.

International Financial Markets ❖11

Plan 2—Immediate Conversion

Calculation of baht-denominated revenue:

Price per pair of “Speedos”

4,594

× Pairs of “Speedos”

180,000

= Baht-denominated revenue

826,920,000

Calculation of baht-denominated cost of goods sold:

Cost of goods sold per pair of “Speedos”

2,871

× Pairs of “Speedos”

72,000

= Baht-denominated expenses

206,712,000

Calculation of dollar receipts due to conversion of baht into dollars:

Net baht-denominated cash flows to be converted (826,920,000 –

206,712,000)

620,208,000

× Spot rate of baht now

$ 0.024

= Dollar receipts now

$ 14,884,992

Interest earned on dollars over a one-year period (8%)

1,190,799

= Dollar receipts in one year

$ 16,075,791

Calculation of dollar difference between the two plans:

Plan 1

$ 15,691,262

Plan 2

16,075,791

Dollar difference

$ (384,529)

Thus, the cash flow generated in one year by Plan 1 exceed those generated by Plan 2 by approximately

$384,529. Therefore, Ben Holt’s plan should not be implemented.

Solution to Supplemental Case: Gretz Tool Company

a. Citicorp could facilitate the following financial transactions:

1. Foreign Exchange. Citicorp could provide whatever currency was needed by Gretz in the foreign

exchange market.

2. Short-Term Financing. Citicorp could provide short-term loans to Gretz in whatever currency is

4. Long-Term Financing. Citicorp could place bonds issued by Gretz in the international bond

market (Citicorp would normally serve as an intermediary rather than the creditor here). Citicorp

could also help Gretz place newly issued stock in foreign stock markets.

International Financial Markets ❖12

b. Normally, a subsidiary would prefer to borrow the currency that it uses to invoice its products. Thus,

the future cash inflows would be in the same currency that is needed to pay back the loan, and

Small Business Dilemma

Use of the Foreign Exchange Markets by the Sports Exports Company

1. Explain how the Sports Exports Company could utilize the spot market to facilitate the exchange of

currencies. Be specific.

2. Explain how the Sports Exports Company is exposed to exchange rate risk and how it could use the

forward market to hedge this risk.

ANSWER: The Sports Exports Company is exposed to exchange rate risk, because the value of the

British pound will change over time. If the pound depreciates over time, the payment in pounds will