International Buisness & Finance

Why is it important to study international finance? We are now living in a world where all the major economic functions, i.e., consumption, production, and investment, are highly globalized. It is thus essential for financial managers to fully understand vital international dimensions of financial management. This global shift is in marked contrast to a situation that existed when the authors of this book were learning finance some twenty years ago. At that time, most professors customarily (and safely, to some extent) ignored international aspects of finance. This mode of operation has become untenable since then. Role of International finance manager The three roles of financial managers are financial planning and control, the allocation of funds, and the acquisition of funds. In recent years, the role of the financial manager has begun expanding. 1-Financial control and planning mainly involves the preparation of budgets (a type of established standard), a planning function, and the administration of these budgets, a controlling function. The foreign exchange market and international accounting play a key role in this process. The cornerstone of effective control and planning is meaningful financial reports. 2-Each dollar invested has alternative uses. A financial manager plans for the allocation of these funds, especially the wise investment of funds within the firms. For international firms, there are more opportunities for investment but there is a corresponding increase in risk, both of which should be considered by financial managers. 3-A critical role for financial managers is to determine the combination of methods to acquire funds that best meets the stated needs of the firm. This requires balancing low cost and the risk of not being able to pay bills. There are three methods for financial managers of MNCs to acquire funds on more positive terms picking instruments, picking countries, and picking currencies. 4-The role of the financial manager has expanded to include increased concern with financial strategy. This change is driven by the globalization of competition and the integration of world financial markets, thereby increasing the important of international finance. Major risks of international business Political risks range from moderate actions (e.g. exchange controls) to extreme actions (e.g. confiscation of assets). Financial risks involve varying exchange rates, divergent tax laws, different interest and inflation rates, and balance-of-payments considerations. Regulatory risks are difference in legal systems, overlapping jurisdictions, and restrictive business practices against foreign companies. What is the Foreign Exchange Market? The Foreign Exchange Market is the financial market in which currencies are bought and sold that is a transaction is entered into where a given amount of currency is exchanged for another amount of currency. The need for the Foreign Exchange Market (commonly referred to as the Forex Market) developed to facilitate International trade where currencies were required to be settled from the country of both the importer and the exporter. It therefore plays an extremely important role in facilitating cross-border trade, financial transactions and investment. More recently, it allows borrowers to have access to the International capital markets in order to meet their financing needs in the currency which is most conducive to their requirements.

Functions of the Foreign Exchange Market The foreign exchange market is the mechanism by which a person or firm transfers purchasing power from one country to another, obtains or provides credit for international trade transactions, and minimizes exposure to foreign exchange risk. Transfer of Purchasing Power: Transfer of purchasing power is necessary because international transactions normally involve parties in countries with different national currencies. Each party usually wants to deal in its own currency, but the transaction can be invoiced in only one currency. Provision of Credit: Because the movement of goods between countries takes time, inventory in transit must be financed. Minimizing Foreign Exchange Risk:
The foreign exchange market provides "hedging" facilities for transferring foreign exchange risk to someone else.

Transactions in the Foreign Exchange Market Transactions in the foreign exchange market can be executed on a spot, forward, or swap basis. Spot Transactions: A spot transaction requires almost immediate delivery of foreign exchange. In the interbank market, a spot transaction involves the purchase of foreign exchange with delivery and payment between banks to take place, normally, on the second following business day.The date of settlement is referred to as the "value date." Spot transactions are the most important single type of transaction (43 % of all transactions). Forward Transactions: A forward transaction requires delivery at a future value date of a specified amount of one currency for a specified amount of another currency. The exchange rate to prevail at the value date is established at the time of the agreement, but payment and delivery are not required until maturity. Forward exchange rates are normally quoted for value dates of one, two, three, six, and twelve months. Actual contracts can be arranged for other lengths. transactions. Swap Transactions: Swap transactions provide a means for the bank to mitigate the currency exposure in a forward trade. A swap transaction is the simultaneous sale (or purchase) of spot foreign exchange against a forward purchase (or sale) of an approximately equal amount of the foreign currency Direct and Indirect Quotations: A direct quote is a home currency price of a unit of foreign currency. An indirect quote is a foreign currency price of a unit of home currency. In the US, a direct quote for the CAD is USD 0.6341 / CAD .This quote would be an indirect quote in Canada. Bid and Ask spread: A bid is the exchange rate in one currency at which a dealer will buy another currency An ask is the exchange rate at which a dealer will sell the other currency. Dealers buy at the bid price and sell at the ask price, profiting from the spread between the bid and ask prices: Bid-ask spread= Ask price Bid price __________________ Ask price X 100

Factors that affect the spread Order costs (positive) Inventory costs (positive) Competition (negative) Volume (negative) Currency risk (positive) Cross exchange Rate: A cross rate is an exchange rate between two currencies, calculated from their Common relationship with a third currency or the exchange rate between two
foreign currencies.

Find the direct cross quote of FRF in India, given that Rs / $ = 48.08/48.16 $ / AUD = 20.10/20.18 GBP/ AUD = 0.5291/0.5300 GBP/FRF = 0.0815/0.0818 What is triangular arbitrage? What is a condition that will give rise to a triangular arbitrage opportunity? Triangular arbitrage is the process of trading out of the U.S. dollar into a second currency, then trading it for a third currency, which is in turn traded for U.S. dollars. The purpose is to earn an arbitrage profit via trading from the second to the third currency when the direct exchange between the two is not in alignment with the cross exchange rate. Most, but not all, currency transactions go through the dollar. Certain banks specialize in making a direct market between non-dollar currencies, pricing at a narrower bid-ask spread than the cross-rate spread. Nevertheless, the implied cross-rate bid-ask quotations impose a discipline on the non-dollar market makers. If their direct quotes are not consistent with the cross exchange rates, a triangular arbitrage profit is possible. . Factors that Influence Exchange Rates Or Determinants of Foreign Exchange Rates 1. Relative Inflation Rates Changes in relative inflation rates can affect international trade activity, which influences the demand for and supply of currencies and therefore influences exchange rates. Example: Let us consider that Pakistans inflation suddenly increased substantially while U.S. inflation remained the same. (Assume that both U.S. and Pakistani firms sell goods that can serve as substitutes for each other.) The sudden jump in Pakistans inflation should cause an increase in the Pakistans demand for U.S. goods and therefore also cause an increase in the Pakistans demand for U.S. dollars. In addition, the jump in Pakistans inflation should reduce the U.S. desire for Pakistani goods and therefore reduce the supply of dollars for sale. The increased Pakistani demand for dollars and the reduced supply of dollars for sale place upward pressure on the value of the dollar. If U.S. inflation increased (rather than U.S. inflation), the opposite forces would occur. 2. Relative Interest Rates Changes in relative interest rates affect investment in foreign securities, which influences the demand for and supply of currencies and therefore influences exchange rates.

Example: Assume that Pakistans interest rates rise while US interest rates remain constant. In this case, Pakistani investors will likely reduce their demand for dollars, since Pakistani rates are now more attractive relative to US rates, and there is less desire for US bank deposits. Because Pakistani rates will look more attractive to US investors with excess cash, the supply of dollars for sale by US investors should increase as they establish more bank deposits in Pakistan. In some cases, an exchange rate between two countries currencies can be affected by changes in a third countrys exchange rate. Real interest Rates Although a relatively high rate may attract foreign inflows, the relatively high interest rate may reflect expectations of relatively high inflation. To this reason, it is helpful to consider the real interest rate which adjusts the nominal interest rate for inflation. Real interest rate Nominal interest rate Inflation rate. This is sometimes called the Fisher effect. The real interest rate is commonly compared among counters it assess exchange rate movements because it combines nominal interest rates and inflation, both of which influence exchange. Other things held constant, there should be a high correlation between the real interest rate differential and the dollars value. 3. Relative Income Levels A third factor affecting exchange rates is relative income levels. Because income can affect the amount imports demanded. It can affect exchange rates. Changing income levels can also affect exchange rates indirectly through effects on interest rates. When this effect is considered the impact may differ from the theory presented here. Example: Assume that Pakistans income level rises substantially while the British income level remains unchanged. Consider the impact of this scenario on 1) The demand schedule for pounds. 2) The supply schedule for pounds. 3) The equilibrium exchange rate. First the demand schedule for pounds will shift outward, reflecting the increase in Pakistans income and therefore increased demand for British goods. Second, the supply schedule of pounds for sale is not expected to change. Changing income levels can also affect exchange rates indirectly through effects on interest rates. When this effect is considered, the impact may differ from the theory presented here. 4. Government Controls A fourth factor affecting exchange rate is government controls. The government of foreign countries can influence the equilibrium exchange rate in many ways. 1) Imposing foreign exchange barriers, 2) Imposing foreign trade barriers. 3) Intervening in the foreign exchange markets. 4) Affecting macro variables such as inflation, interest rates and income levels. Example: Assume that Pakistans interest rates are raised relative to the U.S. interest rates. The expected reaction is increase in the U.S. supply of dollars for sale to obtain more Pakistani rupees (in order to capitalize on high Pakistani money market yields). Yet, if the U.S. government placed a heavy tax on interest income earned from foreign investments, this could discourage the exchange of dollars for rupees.

