Chapter 1

Chapter 1
An Overview
Objectives
To identify factors that have led to the prominence of
international finance
To explain the role of the financial manager
To verify the internationalisation of finance
To identify the developments leading to the formation
of the present financial environment
To examine the causes and consequences of the
global financial crisis
Copyright 2010 McGraw-Hill Australia Pty Ltd

PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
1-2
Introduction
International finance as studied here deals with the
financial operations of business firms in an
environment of open and integrated financial
markets
The world of finance has changed as a result of the

1-3
The importance of international finance

International finance has assumed increasing
importance at an accelerating rate
Things started to change with the collapse of the
Bretton Woods system
(cont.)
1-4
The importance of international finance (cont.)

The shift to floating exchange rates was
accompanied by a trend towards the abolition of
capital controls and the implementation of financial
deregulation
(cont.)
1-5
The importance of international finance (cont.)

The pace of deregulation has been slowed down by
the onset of financial crises, particularly the global
financial crisis

1-6
International , multinational and transnational

firms
Traditionally, the term international business firm
refers to firms involved in importing and exporting
A multinational firm carries out some of its production
activity abroad
(cont.)
1-7
International , multinational and transnational

firms (cont.)
As the distinction between home and abroad
becomes blurred, transnational firms emerge
Here, international firms indulge in international
operations in the modern sense

1-8
Examples of international interdependence

A decision to change US interest rates affects
Australian home owners
The Asian crisis affected the operations of Australian
companies
The US accounting scandals (e.g. Enron) affected
stock markets worldwide
The US subprime crisis that surfaced in 2007
became a global financial crisis in 2008-09 (and
perhaps beyond)
1-9
The micro and macro aspects of international

finance
The micro aspects pertain to the financial operations
of business firms, including financing, investment,
hedging, arbitrage and speculation
(cont.)
1-10
The micro and macro aspects of international

finance (cont.)
The macro aspects pertain to the international
monetary system and the determination of interest
and exchange rates

1-11
International finance and the role of the

financial manager
The financial manager needs to be concerned about:
4 Fluctuations in exchange and interest rates
4 Balance-of-payments difficulties
4 Financial contagion

1-12
The effect of exchange rate fluctuations

Exchange rate fluctuations can demolish businesses.
Examples include:
4
4
4
4
4
4
The Beecham Group

Laker Airlines
Caterpillar and Eastman Kodak
Canon
Coca-Cola Amatil
NAB

1-13
Knowledge needed by the financial manager
Major economic indicators

Government policies
The channels and effects of contagion
Foreign exchange risk management
Factors affecting the demand for the firms products

1-14
Indicators of the internationalisation of finance
International bank lending

Securities transactions with foreigners
Flows of portfolio investment and FDI
Trading volume in the FX market
The percentage of FX trading conducted with crossborder counterparties

1-15
Post-war developments
The economic and financial environment within
which business firms operate is the product of some
developments that followed World War II

1-16
1. The emergencee of the Eurodollar market

The Eurodollar market emerged in London in the late
1950s
Currently known as the Eurocurrency market, it
encompasses non-dollar currencies

1-17
2. Currency convertibility
European currencies became convertible in the late
1950s
The yen became convertible in the early 1960s

1-18
3. The EEC and EMU

The EEC was established in 1957 by the Treaty of
Rome
Related developments include the EMS and the
EMU
From an original membership of 6 countries,
membership stood at 27 countries in early 2009

1-19
4. Changes in relative economic size

There has been a trend towards greater symmetry in
economic size
The relative size of the United States has declined
significantly. Those of the EU, Japan and China have
risen

1-20
5. Deterioration of the US external position

The United States has become a deficit and net
debtor country
The twin deficit problem refers to deficits in the
budget and the current account
Japan has been a surplus country, but a deficit was
registered in early 2009 because of the global
financial crisis
China has replaced Japan as the financier of the
US deficit
1-21
Current account balance (US)

200
-200
-400
-600
-800
-1000

1-22
Current account balance (Japan)

250
200
150
100
50
-50

1-23
Current account balance (UK)

