Professional Documents
Culture Documents
2.6.3
2.6.4
2.6.5
The differential between a bid quote and an ask quote will look much
smaller for currencies that have a smaller value. This differential can be
Order costs. Order costs are the costs of processing orders, including
The origins of the European money market can be traced to the Eurocurrency
market that developed during the 1960s and 1970s. As MNCs expanded their
operations during that period, international financial intermediation emerged to
accommodate their needs.
5.2 Asian Money Market
Like the European money market, the Asian money market originated as a market
involving mostly dollar-denominated deposits, and was originally known as the
Asian dollar market.
6. Money Market Interest Rates among Currencies
6.1 Global Integration of Money Market Interest Rates
When economic conditions weaken in many countries, the corporate need for
liquidity declines, and corporations reduce the amount of shortterm funds they
wish to borrow. Thus, the aggregate demand for short-term funds declines in many
countries, and money market interest rates decline as well in those countries.
Conversely, when economic conditions strengthen in many countries, there is an
increase in corporate expansion, and corporations need additional liquidity to
support their expansion.
6.2 Risk of International Money Market Securities
The debt securities issued by MNCs and government agencies with a short-term
maturity (1 year or less) within the international money market are referred to as
international money market securities.
7. International Credit Market
The international credit market is well developed in Asia and is developing in South
America. Periodically, some regions are affected by an economic crisis, which
increases the credit risk. Financial institutions tend to reduce their participation in
those markets when credit risk increases. Thus, even though funding is widely
available in many markets, the funds tend to move toward the markets where
economic conditions are strong and credit risk is tolerable.
8. Regulations in the Credit Market
8.1 Single European Act
One of the most significant events affecting international banking was the Single
European Act, which was phased in by 1992 throughout the European Union (EU)
countries. The following are some of the more relevant provisions of the Single
European Act for the banking industry:
- Capital can flow freely throughout Europe.
- Banks can offer a wide variety of lending, leasing, and securities activities
in the EU.
5
future.
Underwriting Process
Eurobonds are underwritten by a multinational syndicate of investment banks
and simultaneously placed in many countries, providing a wide spectrum of
fund sources to tap. The underwriting process takes place in a sequence of
steps. The multinational managing syndicate sells the bonds to a large
12.4
underwriting crew.
Secondary Market
Eurobonds also have a secondary market. The market makers are in many
cases the same underwriters who sell the primary issues. A technological
advance called Euro-clear helps to inform all traders about outstanding issues
12.5
14.2
The interest rate risk of international bonds represents the potential for the
value of bonds to decline in response to rising long-term interest rates. When
14.3
long-term interest rates rise, the required rate of return by investors rises.
Exchange Rate Risk
Exchange rate risk represents the potential for the value of bonds to decline
(from the investors perspective) because the currency denominating the bond
14.4
CASES
BLADES, INC. CASE
1. One point of concern for you is that there is a trade-off between the higher interest
rates in Thailand and the delayed conversion of baht into dollars. Explain what this
means.
ANSWER: If the net baht-denominated cash flows are converted into pounds today,
Blades is not subject to any future depreciation of the baht that would result in less
pound cash flows.
2. If the net baht received from the Thailand operation are invested in Thailand, how will
UK operations be affected? (Assume that Blades is currently paying 10 percent on
dollars borrowed, and needs more financing for its firm.)
ANSWER: If the cash flows generated in Thailand are all used to support UK
operations, then Blades will have to borrow additional funds in the UK (or the
international money market) at an interest rate of 10 percent. For example, if the baht
will depreciate by 10 percent over the next year, the Thai investment will render a
yield of roughly 5 percent, while the company pays 10 percent interest on funds
borrowed in the UK Since the funds could have been converted into pounds
immediately and used in the UK, the baht should probably be converted into pounds
today to forgo the additional (expected) interest expenses that would be incurred from
this action.
3. Construct a spreadsheet to compare the cash flows resulting from two plans. Under the
first plan, net baht-denominated cash flows (received today) will be invested in
Thailand at 15 percent for a one-year period, after which the baht will be converted to
dollars. The expected spot rate for the baht in one year is about 0.0147 (Ben Holts
plan). Under the second plan, net baht-denominated cash flows are converted to
pounds immediately and invested in the United Kingdom for one year at 8 percent. For
this question, assume that all baht-denominated cash flows are due today. Does Holts
plan seem superior in terms of pound cash flows available after one year? Compare
the choice of investing the funds versus using the funds to provide needed financing to
the firm.
ANSWER: If Blades can borrow funds at an interest rate below 8 percent, it should
invest the excess funds generated in Thailand at 8 percent and borrow funds at the
lower interest rate. If, however, Blades can borrow funds at an interest rate above 8
percent (as is currently the case with an interest rate of 10 percent), Blades should use
the excess funds generated in Thailand to support its operations rather than borrowing.
Plan 1Ben Holt's Plan
9
4,594
180,000
826,920,000
2,871
72,000
206,712,000
620,208,000
93,031,200
713,239,200
0.0147
10,484,616
4,594
180,000
826,920,000
2,871
72,000
206,712,000
620,208,000
0.016
9,923,328
793,866
10,717,194
10,484,616
10,717,194
(232,578)
Thus, the cash flow generated in one year by Plan 1 is very close to Plan 2,
Plan 2 is slightly better.
SMALL BUSINESS DILEMMA Case
1. Explain how the Sports Exports Company could utilize the spot market to facilitate the
10
11
CHAPTER 4
International Parity Conditions and Currency Forecasting
IFE
II.
12
II.
services
The LAW OF ONE PRICE prevails
III.
2.
=
=
=
=
=
If purchasing power parity is expected to hold, then the best prediction for the
one period spot rate should be
t
( 1+ ih )
e t=e0
t
( 1+if )
3.
4.
Sample Problem :
13
Projected inflation rates for the U.S. and Germany for the next twelve months are 10% and
4%, respectively. If the current exchange rate is $.50/dm, what should the future spot rate be
at the end of next twelve months?
t
( 1+ ih )
e t=e0
=
1+i t
e 1=0,50(1,0577)
III.
e t=0,50
( 1,10 )1
( 1,04 )1
e 1=$ 0,529
IV.
14
If the /$ spot rate is 108/$ and the interest rates in Tokyo and
New York are 6% and 12%, respectively, what is the future spot rate
two years from now?
t
( 1+ ih )
e t=e0
=
1+i t
e 2=108
V.
e 2=108
( 1,1236 )
( 1,2544 )
( 1,06 )2
( 1,12 )2
e 2= 96,74/ $
C.
F
=
S ( 1+r f )
D.
Covered Interest Arbitrage
1. Conditions required: interest rate differential does not equal the forward premium or
discount.
2. Funds will move to a country with a more attractive rate.
3. Market pressures develop:
a.
As one currency is more demanded spot and sold forward.
b.
Inflow of funds depresses interest rates.
c.
Parity eventually reached.
CASES
President Carter Lectures The Foreign Exchange Markets - Mini-Case
1. How were financial markets likely to respond to President Carter's lecture? Explain.
ANSWER.
15
big tax cuts and a reduction in the anti-business policies and rhetoric so common under
Jimmy Carter.
18