5. Expectations A fifth factor affecting exchange rates. Like other financial markets, foreign exchange markets react to any news that may have a future effect. News of potential surge in Pakistani inflation may cause currency dealers to sell rupees, anticipating future decline in rupees value. This response places immediate downward pressure on the rupee. Many institutional investors (such as commercial banks and insurance companies) take currency positions based on anticipated interest rate movements in various countries. Impact of Signals on Currency Speculation: Signals of the future economic conditions that affect exchange rates can change quickly, so the speculative positions in currencies may adjust quickly, causing unclear patterns in exchange rates. It is not unusual for the rupee to strengthen substantially on a given day (causing the rupee to be overvalued), which results in a correction on next day. Overreactions occur because speculators are commonly taking positions based on signals of future actions (rather than the confirmation of actions), and these signals may be misleading. When speculators speculate on currencies in emerging markets, they can have a substantial impact on exchange rates. Who are the market participants in the foreign exchange market? The market participants that comprise the FX market can be categorized into five groups: international banks, bank customers, non-bank dealers, FX brokers, and central banks. International banks provide the core of the FX market. Approximately 100 to 200 banks worldwide make a market in foreign exchange, i.e., they stand willing to buy or sell foreign currency for their own account. These international banks serve their retail clients, the bank customers, in conducting foreign commerce or making international investment in financial assets that requires foreign exchange. Non-bank dealers are large non-bank financial institutions, such as investment banks, mutual funds, pension funds, and hedge funds, whose size and frequency of trades make it cost- effective to establish their own dealing rooms to trade directly in the interbank market for their foreign exchange needs. Most interbank trades are speculative or arbitrage transactions where market participants attempt to correctly judge the future direction of price movements in one currency versus another or attempt to profit from temporary price discrepancies in currencies between competing dealers. FX brokers match dealer orders to buy and sell currencies for a fee, but do not take a position themselves. Interbank traders use a broker primarily to disseminate as quickly as possible a currency quote to many other dealers. Central banks sometimes intervene in the foreign exchange market in an attempt to influence the price of its currency against that of a major trading partner, or a country that it fixes or pegs its currency against. Intervention is the process of using foreign currency reserves to buy ones own currency in order to decrease its supply and thus increase its value in the foreign exchange market, or alternatively, selling ones own currency for foreign currency in order to increase its supply and lower its price. EXCHANGE RATE SYSTEMS. We can roughly categorize countries as falling into three main categories of exchange rate regimes. 1. Flexible exchange rate systems (also known as floating exchange rate systems.) 2. Managed floating rate systems. 3. Fixed exchange rate systems (also known as pegged exchange rate systems). Flexible Exchange Rate Systems In a flexible exchange rate system, the value of the currency is determined by the market, i.e. by the interactions of thousands of banks, firms and other institutions seeking to buy and sell currency for purposes of transactions clearing, hedging, arbitrage and speculation.

 So higher demand for a currency, all else equal, would lead to an appreciation of the currency. Lower demand, all else equal, would lead to a depreciation of the currency. An increase in the supply of a currency, all else equal, will lead to a depreciation of that currency while a decrease in supply, all else equal, will lead to an appreciation. Since 1971, economies have been moving towards flexible exchange rate systems although only relatively few currencies are classifiable as truly floating exchange rates. Most OECD countries have flexible exchange rate systems: the U.S., Canada, Australia, Britain, and the European Monetary Union. Managed Floating Rate Systems A managed floating rate systems is a hybrid of a fixed exchange rate and a flexible exchange rate system. In a country with a managed floating exchange rate system, the central bank becomes a key participant in the foreign exchange market. Unlike in a fixed exchange rate regime, the central bank does not have an explicit set value for the currency; however, unlike in a flexible exchange rate regime, it doesnt allow the market to freely determine the value of the currency. Instead, the central bank has either an implicit target value or an explicit range of target values for their currency: it intervenes in the foreign exchange market by buying and selling domestic and foreign currency to keep the exchange rate close to this desired implicit value or within the desired target values. So under a managed floating regime, the central bank holds stocks of foreign currency: these holdings are known as foreign exchange reserves. It is important to realize that a managed float can only work when the implicit target is close to the equilibrium rate that would prevail in the absence of central bank intervention. Otherwise, the central bank will deplete its foreign exchange reserves and the country will be in a flexible exchange rate system because they can no longer intervene. Fixed (Pegged) Exchange Rate Systems Prior to the 1970s most countries operated under a fixed exchange rate system known as the Bretton-Woods system. We will discuss Bretton-Woods in more detail later, for now think of it as a system whereby the exchange rates of the member countries were fixed against the U.S. dollar, with the dollar in turn worth a fixed amount of gold. Even though this system broke down, many countries still have an exchange rate system where the central bank announces a fixed exchange rate for the currency and then agrees to buy and sell the domestic currency at this value. The basic motivation for keeping exchange rates fixed is the belief that a stable exchange rate will help facilitate trade and investment flows between countries by reducing fluctuations in relative prices and by reducing uncertainty. THE DETERMINATION OF EXCHANGE RATES 1-Floating Rate Regimes Floating rates regimes are those whose currencies respond to the conditions of supply and demand. Technically, an independent floating currency is one that floats freely, unhampered by any form of government intervention. Equilibrium exchange rates are achieved when supply equals demand 2-Managed Fixed-Rate Regimes In a managed fixed exchange-rate system, a nations central bank intervenes in the foreign exchange market in order to influence the currencys relative price. To buy foreign currencies, it must have sufficient reserves on hand. When economic policies and market intervention dont work, a country may be forced to either revalue or devalue its currency. A currency that is pegged to another (or to a basket of currencies) is usually changed on a formal basis.

3-Purchasing-Power Parity The theory of purchasing-power parity (PPP) states that the prices of tradable goods, when expressed in a common currency, will tend to equalize across countries as a result of exchangerate changes. Put another way, the theory claims a change in the comparative rates of inflation in two countries necessarily causes a change in their relative exchange rates in order to keep prices fairly similar. While purchasing-power parity may be a reasonably good long-term indicator of exchange-rate movements, it is less accurate in the short-run because it is difficult to determine an appropriate basket of commodities for comparison purposes, profit margins vary according to the strength of competition, different tax rates will influence prices differently, and the theory falsely assumes no barriers to trade exist and transportation costs are zero. 4. Interest rates Although inflation is the most important long-run influence on exchange rates, interest rates are also important. While the Fisher Effect theory links inflation and interest rates, the International Fisher Effect (IFE) theory links interest rates and exchange rates. The Fisher Effect theory states a countrys nominal interest rate r is determined by the real interest rate R and the inflation rate as follows: R=r- Because the real interest rate should be the same in every country, the country with the higher interest rate should have higher inflation. Thus, when inflation rates are the same, investors will likely place their money in countries with higher interest rates in order to get a higher real return. The International Fisher Effect implies the currency of the country with the lower interest rate will strengthen in the future, i.e., the interest-rate differential is an unbiased predictor of future changes in the spot exchange rate. The country with the higher interest rate (and higher inflation) should have the weaker currency. In the short-run, however, and during periods of price instability, a country that raises its interest rate is likely to attract capital and see its currency rise in value due to increased demand. 5-Other Factors in Exchange-Rate Determination A key factor affecting exchange-rate movements is confidence in a countrys economy and administration. Technical factors such as the seasonal demand patterns for a given currency, the release of national economic statistics and events such as 9/11, corporate scandals and budget deficits also exert their influence. Government Influence on Exchange Rates Reasons for Government Intervention In foreign exchange market The degree to which the home currency is controlled, or managed varies among central banks. Central banks commonly manage exchange rates for three reasons: 1. To smooth exchange rate movements. 2. To establish implicit exchange rate boundaries 3. Respond to temporary disturbances Smooth Exchange Rate Movements If central bank is concerned that its economy will be affected by abrupt movements in its home currencys value; it may attempt to smooth the currency movements over time. Its actions may keep business cycles less volatile. The Central bank may also encourage international trade by reducing exchange rate uncertainty. Furthermore, smoothing currency movements may reduce fears in the financial markets and speculative activity that could cause a major decline in a currencys value. Establish Implicit Exchange Rate Boundaries Some central banks attempt to maintain their home currency rates within some unofficial or implicit boundaries. Analysts are commonly quoted as forecasting that a currency will not fall

below or rise above a particular benchmark value because the central bank intervenes to prevent that. The State Bank periodically intervenes to reverse the Rupee upward or downward. Respond to Temporary Disturbances In some case a central bank may intervene to insulate a currencys value from a temporary disturbance. Infect the stated objective of the Central bank policy is to counter disorderly market conditions. Several studies have found that government intervention does not have a permanent impact on exchange rate movements.

Direct and Indirect Intervention

Direct Intervention To depreciate the rupee SBP can intervene directly by exchanging rupees that it holds as reserves for other foreign currencies in the foreign exchange market. By flooding the market with rupees in this manner, the SBP puts downward pressure on the rupees. If the SBP desires to strengthen the rupee it can exchange foreign currencies for rupees in the foreign exchange market, thereby putting upward pressure on the rupee. Direct intervention is usually most effective when there is a coordinated effort among all central banks. If all central banks simultaneously attempt to strengthen or weaken the currency in the manner just described, they can exert greater pressure on the currencys value. Example: During early 2004, Japans central bank, the Bank of Japan, intervened on several occasions to lower the value of yen. In the first 2 months of 2004, the Bank of Japan sold yen in the foreign exchange market in exchange for $100 billion. Then on March 5, 2004, the Bank of Japan sold yen in exchange for $20 billion, which put immediate downward pressure on the value of the yen. Reliance on Reserves The potential effectiveness of a central banks direct intervention is the amount of reserves it can use. If the central bank has a low level of reserves, it may not be able to exert much pressure on the currencys value. Market forces would likely overwhelm its actions. As foreign exchange activity has grown, central bank intervention has become less effective. The volume of foreign exchange transactions on a single day now exceeds the combined values of reserves at all central banks. Consequently, the number of direct interventions has declined. Example: The central bank of China has a substantial amount of reserves that it can use to intervene in the foreign exchange market. Thus it can more effectively use direct intervention that many other countries in Asia. Indirect Intervention The central bank can also affect the currencys value indirectly by influencing the factors that determine iti.e inflation rate, interest rate, income level etc. The Central bank can influence these variables, which in turn can affect the exchange rate. Since these variables will likely have a more lasting impact on a spot rate than direct intervention, a central bank may use indirect intervention by influencing these variables. Government Adjustment of Interest Rates When countries experience substantial net outflows of funds, they commonly intervene indirectly by raising interest rates to discourage excessive outflows of funds and therefore limit any downward pressure on the value of their currency. However, this strategy adversely affects local borrowers and may weaken the economy. No sterilized vs. Sterilized Intervention When the SBP intervenes in the foreign exchange market without adjusting of the change in the money supply, it is engaging in a no sterilized intervention.