40
20
0
-20
-40
-60
-80
-100
-120

1-24
Current account balance

(Australia)
10
-10
-20
-30
-40
-50
-60

1-25
6. Fluctuations in oil prices

The price of oil rose in 1973-1974 and again in
1979-1980
The price collapsed in 1986, and declined
significantly in 1998
In 2003, the price rose and then fell as
developments in Iraq unfolded
Having reached a record of USD147 a barrel in
2008, the price of oil collapsed during the
1-26
Average real and nominal price

of oil (1971=100)
4800
4000
3200
2400
1600
800
Nominal
Real

1-27
Monthly average oil price in

2008
140
120
100
80
60
40
20
0
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug

Sep
Oct
Nov
Dec
1-28
7. The international use of nondollar currencies

The US dollars use has declined with respect
to trading volume in the FX market, the
invoicing of trade, the holding of reserves, and
the denomination of Eurocurrency deposits,
international loans and international bonds

1-29
8. Increased capital mobility

Since the 1980s, the volume of net and gross
capital flows has increased significantly

1-30
9. Integration, deregulation and

globalisation
There has been a trend towards deregulation
and integration of financial markets
Globalisation has emerged due to increasing
market integration
In the aftermath of the global financial crisis,
more thought is given to the costs and
benefits of globalisation and deregulation

1-31
10. Regional cooperation

Examples of regional cooperation are the
following:
4 European Economic Community (EEC)
4 North American Free Trade Agreement (NAFTA)
4 Asia-Pacific Economic Cooperation Council
(APEC)
4 Closer Economic Relations (CER) Agreement
4 Central Europe Free Trade Area (CEFTA)
4 Baltic Free Trade Area (BFTA)
1-32
11. Increased volatility of

financial markets
Increased volatility of exchange rates can be
traced back to the collapse of the BW system
Increased volatility of interest rates can be
traced back to the 1979 shift by the Federal
Reserve to money supply targeting

1-33
JPY/USD exchange rate

400
350
300
250
200
150
100
50

1-34
GBP/USD exchange rate

1.00
0.80
0.60
0.40
0.20

1-35
Percentage change in JPY/USD

exchange rate
10.0
7.5
5.0
2.5
0.0
-2.5
-5.0
-7.5
-10.0

1-36
Percentage change in GBP/USD

exchange rate
15
10
-5
-10

1-37
12. Securitisation and financial

innovation
Securitisation is the tendency for raising funds
by issuing marketable securities
Innovation refers to the creation of new
financial instruments or the recreation of old
instruments in a new form
The global financial crisis has changed
attitude towards securitisation and financial
engineering. A financial innovation (CDOs)
played a big role in the crisis
1-38
13. Financial crises and

contagion
Financial crises have become widespread in
the post-war period, particularly since the
1980s
Contagion is the process whereby a financial
crisis moves from one country to another
Major examples are the EMS crisis, Asian
crisis, Mexican crisis, Argentine crisis and the

1-39
The global financial crisis

The global financial crisis has resulted from
the US subprime crisis, leading to the Great
Recession of 2009
This crisis is far more complex than earlier
crises because financial innovation and
securitisation have created complex securities
whose risk profile is difficult to assess

1-40
Origin of the crisis

Mortgage originators provide loans to lowquality borrowers
Loans are converted into complex securities,
which are sold to investors
When house prices start to fall, payment to
the holders of these securities ceases
All financial markets are adversely affected

1-41
The DJIA during the crisis

16000
14000
12000
10000
8000
6000

1-42
The players and causes
Mortgage originators
Rating agencies
Policy makers and regulators
The role of securitisation
The role of globalisation

1-43

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The importance of international finance

The importance of international finance (cont.)

The importance of international finance (cont.)

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International , multinational and transnational

International , multinational and transnational

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Examples of international interdependence

The micro and macro aspects of international

The micro and macro aspects of international

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International finance and the role of the

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The effect of exchange rate fluctuations

The Beecham Group

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Knowledge needed by the financial manager

Major economic indicators

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Indicators of the internationalisation of finance

International bank lending

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1. The emergencee of the Eurodollar market

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3. The EEC and EMU

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4. Changes in relative economic size

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5. Deterioration of the US external position

Current account balance (US)

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Current account balance (Japan)

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Current account balance (UK)

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Current account balance

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6. Fluctuations in oil prices

Average real and nominal price

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Monthly average oil price in

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7. The international use of nondollar currencies

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8. Increased capital mobility

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9. Integration, deregulation and

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10. Regional cooperation

11. Increased volatility of

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JPY/USD exchange rate

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GBP/USD exchange rate

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Percentage change in JPY/USD

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