In the Sterilized intervention the SBP intervenes in the foreign exchange market and simultaneously engages in offsetting transactions in the Treasury securities markets. As a result the money supply is unchanged. Use of Foreign Exchange Controls Some governments attempt to use foreign exchange controls as form of indirect intervention toll maintain the exchange rate of their currency. Under severe pressure, however, they tend to let the currency float temporarily toward its market determined level and set new bands around that level. Example: During the mid-1990s, Venezuela imposed foreign exchange controls on its currency (the bolivar). In April 1996, Venezuela removed its controls on foreign exchange, and the bolivar declined by 42% the next day. This result suggests that the market-determined exchange rate was substantially lower than the exchange rate at which the government artificially set the bolivar.

Intervention as a Policy Tool

The government of any country can implement its own fiscal and monetary policies to control its economy. In addition, it may attempt to influence the value of its home currency in order to improve its economy, weakening its currency under some conditions and strengthening it under others. In essence, the exchange rate becomes a tool, like the tax laws and the money supply that the government can use to achieve its desired economic objectives. Influence of a Strong Home Currency on the Economy A weak home currency can stimulate foreign demand for products. A weak dollar, for example, can substantially boost U.S. exports and U.S. jobs. In addition it may also reduce U.S. imports. Though a weak currency can reduce unemployment home, it can lead to higher inflation. In the early 1990s, the U.S. dollar was weak, causing U.S. imports from foreign countries to be highly priced. This situation priced firms such as Bayer, Volkswagen, and Volvo out of the U.S. market. Under these conditions U.S. companies were able to raise their domestic prices because it was difficult for foreign producers to compete. In addition, U.S. firms that are heavy exporters, such as Goodyear Tire & Rubber Co., Northrup Grumman, Merck, DuPont, and Whirlpool, also benefit from a weak dollar. Influence of a Strong Home Currency on the Economy A strong home currency can encourage consumers and corporations of that country to buy goods form other countries. This situation intensifies foreign competition and forces domestic producers to refrain from increasing prices. Therefore the countrys overall inflation rate should be lower if its currency is stronger, other things being equal. Though a strong currency is a possible cure for high inflation, it may cause higher unemployment due to attractive foreign prices that result from a strong home currency. The ideal value of the currency depends on the perspective of the country and the officials who must make these decisions. The strength or weakness of currency is just one of many factors that influence a countrys economic conditions.

The Forward Discount/ Premium What is meant by a currency trading at a discount or at a premium in the forward market? Answer: The forward market involves contracting today for the future purchase or sale of foreign exchange. The forward price may be the same as the spot price, but usually it is higher (at a premium) or lower (at a discount) than the spot price. The forward premium / discount is the difference between the forward exchange rate, F and the spot exchange rate, S, expressed as a percentage of the spot rate. Thus, denote forward discount or premium between the home currency and the foreign currency as f = FS _________ S X 100

Example Let 1 year forward rate for in terms of $ be F$ = 1.46344 and S$ = 1.4855.

$ =

F$ S $ 1.46344 1.4855 100 = 100 = 1.4% S $ 1.4855

Hence the is trading at a forward discount against the $. The forward value for the in terms of $ is less than todays value of the in terms of $s International financial markets Motives for Using International Financial Markets Basic reason: markets are imperfect (e.g., labor, taxes, etc.) Motives for investing in foreign markets economic conditions exchange rate expectations international diversification Motives for providing credit in foreign markets interest rates exchange rate expectations international diversification Motives for borrowing in foreign markets interest rates exchange rate expectations Foreign Exchange Market the market where currencies are exchanged Spot market allows for immediate exchange average daily trading of $1.5 trillion many foreign transactions do not require an exchange of currencies but allow a given currency to cross country borders Spot market structure hundreds of banks facilitate foreign exchange transactions the top 20 banks handle about 50% of transactions similar quotes facilitated by arbitrage opportunities

Spot market liquidity the more willing buyers and sellers there are, the more liquid a market is a currencys liquidity reflects the ease with which an MNC can obtain or sell that currency Forward rate - the rate at which currencies will be exchanged at a future point in time a contract between a firm and a bank to exchange currencies at a specified rate in a specified number of days used by MNCs to hedge exchange rate exposure the forward market for euros is very liquid because many MNCs take forward positions to hedge their future payments in euros International Money Market Origins and development includes large banks around the world, such as J.P. Morgan European money market Eurocurrency market developed in the 60s and 70s dollar deposits in banks in other countries are Eurodollars growth due to 1968 U.S. regulations limiting foreign lending by U.S. banks Petrodollars - dollar deposits by OPEC countries Asian money market Originally known as the Asian dollar market emerged to accommodate needs of businesses using dollars for international trade centered in Hong Kong and Singapore Standardizing global bank regulations Single European Act (1987) allows capital to move freely within EEC countries and allows banks to expand freely within other EEC countries Basel Accord (1988) - made capital requirements standard for 12 major industrialized countries Basel II Accord corrects existing inconsistencies banks in some countries have required better collateral to back loans accounts for operational risk plans to require banks to provide more information to existing and prospective shareholders International Credit Market Eurocredit loans are loans of one year or longer maturity extended to MNCs by banks interest rate risk motivates floating rate loans tied to LIBOR loans are provided in the Eurocredit market Syndicated loans each bank participates in lending of large-volume transactions lead bank responsible for negotiating terms and organizing group of banks International Bond Market MNCs issue international bonds for three reasons may be able to attract stronger demand the foreign currency may be widely used financing in a foreign currency may reduce financing costs A foreign bond is issued by a borrower foreign to the country where the bond is placed Parallel bonds are issued in various countries and denominated in various currencies Eurobond market Eurobonds are bonds that are sold in countries other than the country of the currency

denominating the bond U.S. investment in foreign bonds: Interest Equalization Tax in 1963 foreign Investment in U.S. Bonds: 30% withholding tax before 1984 Antilles-based subsidiaries features bearer form, convertibility, few protective covenants denominations commonly denominated in a number of currencies the U.S. dollar denominates 70 to 75% of Eurobonds underwriting process accomplished through a multinational syndicate of investment banks secondary market facilitated by Euro-clear International Stock Markets Yankee Stock - foreign stock issued in the U.S. liquidity of U.S. market size of U.S. market American Depository Receipts (ADRs) - receipts representing a number of foreign shares that are deposited in a U.S. bank Issuance of stock in foreign markets listing on multiple exchanges - greater exposure and liquidity of stock e.g., Coke is traded in U.S., Frankfurt, and Switzerland U.S., Japan, and U.K. combined allow for around-the-clock trading more U.S. firms are willing to list their stock in Europe because of the euro Balance of Payments The balance of payments (BOP) accounting system is double-entry bookkeeping systems designed to measure and record all economic transactions between residents of one country and residents of all other countries during a particular time period. There are several reasons why international business people should pay attention to the BOP. First, BOP statistics help identify emerging markets for goods and services. Second, they can warn of possible new policies that may alter a countrys business climate, thereby affecting the profitability of a firms operations in that country. Third, they can indicate reductions in a countrys foreign reserves, which may mean that a countrys currency will depreciate in the future. Fourth, they can signal increased riskiness of lending to particular countries. The Major Components of the BOP Accounting System The BOP can be divided into four major accounts: the current account; the capital account; the official reserves account; and the errors and omissions account. Current Account The current account records exports and imports of merchandise and services, investment income, and gifts. To Germany, a sale of a Mercedes-Benz automobile to a doctor in Brazil is a merchandise export, and the purchase by a German resident from France is a merchandise import. The difference between a countrys exports and imports of goods is called the balance on merchandise trade. The sale of a service (i.e., consulting services) to a resident of another country is a service export, while the purchase of a service by a resident of another country is a service import. The term trade in invisibles is also used to describe trade in services. The difference

between a countrys export of services and its import of services is called the balance on services trade. Income (i.e., interest and dividends) German residents earn from their foreign investment is viewed as an export of the services of capital by Germany. Income earned by foreigners from their investments in Germany is known as an import of the services of capital by Germany. Unilateral transfers are gifts between residents of one country and another country. Current account balance measures the net outflow or inflow resulting from merchandise trade, service trade, investment income, and unilateral transfers.

Capital Account The capital account records capital transactions -- purchases and sales of assets -- between residents of one country and those of other countries. Capital account transactions can be divided into foreign direct investment (FDI) and portfolio investment. The former is any investment made for the purpose of controlling the organization in which the investment is made, while the latter is any investment made for purposes other than control. Short-term portfolio investments are financial instruments with maturities of one year or less. Long-term portfolio investments are stocks, bonds, and other financial instruments issued by private and public organizations that have maturities greater than one year and that are held for purposes other than control. Current account transactions affect the short-term components of the capital account because the first entry in the double-entry BOP accounting system involves the purchase or sale of something, and the second entry typically records the payment or receipt of payment for the thing bought or sold. Capital inflows are credits in the BOP accounting system and occur either when foreign ownership of assets in a county increases or when ownership of foreign assets by a countrys residents declines. Capital outflows are debits in the BOP accounting system and occur either when ownership of foreign assets by a countrys residents increases or when foreign ownership of assets in a country declines. Official Reserves Account The official reserves account records holdings of the official reserves held by a national government including gold, convertible currencies (currencies that are freely exchangeable in world currency markets), SDRs, and reserve positions at the IMF. Errors and Omissions The errors and omissions account is used to make the BOP balance in accordance with the following equation: Current Account + Capital Account + Errors and Omissions + Official Reserves = 0. A large portion of the errors and omissions account is probably due to underreporting of capital account transactions. It is becoming more and more difficult to keep track of legal capital transactions as they become increasingly sophisticated and grow in volume. Other errors and omissions are deliberate actions and are frequently illegal. Purchasing power parity: Arbitrage is the basis for all of the parity conditions. Arbitrage is buying an item market and selling it at a higher price in another market. Law of One Price The law of one price implies that a good selling in a foreign country should sell for the same price, measured in the same currency, as a good sold domestically. Arbitrage is the basis for

all of the parity conditions. Arbitrage buys an item from one market and selling it at a higher price in another market. S=Pi/P* Example: The law of one price states that if the Pakistani price of a digital camera is Rs3000 in the Pakistan and the exchange rate S is Rs.90 per dollar, the price of the camera in USA should be of dollar 33.33 (3000/90). Otherwise profitable arbitrage would be possible. Suppose for example the camera costs $25 in USA. As entrepreneurs purchased cameras in USA, the price will begin to rise on increased demand. The cameras will be transported to the Pakistan and sold there, increasing a rise in the U.S. supply, and causing the price to decline and price again will be equalized. a. Absolute Purchasing Power Parity Whereas the law of one price applies to single good, absolute purchasing power parity (absolute PPP) is a theory that applies to all goods and services in two countries. According to absolute PPP, the exchange rate S (expressed in units of home currency per unit of foreign currency), and the price levels in the two countries under considerations P should be related such that S = P / P* where P = domestic price level and P* = the foreign price level. Example 1: Absolute PPP Example: If the Pakistani price level is 18000 and the U.S. price level is 180 then the exchange rate should be S = 18000 / 180 = Rs100/$ Problems with Absolute PPP: Absolute PPP is unlikely to hold for two countries because of the following reasons: Transportation costs, time to ship, and the riskiness of shipping goods internationally are all ignored. These are not particularly serious problems because relaxing these assumptions implies that parity will still hold within a band of the parity level (parity level plus or minus these costs). Taxes, tariffs, quotas and other non-tariff barriers are ignored. Entities in the two countries do not consume the same basket of goods and services and do not value the baskets equally. For this reason especially absolute PPP is not likely to hold. Relative Purchasing Power Parity Relative PPP avoids the problem of having different baskets of goods and services consumed in different countries. This is unlikely to be true if people in different countries consume goods and services in different proportions. According to relative PPP, %S = %P - %P*, so that the percentage change in a rate of exchange for two countries currencies equals the difference between the two nations inflation rates. If a businessperson anticipates, for instance, that the inflation rate in pakistan will be 7 percent next year while the U.S. inflation rate will be 2 percent, the relative PPP condition indicates that the Rupee will depreciate by 5 percent relative to the U.S. dollar. 2. Interest Rate Parity The covered interest parity condition states that if the foreign exchange risk is covered in the forward foreign exchange market the return on a domestic asset will be equal to the return of a comparable foreign asset. K(1+i) = K/S(1+i*) F Or (F - S)/S =I i*

where i is the domestic interest rate, i* is the foreign interest rate, F is the forward exchange rate in units of domestic currency per unit of foreign currency, and S is the spot exchange rate in units of domestic currency per unit of foreign currency. The quantity (F - S)/S is the forward premium or discount, so the covered interest parity condition states that the interest rate on a domestic asset should approximately equal the interest rate on a foreign asset plus the forward premium or discount. If covered interest parity did not hold, then the return from holding a domestic asset would differ from the domestic-currency-denominated return, covered from risk by a transaction in the forward exchange market, on a foreign asset. In that case, arbitrage opportunities for riskless profit would exist simply from a choice of one asset over the other. There are two types of arbitrage (a) outward arbitrage and (b) Inward arbitrage If (F - S)/S >I i* Inward arbitrage If (F - S)/S <I i* Outward arbitrage Q#1 Currently, the spot exchange rate is $1.50/ and the three-month forward exchange rate is $1.52/. The three-month interest rate is 8.0% per annum in the U.S. and 5.8% per annum in the U.K. Assume that you can borrow as much as $1,500,000 or 1,000,000. a. Determine whether the interest rate parity is currently holding. b. If the IRP is not holding, how would you carry out covered interest arbitrage? Show all the steps and determine the arbitrage profit. c. Explain how the IRP will be restored as a result of covered arbitrage activities. Solution: Lets summarize the given data first: S = $1.5/; F = $1.52/; I$ = 2.0%; I = 1.45% Credit = $1,500,000 or 1,000,000. a. (1+I$) = 1.02 (1+I)(F/S) = (1.0145)(1.52/1.50) = 1.0280 Thus, IRP is not holding exactly. b. (1) Borrow $1,500,000; repayment will be $1,530,000. (2) Buy 1,000,000 spot using $1,500,000. (3) Invest 1,000,000 at the pound interest rate of 1.45%; maturity value will be 1,014,500. (4) Sell 1,014,500 forward for $1,542,040 Arbitrage profit will be $12,040 c. Following the arbitrage transactions described above, The dollar interest rate will rise; The pound interest rate will fall; The spot exchange rate will rise; The forward exchange rate will fall. These adjustments will continue until IRP holds. Q#2 Suppose that the current spot exchange rate is 0.80/$ and the three-month forward exchange rate is 0.7813/$. The three-month interest rate is 5.6 percent per annum in the United States and 5.40 percent per annum in France. Assume that you can borrow up to $1,000,000 or 800,000. a. Show how to realize a certain profit via covered interest arbitrage, assuming that you want to realize profit in terms of U.S. dollars. Also determine the size of your arbitrage profit. b. Assume that you want to realize profit in terms of euro. Show the covered arbitrage process and

determine the arbitrage profit in euro. Solution: a. (1+ i$) = 1.014 < (S/F) (1+ i ) = 1.0378. Thus, one has to borrow dollars and invest in euro to make arbitrage profit. 1. Borrow $1,000,000 and repay $1,014,000 in three months. 2. Sell $1,000,000 spot for 800,000. 3. Invest 800,000 at the euro interest rate of 1.35 % for three months and receive 810,800 at maturity. 4. Sell 810,800 forward for $1,037,758. Arbitrage profit = $1,037,758 - $1,014,000 = $23,758. b. Follow the first three steps above. But the last step, involving exchange risk hedging, will be different. 5. Buy $1,014,000 forward for 1,034,280. Arbitrage profit = 1,074,310 - 1,034,280 = 40,030 Q#3 As of November 1, 1999, the exchange rate between the paki Rupee and U.S. dollar is Rs45/$. The consensus forecast for the U.S. and Pakistani inflation rates for the next 1-year period is 2.6% and 20.0%, respectively. How would you forecast the exchange rate to be at around November 1, 2000? Solution: Since the inflation rate is quite high in Pakistan, we may use the purchasing power parity to forecast the exchange rate. %S = %P - %P*, = 20% - 2.6% = 17.4% S 2000= S 1999(1+%S)=Rs.45(1+17.4%)=Rs.52.83 Q#4 Here are some prices in the international money markets: Spot rate = $1.46/ Forward rate (one year) = $1.49/ Interest rate () = 7% per year Interest rate ($) = 9% per year a. Assuming no transaction costs or taxes exist, do covered arbitrage profits exist in the above situation? Describe the flows. Solution: The annual dollar return on dollars invested in Germany is (1.07 x 1.49)/1.46 - 1 = 9.20%. This return exceeds the 9% return on dollars invested in the United States by 0.25% per annum. Hence arbitrage profits can be earned by borrowing dollars or selling dollar assets, buying euros in the spot market, investing the euros at 7%, and simultaneously selling the euro interest and principal forward for one year for dollars. International Fisher effect: In an efficient international capital market, the real rate of return in two countries shall equate due to arbitrage. Thus, the difference in nominal rates of interest will adjust exactly for the difference in inflation rates of the two countries. This is known as International Fisher Effect. Nominal Interest rate differential = Expected Inflation rate differential (1+Rd) = E (1 + I d) (1+Rf) E (1 + I f) OR, Rd Rf = I d I f

(1+Rf) (1 + I f) Ex- Suppose Interest Rate is 11% and 9% in Germany and U.K. respectively. The expected inflation rate in Germany is 5%. Then the expected inflation rate in U.K. shall be: 1.11 1.05 = 1.09 (1+I f)

E (1+I f) = 1.031 E (I f) = 1.031-1 = 0.031 or 3.1 % Methods of Payment in International Trade Prepayment With cash-in-advance payment terms, the exporter can avoid credit risk because payment is received before the ownership of the goods is transferred. Wire transfers and credit cards are the most commonly used cash-in-advance options available to exporters. However, requiring payment in advance is the least attractive option for the buyer, because it creates cash-flow problems. Foreign buyers are also concerned that the goods may not be sent if payment is made in advance. Thus, exporters who insist on this payment method as their sole manner of doing business may lose to competitors who offer more attractive payment terms. Letters of Credit Letters of credit (LCs) are one of the most secure instruments available to international traders. An LC is a commitment by a bank on behalf of the buyer that payment will be made to the exporter, provided that the terms and conditions stated in the LC have been met, as verified through the presentation of all required documents. The buyer pays his or her bank to render this service. An LC is useful when reliable credit information about a foreign buyer is difficult to obtain, but the exporter is satisfied with the creditworthiness of the buyers foreign bank. An LC also protects the buyer because no payment obligation arises until the goods have been shipped or delivered as promised. Documentary Collections A documentary collection (D/C) is a transaction whereby the exporter entrusts the collection of a payment to the remitting bank (exporters bank), which sends documents to a collecting bank (importers bank), along with instructions for payment. Funds are received from the importer and remitted to the exporter through the banks involved in the collection in exchange for those documents. D/Cs involve using a draft that requires the importer to pay the face amount either at sight (document against payment) or on a specified date (document against acceptance). The draft gives instructions that specify the documents required for the transfer of title to the goods. Although banks do act as facilitators for their clients, D/Cs offer no verification process and limited recourse in the event of non-payment. Drafts are generally less expensive than LCs. Open Account An open account transaction is a sale where the goods are shipped and delivered before payment is due, which is usually in 30 to 90 days. Obviously, this option is the most advantageous option to the importer in terms of cash flow and cost, but it is consequently the highest risk option for an exporter. Because of intense competition in export markets, foreign buyers often press exporters for open account terms since the extension of credit by the seller to the buyer is more common abroad. Therefore, exporters who are reluctant to extend credit may lose a sale to their competitors. However, the exporter can offer competitive open account terms while substantially mitigating the risk of non-payment by using of one or more of the appropriate trade finance techniques, such as export credit insurance.

Trade Finance Methods: Accounts Receivable Financing: - An exporter that needs funds immediately may obtain a bank loan that is secured by an assignment of the account receivable. Letters of Credit (L/C) These are issued by a bank on behalf of the importer promising to pay the exporter upon presentation of the shipping documents. The importer pays the issuing bank the amount of the L/C plus associated fees. Commercial or import/export L/Cs are usually irrevocable. Sometimes, the exporter may request that a local bank confirm (guarantee) the L/C. Bankers Acceptance (BA) This is a time draft that is drawn on and accepted by the importers bank. The accepting bank is obliged to pay the holder of the draft at maturity. If the exporter does not want to wait for payment, it can request that the BA be sold in the money market. Trade financing is provided by the holder of the BA. Working Capital Financing Banks may provide short-term loans that finance the working capital cycle, from the purchase of inventory until the eventual conversion to cash. Countertrade These are foreign trade transactions in which the sale of goods to one country is linked to the purchase or exchange of goods from that same country. Common countertrade types include barter, compensation (product buy-back), and counterpurchase. The primary participants are governments and multinationals. Factoring Factoring, or invoice discounting, receivables factoring or debtor financing, is where a company buys a debt or invoice from another company. In this purchase, accounts receivable are discounted in order to allow the buyer to make a profit upon the settlement of the debt. Essentially factoring transfers the ownership of accounts to another party that then chases up the debt. Factoring therefore relieves the first party of a debt for less than the total amount providing them with working capital to continue trading, while the buyer, or factor, chases up the debt for the full amount and profits when it is paid. The factor is required to pay additional fees, typically a small percentage, once the debt has been settled. The factor may also offer a discount to the indebted party. Forfaiting (note the spelling) is the purchase of an exporter's receivables the amount importers owe the exporter at a discount by paying cash. The purchaser of the receivables, or forfaiter, must now be paid by the importer to settle the debt. As the receivables are usually guaranteed by the importer's bank, the forfaiter frees the exporterfrom the risk of non-payment by the importer. The receivables have then become a form of debt instrument that can be sold on the secondary market as bills of exchange or promissory notes. FORWARDS and FUTURES CONTRACTS a. Forward Contracts are an agreement to buy or sell a fixed amount of currency at a pre-established future date and price. b. If you agree to buy a currency, you are in the long position, and if you sell a currency, you are in the short position. c. Highly customized contracts that are illiquid. d. Subject to counterparty risk. e. The contracts are fully settled upon maturity, not before. f. Zero sum game: Gains (losses) to long position are losses (gains) to short

Futures contracts are standardized exchange-traded contracts The contract is with the issuing exchange. This feature standardizes the credit of the counter-party, because the counter-party is the exchange. The contract is marked to market daily. The original contract is liquidated daily, whoever has lost money on the contract must pay the difference between the current contract price, and the contract is then re-written so that the contract price equals the current futures price. A margin account must be maintained. This is essentially a deposit held by the exchange preventing an investor from walking away from a contract at the end of a bad trading session without settling his account. Further, the number of shares in a contract, the maturity dates, and a number of other features are standardized. Hence, the contracts are liquid.
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Explain the basic differences between the operation of a currency forward market and a futures market. The forward market is an OTC market where the forward contract for purchase or sale of foreign currency is tailor-made between the client and its international bank. No money changes hands until the maturity date of the contract when delivery and receipt are typically made. A futures contract is an exchange-traded instrument with standardized features specifying contract size and delivery date. Futures contracts are marked-to-market daily to reflect changes in the settlement price. Delivery is seldom made in a futures market. Rather a reversing trade is made to close out a long or short position. Q#1. Assume todays settlement price on a DM futures contract is $0.6080/DM. You have a short position in one contract. Your margin account currently has a balance of $1,700. The next three days settlement prices are $0.6066, $0.6073, and $0.5989. Calculate the changes in the margin account from daily marking-to-market and the balance of the margin account after the third day. Solution: $1,700 + [($0.6080 - $0.6066) + ($0.6066 - $0.6073) + ($0.6073 - $0.5989)] x DM125,000 = $2,837.50, where DM125,000 is the contractual size of one DM contract. Q#2 Do problem 1 again by assuming you have a long position in the futures contract. Solution: $1,700 + [($0.6066 - $0.6080) + ($0.6073 - $0.6066) + ($0.5989 - $0.6073)] x DM125,000 = $562.50, where DM125,000 is the contractual size of one DM contract. With only $562.50 in your margin account, you would experience a margin call requesting that additional cash be added to the margin account to bring it back up to the initial margin level. Options: A currency option contract is an agreement between two parties that gives the purchaser the right, but not the obligation, to exchange a given amount of one currency for another, at a specified rate, on an agreed date in the future. Options provide many benefits. Speculators purchase options because they are an efficient way to express a view on the underlying asset. Options also provide insurance because effectively they transfer risk from one party to another. Intuitively, currency options insure the purchaser against adverse exchange rate movements. For example, many international business firms- use options to hedge the value of their overseas revenues. The up-front, sunk cost one pays to purchase an options contract is analogous to an insurance premium.

A call option on a particular currency gives the holder the right to buy that currency. A put option gives the holder the right to sell the currency. The seller, or writer of the option, receives a payment, referred to as the option premium, that then obligates him to sell the foreign currency at the pre-specified price, known as the strike price, if the option purchaser chooses to exercise his right to buy or sell the currency. The holder will only decide to exchange currencies if the strike price is a more favourable rate than can be obtained in the spot market at expiration. European option that is, they can only be exercised on the expiration date. The altemative is an American option, that can be exercised at any time during its life. The date on which the contract ends is called the expiration date. The holder of a call option on a currency will only exercise the option if the underlying currency is trading in the market at a higher price than the strike price of the option(S>E). The call option gives the right to buy, so in exercising it the holder buys currency at the strike price and can then sell it in the market at a higher price. Similarly, the holder of a put option on a currency will only exercise the option if the spot currency is trading in the market at a lower price than the strike price(S<E). The put option gives the right to sell, so in exercising it the holder sells currency at the strike price and can then buy it in the market at a lower price. From the point of view of the option holder, the negative profit and loss represent the premium that is paid for the option. Thus, the premium is the maximum loss that can result from purchasing an option. In, out, and at the Money Options In the Money implying that the current exchange rate is higher (or less) than the strike price on a currency call (or put option.) Out of the Money implying that the current exchange rate is less (or higher) than the strike price on a currency call (or put) option. At the Money implying that the strike price of any call or put option equals the current spot rate. Currency option premium is the price of a call or a put, the option buyer must pay the option seller (option writer). An option's value is made up of two components: its intrinsic value and its time value. Intrinsic Value is the difference between the exchange rate of the underlying currency and the strike price of a currency option. Time value is the amount of money that options buyers are willing to pay for an option in the anticipation that over time a change in the underlying spot rate will cause the option to increase in value. The factors affecting option price or premium. 1-Current (spot) price: As the market price of the exchange rate increases (S), the value of a call on this exchange rate will increase and the value of a put will decrease. 2-The strike price: The strike price (E) is the price at which the currency is exchanged if the option is exercised. For a call, the higher the strike is set, the lower the value of the call since it will be increasingly less likely that the call will end up in the money - or if it does, the payoff is likely to be smaller. For a put, the lower the strike, the lower the value of the option. 3-The time to expiration: For a call or a put, the longer the time to expiration, the greater the value of the option. Increasing the time period must necessarily raise the expected range of price movements 4- Type of an option: American options have more premium than European as they are more flexible. Questions: 1. The price that the buyer of a call option pays to acquire the option is called the A. strike price B. exercise price C. execution price

D. acquisition price E. premium The price that the buyer of a call option pays to acquire the option is called the premium. 2. The price that the writer of a call option receives to sell the option is called the A. strike price B. exercise price C. execution price D. acquisition price E. premium The price that the writer of a call option receives to sell the option is called the premium. 3. The price that the buyer of a put option pays to acquire the option is called the A. strike price B. exercise price C. execution price D. acquisition price E. premium The price that the buyer of a put option pays to acquire the option is called the premium. 4. The price that the writer of a put option receives to sell the option is called the A. premium B. exercise price C. execution price D. acquisition price E. strike price The price that the writer of a put option receives to sell the option is called the premium. 5. The price that the buyer of a call option pays for the underlying asset if she executes her option is called the A. strike price B. exercise price C. execution price D. A or C E. A or B The price that the buyer of a call option pays for the underlying asset if she executes her option is strike price or exercise price. 6. The price that the writer of a call option receives for the underlying asset if the buyer executes her option is called the A. strike price B. exercise price C. execution price D. A or B E. A or C The price that the writer of a call option receives for the underlying asset if the buyer executes her option is called the strike price or exercise price. 7. The price that the buyer of a put option receives for the underlying asset if she executes her option is called the A. strike price B. exercise price C. execution price D. A or C E. A or B

The price that the buyer of a put option receives for the underlying asset if she executes her option is called the strike price or exercise price. 8. The price that the writer of a put option receives for the underlying asset if the option is exercised is called the A. strike price B. exercise price C. execution price D. A or B E. none of the above The price that the writer of a put option receives for the underlying asset if the option is exercised depends on the market price at the time. 9. An American call option allows the buyer to A. sell the underlying asset at the exercise price on or before the expiration date. B. buy the underlying asset at the exercise price on or before the expiration date. C. sell the option in the open market prior to expiration. D. A and C. E. B and C. An American call option may be exercised (allowing the holder to buy the underlying asset) on or before expiration; the option contract also may be sold prior to expiration. 10. A European call option allows the buyer to A. sell the underlying asset at the exercise price on the expiration date. B. buy the underlying asset at the exercise price on or before the expiration date. C. sell the option in the open market prior to expiration. D. buy the underlying asset at the exercise price on the expiration date. E. C and D. A European call option may be exercised (allowing the holder to buy the underlying asset) on the expiration date; the option contract also may be sold prior to expiration. 11. An American put option allows the holder to A. buy the underlying asset at the striking price on or before the expiration date. B. sell the underlying asset at the striking price on or before the expiration date. C. potentially benefit from a stock price decrease with less risk than short selling the stock. D. B and C. E. A and C. An American put option allows the buyer to sell the underlying asset at the striking price on or before the expiration date. The put option also allows the investor to benefit from an expected stock price decrease while risking only the amount invested in the contract. 12. A European put option allows the holder to A. buy the underlying asset at the striking price on or before the expiration date. B. sell the underlying asset at the striking price on or before the expiration date. C. potentially benefit from a stock price decrease with less risk than short selling the stock. D. sell the underlying asset at the striking price on the expiration date. E. C and D. A European put option allows the buyer to sell the underlying asset at the striking price on or before the expiration date. The put option also allows the investor to benefit from an expected stock price decrease while risking only the amount invested in the contract. 13. An American put option can be exercised A. any time on or before the expiration date. B. only on the expiration date. C. any time in the indefinite future.

D. only after dividends are paid. E. none of the above. American options can be exercised on or before expiration date. 14. An American call option can be exercised A. any time on or before the expiration date. B. only on the expiration date. C. any time in the indefinite future. D. only after dividends are paid. E. none of the above. American options can be exercised on or before expiration date. 15. A European call option can be exercised A. any time in the future. B. only on the expiration date. C. if the price of the underlying asset declines below the exercise price. D. immediately after dividends are paid. E. none of the above. European options can be exercised at expiration only. 16. A European put option can be exercised A. any time in the future. B. only on the expiration date. C. if the price of the underlying asset declines below the exercise price. D. immediately after dividends are paid. E. none of the above. European options can be exercised at expiration only. 20. The current exchange rate of dollar is Rs90/$. If a call option has a strike price of Rs88/$. the call A. is out of the money. B. is in the money. If the striking price on a call option is less than the spot price, the option is in the money and sells for more than an out of the money option. 21. The call premium per Canadian dollar on April 19 is $0.04, the expiration date is September 19, and the strike price is $0.80. You believe that the spot rate for the Canadian dollar will rise to $0.92 by September 19. If your expectations are correct, what will be your profit from speculating three call options (Can $150,000). Net profit = S (E+) =$0.92 ($0.80+ $0.04) = $0.08 Total net profit from three contracts= Can $150,000 X $0.08=$12000 22. The call premium per Canadian dollar on April 19 is $0.04, the expiration date is September 19, and the price is $0.80. You purchased three call options for Canadian dollars (Can $150,000) on April 19. You decide to let this options expire unexercised on September 19 because the spot rate for the Canadian dollar fell to $0.70 on that day. What is your total loss from this speculation. Total loss = Can$150,000 x $0.04 = $6,000, as the total loss is the premium lost. 23. On June 10, the closing exchange rate of French francs was $0.15. Calls which would mature on September 19 with a strike price of $0.16 were traded at $0.05. What will be the intrinsic value of the call on June 10.

Intrinsic value = $0.16 - $0.15 = $0.01 24. The premium for a British pound call with a strike price of $1.75 is $0.07. What will be the breakeven point for the buyer of the call. Breakeven point : S = (E +) = $1.75 + $0.07 = $1.82 25. Assume you want to use a currency put option on 10 million French francs in accounts receivable. The premium of the currency put option with a strike price of $0.20 is $0.05.If the option is exercised, what total amount of dollars you will receive after accounting for the premium. Total receipts = FF10, 000,000 x $0.20 = $2,000,000 Total premium = FF10, 000,000 x $0.05 = $ 500,000 Net receipts = $1,500,000 26. The premium for a German mark put with an exercise price of $0.70 is $0.05. What will be the breakeven point for the buyer of the put? Breakeven point for put: E = (S +) As we know E and , we can find S as; $0.70 - $0.05 = $0.65,so at spot price of $0.65 put option will be at break-even. 27. The current exchange rate of dollar is Rs90/$. If a call option has a strike price of Rs92/$. the call A. is out of the money. B. is in the money. If the striking price on a call option is more than the spot price, the option is out of the money and cannot be exercised profitably. 28. The current exchange rate of dollar is Rs90/$. If a call option has a strike price of Rs90/$. the call A. is out of the money. B. is in the money. C. is at the money. If the striking price on a call option is equal to the market price, the option is at the money. 29. A put option on a foreign currency is said to be out of the money if A. the exercise price is higher than the spot price. B. the exercise price is less than the spot price. C. the exercise price is equal to the spot price. The exercise price is less than the spot price for an out of the money put option. Advantages of options over forwards and futures 1. Options are better when time of cash flows is not known 2. Options are better when cash-flows are contingent, that is, not certain 3. Options gives the holder only rights not the obligation. Theories of International trade Mercantilism. Mercantilists argued that the best way for a nation to enjoy faster growth was to export more than it imported. The revenue would be a real inflow of gold. Since the amount of gold was fixed in the short run, not all nations could have such inflows simultaneously and gains from trade might be enjoyed only at the expense of the other nations. That is why mercantilist advocated import restrictions and export promotion. Absolute advantages. Adam Smith proved that the advantages of international division of labor and specialization would be shared by all nations who may benefit simultaneously from free international trade. Thus, when nations specialize in industries where they have absolute factor

advantages, gains from trade come to every nation and not at the expense of others and there is no need for government intervention that only deteriorates allocation of resources and productivity. This is the most important contribution of Adam Smith to international trade theory and policies. What he did not explain, was the case when a nation had absolute advantages in the production of all goods. Comparative advantage : David Ricardo developed this theory to prove that mutually beneficial trade could occur even when one nation was absolutely more efficient in the production of all goods. According to Ricardo, nations specialize in industries where they have lower opportunity cost and trade based on these comparative advantages all the countries enjoy gains from international trade. This is one of the most important and still unchallenged principles of economic theory and practice. David Ricardos views were based on the labour theory of value that stresses on the role of labour in value creation. Heckscher- Ohlin: In 1930s two Swedish economists Eli Heckscher and Bertil Ohlin developed a model of factor endowment. They asserted that international trade is based on differences in factor endowments of nations. Because of the different endowments of factors of production nations have comparative advantages in different industries and their relative price levels differ. That is why each nation will export the goods intensive in its relatively abundant and cheap factor and import the goods intensive in its relatively scarce and expensive factor. Thus, all nations will enjoy gains from trade simultaneously. product life cycle :Raymond Vernon developed this theory to explain trade based on technological gaps. He asserts that the initial production of a new product usually requires skilled labour, which can be replaced by a skilled labour once the product acquires mass acceptance and is standardised. Thus, the comparative advantage held by the industrialised nations that introduce new products shifts to lower-wage nations. Vernons contribution to the theory of internationalisation of business is that he put together explanations of international trade and investment flows that were following trade. Competitive advantages of nations: A coherent explanation of modern international trade was given by Michael Porter who developed this theory. He argues that competitiveness and hence international trade is determined by four factors encapsulate in the Porter Diamond. These are Factor Conditions, Demand Conditions, the Structure of Firms and Rivalry and lastly the strength and existence of Related Firms and Supporting Industries. Hence, industry clusters appear that create and enhance competitiveness of local firms. An important contribution of Porters theory is that he associates competitive advantages of nations with firms decision making. These are really firms that conduct international trade, not countries. Economic integration: Economic integration whereby members remove explicit trade barriers among themselves, but keep national barriers to the flow of labor and capital and their fiscal and monetary autonomy. Trade blocs are exemplified mainly by free-trade areas and custom unions. Free Trade Area An area in which members remove trade barriers among themselves but keep their separate national barriers against trade with the outside world. Customs Union One in which members remove all barriers to trade among themselves and adopt a common set of external barriers, thereby eliminating the need for customs inspection at internal borders (e.g., MERCOSUR today, and the EEC from 1957-1992). Common Market An international union going beyond a customs union by also allowing for the free movement of labour and capital (factor flows) among member nations. Economic Union One which extends a common market by harmonizing the monetary and fiscal policies of the member nations as well.

Foreign Direct Investment FDI refers to those investments that involve an equity stake of 10 percent or more in a foreignbased enterprise. FDI requires the direct and active hands-on management of foreign assets. An example of FDI is when a Japanese company takes a majority stake in a company in America, Iran, or elsewhere. FDI requires exercising management control rights, the rights to appoint key managers, and to establish control mechanisms. Due to the importance of management control and the need to managing foreign operations, many firms these days even invest in a large equity of up to 100 percent just to be able to exercise management control rights. The basic entry choices into foreign markets can be categorized into three strategies: exporting, licensing, and FDI. As it is often the case, successful exporting can provoke protectionist responses from host countries, thereby forcing firms to choose between licensing and FDI. There are three reasons that may compel firms to prefer FDI to licensing: (1) FDI reduces dissemination risk i.e., the risk associated with unauthorized diffusion of firm-specific knowhow; (2) FDI results in more direct and tighter managerial control over foreign operations; and (3) FDI promotes the transfer of tacit knowledge through learning by doing. While gains to host countries i.e., recipients of FDI from foreign or international investments are many, in comparison to other foreign investments, the advantages of FDI can take several other forms. Given the appropriate host-country policies and existence of reliable and sufficient infrastructure, it is expected that FDI, at a micro level, contributes to the transfer of technology or even triggers technology spillovers. As FDI comes in many forms and therefore results in new varieties of capital inputs, it promotes a healthy competition in the domestic input market. The host country could also benefit from training and development of its workforce as FDI helps human capital formation across different economic sectors. Clearly, all these in turn contribute to the economic growth of the host country. In addition to these economical benefits, FDI could also improve environmental and social conditions in the host country by, inter alia, transferring cleaner technologies, thereby leading to more socially responsible corporate policies. At a macro level, FDI contributes to international trade integration not least because it results in a more competitive business environment for multinational companies (MNCs). MNCs compete globally through investing their assets into domestic markets of different host countries. There are two main types of FDI: One is horizontal and the other is vertical. Horizontal FDI arises when a firm duplicates its home country-based activities at the same value chain stage in a host country through FDI. For example, Ford assembles cars in the United States. Through horizontal FDI, it does the same thing in different host countries such as the United Kingdom (UK), France, Taiwan, Saudi Arabia, and Australia. Horizontal FDI therefore refers to producing the same products or offering the same services in a host country as firms do at home. While a horizontal pattern occurs when MNCs through FDI produce the same product or service in different host countries, vertical FDI takes place when a firm through FDI moves upstream or downstream in different value chains i.e., when firms perform value-adding activities stage by stage in a vertical fashion in a host country. In other words, a vertical FDI arises when a multinational firm fragments the production process internationally, thereby locating each stage of production in the country where it can be done at the least cost. For example, if a firm only assembles cars and does not manufacture components in France, but in the UK, it can be said that the firm enters into components manufacturing through FDI. This pattern is called upstream vertical FDI. In a similar way, if a firm does not engage in car distribution in Germany and, instead, invests in car dealerships in Saudi Arabia (a downstream activity), it can be said that the firm is engaged in downstream vertical FDI. While horizontal and vertical FDI serve different purposes, the bulk of FDI seems to be horizontal rather than vertical. As mentioned earlier, when a firm engages in horizontal FDI, it

establishes multi-plant operations that duplicate similar products and services in multiple countries. This implies that a firms motive to adopt a horizontal pattern is mainly because it facilitates market access as opposed to reducing production costs and subsequent market share expansion. However, with vertical FDI firms engage in both FDI and exports. Unlike horizontal FDI in that the two countries involved are of similar size, and the nature of their operations resembles more of a pair of developed countries, in vertical FDI patterns, the home country is usually much larger and the two countries involved in FDI operations look like a developed home country and a developing host country. Put simply, in horizontal FDI patterns, the main objective to be met is how best to serve the host market (abroad), whereas in vertical FDI models, the primary objective of a firm is how best to serve the domestic (home) market. Political Perspectives Since FDI requires the flow of capital across national borders, it has always been intertwined with politics. Viewed in this way, three different political perspectives to FDI can be identified: radical view, free market view, and pragmatic nationalism. The radical view, which can be traced back to Marxism, treats FDI as a vehicle for exploitation of domestic resources, industries and people. Those governments who hold a radical view are hostile to FDI and therefore are in favor of nationalizing foreign firm assets or putting into place mechanisms to discourage inbound foreign firms operations. The free market view, on the other hand, is more in favor of FDI and promotes its rationale not least because it enables countries to tap into their absolute or comparative advantages by specializing in the production of certain goods and services. According to the free market view, FDI can be regarded as a winwin situation for both home and host countries. While prior to and during the 1980s the radicalbased view FDI was more common in Africa, Asia, Eastern Europe, and Latin America, the free market-based FDI is now more influential across the world and in particular in emerging economies such as Brazil, India, and China. Finally, the third view, which reflects the current dominant perspective toward FDI and is practised by most countries around the world, is called pragmatic nationalism. Based on a pragmatic nationalism political view, FDI is only approved when its benefits outweigh its costs. For example, this view holds that FDI in the Chinese auto industry should only take the form of a joint venture (JV). By adopting such restrictive policies, the Chinese government helps the domestic auto industry learn from their foreign counterparts. In short, FDI refers to direct investment in (10 percent or more of) business operations in a foreign country. Benefits and costs for both the host (recipient) countries and home (source) countries. In respect to the benefits of FDI to host countries, FDI helps improve a host countrys balance of payments; it can create technology spillovers; it creates advanced management know-how; and it creates jobs both directly and indirectly. However, loss of sovereignty, adverse effects on competition, and capital outflow are the primary costs of FDI to host countries. Similarly, the benefits of FDI to home countries are: Repatriated earnings from profits from FDI; increased exports of components and services to host countries; and learning via FDI from operations abroad. Country Risk Analysis Why Country Risk Analysis is Important? Country risk is the potentially adverse impact of a countrys environment on an MNCs cash flows. Country risk analysis can be used to monitor countries where the MNC is currently doing business. If the country risk level of a particular country begins to increase, the MNC may consider divesting its subsidiaries located there. MNCs can also use country risk analysis as a screening device to avoid conducting business in countries with excessive risk. Events that heighten country risk tend to discourage Pakistans direct foreign investment (FDI) in that particular country.

Country risk analysis is not restricted to predicting major crises. An MNC may also use this analysis to revise its investment or financing decisions in light of recent events. In any given week, the following unrelated international events might occur around the world. A terrorist attack. (e.g., 9/11 and 7/7) A major labor strike in an industry. (They are more pervasive in Airliners, SOEs State Owned Enterprises) A political crisis due to a scandal within a country. (e.g., Watergate Scandal USA, Memo gate Scandal 2011 Pakistan) Concern about a countrys banking system that may cause a major outflow of cash. (Recently Greece has suffered from all famous Euro zone Debt Crisis) The imposition of trade restrictions on imports. Any of these events could affect the potential cash flows to be generated by an MNC or the cost of financing projects and therefore affect the value of the MNC. Even if an MNC reduces its exposure to all such events in a given week, a new set of events will occur in the following week. For each of these events, an MNC must consider whether its cash flows will be affected and whether there has been a change in policy to which it should respond. Country risk analysis is an ongoing process. Most MNCs will not be affected by every event, but they will pay close attention to any events that may have an impact on the industries or countries in which they do business. They also recognize that they cannot eliminate their exposure to all events but may at least attempt to limit their exposure to any single country specific event. Political Risk Factors An MNC must assess country risk not only in countries where it currently does business but also in those where it expects to exporter establish subsidiaries. Several risk characteristics of a country may significantly affect performance, and the MNC should be concerned about the likely degree of the impact of each. The September 11, 2011, terrorist attack on the United States heightened the awareness of political risk. As one might expect, many country characteristics related to the political environment can influence an MNC. An extreme form of political risk is the possibility that the host country will take over the subsidiary, in some cases of expropriation, some compensation (the amount decided by the host country government) is awarded. In other cases, the assets are confiscated and no compensation is provided. Expropriation can take place peacefully or by force. The following are some of the more common forms of political risk: Attitude of consumers in the host country Actions of host government Blockage of funds transfers Currency inconvertibility War Bureaucracy (Red-tapism) Corruption Each of these characteristics will be examined here under: 1-Attitude of Consumers in the Host Country A mild form of political risk (to an exporter) is a tendency of residents to purchase only locally produced goods. Even if the exporter decides to set up a subsidiary in the foreign country, this philosophy could prevent its success. All countries tend to exert some pressure on consumers to purchase from locally owned manufacturers. (In Pakistan, consumers are encouraged to look for the Made in Pakistan label.) MNCs that consider entering a foreign

market (or have already entered the market) must monitor the general loyalty of consumers toward locally produced products. If consumers are very loyal to local products, a joint venture with a local company may be more feasible than an exporting strategy. The September 11, 2011, terrorist attack caused some consumers to pay more attention to the country where products are produced. 2-Actions of Host Government Various actions of a host government can affect the cash flow of an MNC. For example, a host government might impose pollution control standards (Green products requiring lower Carbon Credits) that affect costs and additional corporate taxes that affect after-tax earnings as well as withholding taxes and fund transfer restrictions that affect after-tax cash flows sent to the parent firm. Example: In March 2004, antitrust regulators representing the European Union countries decided to fine Microsoft about 500 million Euros for abusing its monopolistic position in computer software. They also imposed restriction on how Microsoft can bundle its Windows Media Player (needed to access music or videos) in its personal computers sold in Europe. Microsoft argued that the fine is unfair because it is not subject to such restrictions in its home country, the United States. Some critics argue, however, that European regulators are not being too strict, but rather that the U.S. regulators are being too lenient. 3-Lack of Restrictions: In some cases, MNCs are adversely affected by a lack of restrictions in a host country, which allows illegitimate business behavior to take market share. One of the most troubling issues for MNCs is the failure by host government to enforce copyright laws against local firms that illegally copy the MNCs product. For example, local firms in Asia commonly copy software produced by MNCs and sell it to customers at lower prices. Software producers lose an estimated $3 billion in sales annually in Asia for this reason. Furthermore, the legal systems in some countries do not adequately protect a firm against copyright violations or other illegal means of obtaining market share. 4-Blockade of Fund Transfers Subsidiaries of MNCs often send funds back to the headquarters for loan repayments, purchase of supplies, administrative fees, remitted earnings, or other purposes. In some cases, the host government may block fund transfers, which could force subsidiaries to undertake projects that are not optimal (just to make use of the funds). Alternatively, the MNC may invest the funds in local securities that provide some return while the funds care blocked. But this return may be inferior to what could have been earned on funds remitted to the parent. 5-Currency Inconvertibility Some governments do not allow the home currency to be exchanged in other currencies. Thus the earnings generated by a subsidiary in these countries cannot be remitted to the parent through currency conversion. When the currency is inconvertible, an MNCs parent may need to exchange it for goods to extract benefits from projects in that country. 6-War Some countries tend to engage in constant conflicts with neighboring countries or experience internal turmoil. This can affect the safety of employees hired by an MNCs subsidiary or by salespeople who attempt to establish export market for the MNC. In addition, countries plagued by the threat of war typically have volatile business cycles, which make the MNCs cash flows generated from such countries more uncertain. The terrorist attack on the United States on September 11, 2001, aroused the expectation that the United States would be involved in a war. MNCs were adversely affected by their potential exposure to terrorist attacks, especially if their subsidiaries were located in the countries where there might be anti-U.S. sentiment. Even if an

MNC is not directly damaged due to a war, it may incur costs from ensuring the safety of its employees. Example: The 2003 War in Iraq affected MNCs cash flows in various ways. The war caused friction between the United States and some countries in the Middle East. Consequently, the demand for U.S. products and services declined in the Middle East. 7-Bureaucracy Another country risk factor is government bureaucracy, which can complicate an MNCs business. Although this factor may seem irrelevant, it was a major deterrent for the MNCs that considered projects in Eastern Europe in the early 1990s. Many of the Eastern European governments were not experienced at facilitating the entrance of MNCs into their markets. On other side of the picture, Singapore is leading the world by eliminating bureaucratic hurdles and standing number one in terms of ease of doing business. 8-Corruption Corruption can adversely affect an MNCs international business because it can increase the cost of conducting business or it can reduce revenue. Various forms of corruption can occur between firms or between a firm and the government. For example, an MNC may lose revenue because a government contract is awarded to a local firm that paid off a government official. Laws and their enforcement vary among countries, however. For example, in the United States, it is illegal to make a payment to a high-ranking government official in return for political favors, but it is legal for U.S. firms to contribute to a politicians election campaign. A corruption index is derived for most countries by Transparency International every year could be helpful in this regard. Financial Risk Factors Along with political factors, financial factors should be considered when assessing country risk. A countrys economic growth is dependent on several financial factors: Interest Rates Higher interest rates tend to slow the growth of an economy and reduce demand for the MNCs products. Lower interest rates often stimulate the economy and increase demand for the MNCs products. Exchange Rates Exchange rates can influence the demand for the countrys exports, which in turn affects the countrys production and income level. A strong currency may reduce demand for the countrys exports, increase the volume of products imported by the country, and therefore reduce the countrys production and national income. A very weak currency can cause speculative outflows and reduce the amount of funds available to finance growth by business. Inflation Inflation can affect consumers purchasing power and therefore their de3mand for an MNCs goods. It also indirectly affects a countrys financial condition by influencing the countrys interest rates and currency value. A high level of inflation may also lead to a decline in economic growth. Most financial factors affect a countrys economic conditions are difficult to forecast. Thus even if an MNC considers them in its country risk assessment, it may still make poor decisions because of an improper forecast of the countrys financial factors. Some financial conditions may be caused by political risk. For example, the September 11, 2001, terrorist attack on the United States affected U.S.-based MNCs because of political risk and financial risk. Political uncertainty caused uncertainty about economic conditions, which resulted in a reduction in spending by consumers and, therefore, a reduction in the cash flows of MNCs.

Techniques to Assess Country Risk Once a firm identifies all the macro- and micro factors that deserve consideration in the country risk assessment, it may wish to implement a system for evaluating these factors and determining a country risk rating. Various techniques are available to achieve this objective. The following are some of the more popular techniques: Checklist approach Delphi technique Quantitative analysis Inspection visits Combination of techniques Each technique is briefly discussed in turn: Checklist Approach A checklist approach involves making a judgment on all the political and financial factors (both macro and micro) that contribute to a firms assessment of country risk. Ratings are assigned to a list of various financial and political factors, and these ratings are then consolidated to derive an overall assessment of country risk. Some factors (such as real GDP growth) can be measured from available data, while others (such as probability of entering a war) must be subjectively measured. The factors are then converted to some numerical rating in order to assess a particular country. Those factors thought to have a great influence on country risk should be assigned greater weights. Both the measurement of some factors and the weighting scheme implemented are subjective. Delphi Technique The Delphi technique involves the collection of independent opinion without group discussion. As applied to country risk analysis, the MNC could survey specific employees or outside consultants who have some expertise in assessing a specific countrys risk characteristics. The MNC receives responses from its survey and may then attempt to determine some consensus opinions (without attaching names to any of the opinions) about the perception of the countrys risk. Then it sends this summary of the survey back to the survey respondents and asks for additional feedback regarding its summary of the countrys risk. Quantitative Analysis Once the financial and political variables have been measured for a period of time, models for quantitative analysis can attempt to identify the characteristics that influence the level of country risk. For example, regression analysis may be used to assess risk, since it can measure the sensitivity of one variable to other variables. A firm could regress a measure of its business activity (such as its percentage increase in sales) against country characteristics (such as real growth in GDP) over a series of previous months or quarters. Results from such an analysis will indicate the susceptibility of a particular business to a countrys economy. This is valuable information to incorporate into the overall evaluation of countrys risk. Inspection Visits Inspection visits involve travelling to a country and meeting with government officials, business executives, and consumers. Such meetings can help clarify any uncertain opinions the firm has about a country. Indeed, some variables, such as intercountry relationships, may be difficult to assess without a trip to the host country. Combination of Techniques A survey of 193corporations heavily involved in foreign business found that about half of them have no formal method of assessing country risk. This does not mean that they neglect to assess country risk, but rather that there is no proven method to use. Consequently, many MNCs use variety of techniques, possibly using a checklist approach to identify relevant factors and

then using the Delphi technique, quantitative analysis, and inspection visits to assign ratings to the various factors. Exchange rate exposure 1-Transaction exposure: - The degree to which the future cash transactions of a firm are affected by exchange rate movements. 1-Economic exposure: - The degree to which the present value of future transactions of a firm is affected by exchange rate movements. 1-Translation exposure: - The degree to which the consolidated financial statements of a firm are affected by exchange are movements.

Previous papers
1-UNIVESITY OF THE PUNJAB, FIRST A/10

Note: attempt any five questions .all the questions carry equal marks. Part I: International business: 1. Briefly explain the determinants of foreign direct investment in Pakistan? 2. Explain the level and role of economic integration in the economic environment of international business? 3. Discuss inflation and interest rate as determinants of exchange rate? Part II: International Finance: 1. Differentiate between futures contract and forward contract? 2. Explain in detail the different types of financial markets? 3. What are the different balance payment entries and also discuss the factors that influence them? 4. Calculate the following cross rates with the help of given exchange rates. I. Yen /peso II. Yen/INR III. Peso/PKR IV. Peso/CHF V. PKR/INR Japanese Yen Yen 121.13/ US $ Mexican Peso Ps 9.19/ US $ Indian Rupee INR 50.83/ US $ PAK rupee PKR 80.95/ US $ Swiss franc CHF 0.893/US $ UNIVESITY OF THE PUNJAB Second A/10 Note: attempt any five questions .all the questions carry equal marks. Part I: International business: 1. Briefly explain the determinants of exchange rate? 2. Elements of cultural influence the operations of multinational corporations discuss? 3. Explain the different motives of foreign direct investment? Part II: International Finance: 1. What is meant by option? Explain call and put options with examples? 2. Differentiate between future contract and forward contracts? 3. Discuss the past and present of international financial system? 4. Calculate the following cross rates with the help of given exchange rates. a. Yen /peso

b. c. d. e. Japanese Yen Mexican Peso Indian Rupee PAK rupee Swiss franc

Yen/INR Peso/PKR Peso/CHF PKR/INR Yen 118.25/ US $ Ps 10.25/ US $ INR 52.55/ US $ PKR 85.85/ US $ CHF 0.923/US $

UNIVESITY OF THE PUNJAB First A/11 Note: attempt any five questions .all the questions carry equal marks. 1. a. what are the drivers of globalization ? b. Globalization is emerging as inevitable phenomena for business discuss? 2. a. Foreign direct investment is deemed as blessing for developing countries discuss? b. elaborate the determinants of foreign direct investment? 3. Explain cultural environmental challenges which have to face by multinational enterprises? 4. Discuss the formal determinants of exchange rate . a. inflation b. interest rate c. income level 5. Briefly explain the following : a. Forward contract b. Future contract c. Call option d. Put option 6. Calculate the following cross rates with the help of given exchange rates. a. Yen /peso b. Yen/INR c. Peso/PKR d. Peso/CHF e. PKR/INR Japanese Yen Yen 121.1300/ US $ Mexican Peso Ps 1900/ US $ Indian Rupee INR 50.8300/ US $ PAK rupee PKR 80.9500 US $ Swiss franc CHF 0.8930/US $

7. Briefly explain transaction exposure, economic exposure and translation exposure? UNIVESITY OF THE PUNJAB Second A/11 Note: attempt any five questions .all the questions carry equal marks. 1. Define globalization. What are drivers of globalization? 2. Explain benefits and cost of foreign direct investment for howt and home countries?

3. Briefly explain the following. a. Payment methods for international trade. b. Trade finance methods c. Bill of exchange (draft) d. Bill of lading Q4:-Explain the theory of purchasing power parity (PPP). Based on this theory, what is general forecast of the values of currencies in countries with high inflation? Q5:- Discuss various determinants of exchange rate? Q6:- calculate following cross rates with the help of given exchange rates. a. Yen /peso b. Yen/INR c. Peso/PKR d. Peso/CHF e. PKR/INR f. Japanese Yen Yen 126.3456/ US $ Mexican Peso Ps 10.23 /US $ Indian Rupee INR 55.87/ US $ PAK rupee PKR 86.35 /US $ Swiss franc CHF 0.9876/US $

Q7:- How a multinational corporation can reduce exposure to host government takeovers?